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Here’s how the roll-back of Dodd-Frank could impact European banks


President Donald Trump is set to dismantle the 2010 Dodd-Frank financial regulatory framework that was put in place as a response to the financial crisis of 2008.

Last week Trump signed an executive order directing the Treasury secretary to submit a report on recommended changes to bank regulations in 120 days. While banks across the globe wait for these changes to come through, analysts in Europe are speculating the impact of this move on the European banking sector.

"It seems the overall aim of the roll-back is to allow U.S. banks to do more business with fewer capital restrictions," Alastair Winter, chief economist at Daniel Stewart, told CNBC via email.

"Thanks to the Troubled Asset Relief Program (TARP) U.S. banks were able to recover relatively quickly from the crisis and have been in a better competitive position for several years than the Europeans who were left to themselves unless as in the UK, Spain and Portugal full-scale bail-outs were required. A roll-back is going to make the recapitalized U.S. banks even more competitive."

President Donald Trump signs Executive Orders in the Oval Office of the White House, including an order to review the Dodd-Frank Wall Street to roll back financial regulations of the Obama era February 3, 2017 in Washington, DC.
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European banks have seen their stocks fall to all-time lows due to a number of factors such as uncertainty surrounding the U.K.'s vote to leave the European Union, weak earnings and low interest rate across the globe. Now with the roll-back of Dodd-Frank a number of European analysts are wondering if this could create further risks for the European banking system.

Daniel Stewart's Winter explained that the danger for European banks in a Dodd-Frank roll-back is they may be lured back into riskier business because it is easier to do so, alongside the U.S. banks and get caught out again.

"I think this is the danger Mr. Draghi is concerned about as European governments are neither willing nor able to bail-out their banks to any great extent."

The law, passed to prevent a repeat of the global financial crisis, subjects banks to greater oversight and expands regulation of derivatives. Supporters say it has made the financial system stronger, while critics say it has entangled corporations in regulation that hurts the economy.

Pedestrians walk past the Bank of England (BOE) in the City of London, U.K.
Luke MacGregor | Bloomberg | Getty Images

Nicolas Roth, a fund manager at Reyl & Cie, told CNBC via email that Congressman Jeb Hensarling, a long time enemy of Dodd-Frank, had proposed a new form of legislation called the Financial Choice Act in the summer of 2016. The proposed act is expected to dismiss the Volcker rule, allowing banks to re-engage in speculative activities with the bank's own money.

"Congressman Hensarling advocates that the Volcker rule is a significant factor in the draining of liquidity from the market over the last few years,"

But Roth argued that although improving liquidity would be good for the market, dismantling the Volcker rule would allow banks to return to a pre-2008 business model where a number of them acted as hedge funds with their balance sheets.

"Conflicts of interest would resurface, such as when banks traded on their own account while also advising their customers."

Photographer | Collection | Getty Images

A number of analysts however believe that the roll-back of the current regulatory framework will be a slow and arduous process and quite watered down so any impact is not imminent.

"In theory it puts U.S. bank profitability at an advantage over European bank profitability - by easing regulations and capital requirements, allowing higher operational leverage for US banks," Dhaval Joshi, chief strategist at BCA Research, told CNBC via email.

Joshi explained that in the longer term any roll-back of Dodd-Frank will add instability to banks.

"Dodd-Frank was aimed at protecting banks from themselves. The tighter regulations in Europe weigh on long-term profitability but they also prevent future systemic crises and ultimately create a more stable banking system."

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