Today Citigroup reported a healthy $2.2 billion quarterly profit. The news comes days after rival JPMorgan also posted a big quarterly gain of $4.4 billion. As banks continue reap huge profits, they appear to be silencing those who are pessimistic about the industry. Over the next few quarters and years, however, an unprecedented number of major obstacles lie in banks' path. How they turn out could mean that the huge profits either continue or are drastically cut.
The most recently discovered bit of uncertainty facing banks stems from the big foreclosure mess. Documentation and procedural problems have resulted in many banks halting foreclosures. They face lawsuits due to the problem, which could result in sizable damages. One doomsday scenario predicts billions of dollars in losses for banks.
Yet, if these problems turn out to be of little consequence in court, banks could escape harm. The only real inconvenience would have been the temporary delay in foreclosures. That, however, could turn out to be an advantage if it provides the housing market with extra time for demand to rise again. Then, supply wouldn't grow as large and put as much downward pressure on prices.
If the housing market does fall further, that almost certainly means more losses for banks. Many still have real estate assets and mortgage-related securities on their balance sheets, which helped to trigger the financial crisis. A drop in home prices will translate into their values declining further.
Of course, if the housing market does stabilize sooner than later, and banks manage to find a way to create renewed confidence in mortgage-backed securities, then the values of some of these assets could rise. At this point, it doesn't seem likely that much appreciation would occur, but as long as these securities maintain their current values, banks would likely feel relieved.
Over the next several years, banks will begin to comply with new global capital standards from the new Basel III Accords. Although the capital levels themselves shouldn't be too difficult for most big banks to achieve, getting the right mix of capital that the new rules require could be more difficult.
It depends how the details of the new capital requirements look. If banks mostly already satisfy them, then they have nothing to worry about. If the rules pose new challenges, however, then they could have an impact on the industry's growth.
Over the next year, Washington will devise a new framework for how the mortgage market will function. On one hand, this will likely help banks. It's rather plausible that the government will end up guaranteeing all mortgages originated in the U.S. This would take borrower default risk away from banks and give it to taxpayers.
On the other hand, it also looks like those guarantees will come at a cost to banks. They'll have to pay a sort of insurance premium. Although that cost may ultimately be passed on to the borrowers, it will still likely cut into bank profits. So the bigger the premium the government demands, the worse off banks' mortgage business will be.
Securities Industry Regulation
The giant Dodd-Frank financial regulation bill passed this summer has a slew of new rules that banks must follow when creating and trading securities. There are strict new regulations surrounding the derivatives market, for example. And there's some evidence that business from this segment is already traveling overseas. Participating in proprietary trading was also made more cumbersome for banks.
Yet, there were loopholes created for many of these regulations. So it's unclear if these new rules will have a drastic affect on bank profit or just slice off a tiny piece.
Another part of Dodd-Frank resulted in a massive systemic risk regulatory framework. The Federal Reserve will soon begin creating new rules for big banks. This might mean even higher capital requirements for big banks than Basel III demands. The Fed could also impose other requirements like new compensation rules that might harm bank competitiveness.
But what's bad for big banks could be very good for small ones. Moreover, if systemic risk really is curbed, then the profits they all make will be more sustainable in nature.
Finally, banks' future profits from consumer credit products are also uncertain. First, there's the giant new consumer watchdog that Dodd-Frank created. It will likely impose much stricter rules on bank fees and practices surrounding loans. But even without the consumer bureau, many new rules have already been put in place regarding credit and debit card fees.
Yet, banks tend to have a knack for finding ways around such regulations. They responded to 2009's new credit card rules by simply raising interest rates to keep profits flowing. Whether banks can continue to make as much money from consumer lending is unclear.
While these obstacles all pose potential problems for banks, as the financial crisis has shown, they tend to be survivors. Many of these risks are regulation-based, and banks have become quite sophisticated in absorbing new rules without a big impact on their bottom line. The market-based risks, however, could more easily go either way.
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