Global Banks Weighed Down Heavily By Regulations

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Tighter banking regulations are being enforced in many different countries around the world. They will improve confidence in the stability of the global institutions at the cost of more capital needed for banks, layoffs, and closure of unprofitable foreign branches and foreign segments.

With these new regulatory hurdles in mind, investors should demand that banks trade at attractive valuations before considering them as investments.

Global Bank Regulations                         

Global banking was a triumph for many international banks. These entities could service clients in different nations and adjust their operations to best match regulatory requirements. Their global footprints are now facing major challenges from tighter regulations set by multiple governments.

The future of global institutions is at stake as many of their existing business practices are being overruled or sidelined by national or regional regulations. Citigroup (NYSE: C), UBS (NYSE: UBS), and Royal Bank of Scotland (NYSE: RBS) are amongst the global banks that have in the most recent past been challenged by strict national regulations in the various countries they operate. The banks have had to watch years of effort to globalize become overruled as they plan to downsize staff and sell off some foreign operations.

The current global banking panic situation can be traced back to the financial crisis that followed the Great Recession. The crisis saw the Fed bail out many large financial institutions including Bank of America (NYSE: BAC) and Citigroup. Many banks all over the world had capital shortfalls which led them to wind up or liquidate in an attempt to compensate depositors. Though a good number of people were able to recover their assets, many citizens lost millions to the global banks that went bankrupt and could not receive bailouts from local governments. This has prompted many governments to raise the bar for capital requirements for global banks in a bid to protect their citizens. Deloitte & Touche principal Kim Olson studied the effect of the increased multiple capital requirements for global banks and indicated that some may need to seek additional financing. According to Olson, “This new standard is going to be very costly for foreign banks.”

The banks’ plans to retreat are in response to the recent announcement by Federal Reserve Governor Daniel Tarullo. The announcement expressed the Federal Reserve’s move to standardize capital requirements for domestic and foreign lending institutions in an effort to safeguard national interests. Federal Deposit Insurance former chairman Sheila Blair supported the Fed’s move. According to Blair, “When the system blows up every country ring-fences the assets and liabilities in their jurisdiction anyway.”

The United Kingdom and Switzerland have also imposed capital regulations which might force some foreign banks to close down their branches. The United Kingdom forces lenders to isolate their domestic consumer banking operations from investments and foreign businesses. Switzerland, on the other hand, has imposed stricter capital regulations for the largest lenders though they come with a promise for priority bailouts in case of a fail. The minimum capital requirements are nearly double the floor amount set by the Basel Committee on Banking Supervision and there is no guarantee for bailouts for foreign firms. This implies that Basel and the International Monetary Fund will need to review their strategy in line with the new national regulations if they are intent on fostering global finance.

Increased regulations are also being observed in emerging and developing economies. Brazil and Philippines are amongst other countries that are regulating capital inflows to reduce the risk of inflated currencies and asset bubbles, with the former imposing a 6 percent tax on foreign borrowing. The IMF was previously opposed to capital controls for their negative impact on trade but is now warming up to it.

Localized Capital Requirements

U.K. Financial Services Authority have decided to take the subsidiarization approach. This is an approach where foreign bank branches in the U.K. are required to be recognized as subsidiaries if the home country prioritizes on local depositors in case of insolvency. According to Shearman & Sterling’s attorney Azad Ali, many of those banks control business outside the U.S from their London Branch. The shared regulatory supervision with the U.S. makes the firms be seen as leaning towards subsidiarization.

Subsidiarization might face a lot of opposition from banks due to its perceived effect on liquidity. AIG’s former general counsel Ernest Patrikis expressed how the company fought efforts for it to subsidiarize forcefully while indicating how capital got stuck in countries and thus its mobility and liquidity became limited. When speaking on forced subsidiarization, Azad Ali indicated that it would be important for a company to give empirical evidence showing how subsidiarization was forced upon them and how it negatively affected business or the economy.

While analyzing the situation, a partner at Davis Polk Margaret Tahyar gave her view regarding the global bank regulations. According to Tahyar, “There was in recent years over enthusiasm for global finance without having thought through the institutional structures.” Tarullo opined, “For the foreseeable future then our regulatory system must recognize that while internationally active banks live globally they may well die locally,”


Many of these large money center banks trade at extreme discounts to their book values:

<table> <tbody> <tr> <td> <p><span>Ticker</span></p> </td> <td> <p><span>Company</span></p> </td> <td> <p><span>P/E</span></p> </td> <td> <p><span>P/S</span></p> </td> <td> <p><span>P/B</span></p> </td> <td> <p><span>P/FCF</span></p> </td> </tr> <tr> <td> <p><span>RBS</span></p> </td> <td> <p><span>Royal Bank of Scotland</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.67</span></p> </td> <td> <p><span>0.47</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>BAC</span></p> </td> <td> <p><span>Bank of America</span></p> </td> <td> <p><span>29.47</span></p> </td> <td> <p><span>1.94</span></p> </td> <td> <p><span>0.48</span></p> </td> <td> <p><span>3.29</span></p> </td> </tr> <tr> <td> <p><span>BCS</span></p> </td> <td> <p><span>Barclays</span></p> </td> <td> <p><span>1618</span></p> </td> <td> <p><span>1.35</span></p> </td> <td> <p><span>0.56</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>C</span></p> </td> <td> <p><span>Citigroup</span></p> </td> <td> <p><span>15.77</span></p> </td> <td> <p><span>1.59</span></p> </td> <td> <p><span>0.59</span></p> </td> <td> <p><span>5.96</span></p> </td> </tr> <tr> <td> <p><span>JPM</span></p> </td> <td> <p><span>JPMorgan Chase</span></p> </td> <td> <p><span>9.08</span></p> </td> <td> <p><span>2.83</span></p> </td> <td> <p><span>0.81</span></p> </td> <td> <p><span>3.01</span></p> </td> </tr> <tr> <td> <p><span>CS</span></p> </td> <td> <p><span>Credit Suisse</span></p> </td> <td> <p><span>307.87</span></p> </td> <td> <p><span>1.36</span></p> </td> <td> <p><span>0.83</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>UBS</span></p> </td> <td> <p><span>UBS</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>3.52</span></p> </td> <td> <p><span>1.09</span></p> </td> <td> <p><span>1.68</span></p> </td> </tr> <tr> <td> <p><span>HBC</span></p> </td> <td> <p><span>HSBC Holdings</span></p> </td> <td> <p><span>14.67</span></p> </td> <td> <p><span>3.16</span></p> </td> <td> <p><span>1.11</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>TD</span></p> </td> <td> <p><span>Toronto-Dominion Bank</span></p> </td> <td> <p><span>12.01</span></p> </td> <td> <p><span>3.36</span></p> </td> <td> <p><span>1.57</span></p> </td> <td> <p><span>6.39</span></p> </td> </tr> </tbody> </table>

Are these stocks really bargains? If they have to meet higher capital requirements, having positive free cash flows would be useful. These stocks should also trade at discounts to book value and have low price-to-sales ratios for their industry. By these measures, Bank of America, Citigroup, and JPMorgan Chase (JPM) top the list of defensible bets.

Final Thoughts

Global banks are going through big changes and investments in this industry are basically impossible to recommend.

However, if you can’t help yourself and need to go after a few speculative bargain stocks, look to Bank of America, Citigroup, and JPMorgan Chase. Try to keep your positions as small as you can.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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