The Largest U.S. Banks Shouldn’t Expect Much Regulatory Relief Anytime Soon

The Federal Reserve recently proposed changes to the Volcker Rule with the primary aim of tailoring the compliance requirements under the rule based on the size of banks’ trading operations. The Fed’s move is the latest step towards easing the increased regulatory burden on the U.S. financial system since the economic downturn, and follows the Crapo Bill, which was signed into law last week to dilute the Dodd-Frank Act. Notably, both recent regulatory moves target small- and mid-sized U.S. banks, and do not materially benefit the largest U.S. banks. And we do not expect this trend to change in the near future.

The reason for this is that stricter regulations for the U.S. banking system were originally proposed keeping in mind the systematic importance of the largest U.S. banks. While the Dodd-Frank Act (and the Volcker Rule in particular) undeniably reduced the risk exposure of the U.S. banking system as a whole, it clubbed together small commercial banks with financial behemoths like JPMorgan, Citigroup and Goldman Sachs. The one-size-fits-all approach added a regulatory burden on small banks whose securities trading activities are an insignificant part of their business model.

On the other hand, the largest U.S. banks make billions of dollars in revenues by trading securities, as detailed in our interactive dashboard for the five largest U.S. investment banks – with the volatile revenue stream often contributing as much as 50% of their top lines. Additionally, these banks have gained more market share globally over recent years thanks to cutbacks in trading desks at their European rivals. Given their swelling portfolios of trading assets (which stood at a total of $1.5 trillion at the end of 2017, as shown in the table below), it certainly makes sense to maintain the regulations as they apply to these banks.

As seen above, total trading assets at the five largest U.S. investment banks declined from $1.5 trillion in 2013-14 to less than $1.4 trillion over 2015-16 before jumping again to $1.5 trillion at the end of 2017. This recovery in total trading assets has been seen by all of the large banks, and is expected to continue over the foreseeable future.

The table below captures the ratio of trading assets to total assets for each of these banks since 2013, and highlights the relative importance of securities trading to their respective business models. The red-to-green shading along a row makes it easy to visualize how this ratio has changed for a particular bank over the years.

Trading assets constitute around one-third of the total balance sheet for Goldman Sachs and Morgan Stanley, and roughly 15% of the total assets for JPMorgan and Citigroup (despite their significantly diversified business model). The overall reduction in the proportion for most banks over the period can be explained by the fact that higher capital ratio requirements resulted in these banks diverting some of the capital locked in by the trading operations to other areas. However, we expect these ratios to largely remain around current levels going forward.

Details about how changes to Trading Assets affect the share price of these banks can be found in our interactive model for Goldman Sachs | Morgan Stanley | JPMorgan Chase | Bank of America | Citigroup

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