Americans are right to blame the nation's biggest banks for causing the financial crisis, but overregulating the entire industry is doing more harm than good. That's the theme of M&T Bank (NYSE:MTB) CEO Robert Wilmers' 2015 shareholder letter, a must-read for bankers and bank investors.
To understand where Wilmers is coming from, it's critical to appreciate the central role that banks play in economic growth. They provide capital, which is one of three variables that dictate the size and direction of an economy -- the other two being labor and productivity. Banks do this by aggregating the savings of people like you and me and then lending that money out to individuals and businesses that want to invest.
There's no question that this activity is fraught with hazard. By necessity, banks must be highly leveraged in order to play their role in economic growth. The typical bank borrows $10 for every $1 that it holds in capital. Thus, a mere 10% decline in the value of an ordinary bank's assets will render it insolvent -- which, in the absence of deposit insurance, would rob its depositors of their savings.
This is why the bank industry is one of the most heavily regulated industries in the United States. This is particularly true in the wake of the financial crisis, which was fueled in no small part by a handful of the nation's biggest financial institutions who conveniently forgot that their principal job is to allocate other peoples' capital as opposed to lining their own pockets.
But there's a point at which regulations, and public policy more generally, become counterproductive. This is where we're at today, argues Wilmers -- who, it's worth pointing out, has served as a gleaming beacon of prudent and profitable banking for the 33 years that he's led Buffalo, New York-based M&T Bank.
"Despite a shared objective of maintaining the safety and soundness of the financial system, today's banking environment is typified by a relationship between institutions and governing agencies that is less than collaborative -- a product, it seems, of a political atmosphere where pressure remains upon banks to prove themselves reformed," writes Wilmers.
The impasse between regulators and bankers has had two unintended consequences. The first is that it's fueled the growth of shadow banks -- nonregulated financial entities such as hedge funds and private equity firms.
Nonbanks have grown their loan portfolios by 13.2% since the crisis, compared with only 0.5% at commercially chartered banks. And the migration toward nonregulated entities has been especially acute among mortgage servicers. "In 2010, none of the top five and only one of the top 10 mortgage servicers were non-banks," explains Wilmers. "By 2015, five of the top 10 servicers were non-banks, with servicing balances amounting to $1.3 trillion, or about a 13.6% market share."
Lest anyone need a reminder, shadow banks such as Lehman Brothers and Bear Stearns were at the epicenter of the 2008 crisis. It's this paradoxical consequence of the post-crisis regulatory environment, in turn, that concerns the 82-year-old chairman and CEO of M&T Bank: "As nonbanks make new forays into the lending space, one wonders if the proper mechanisms are in place to balance their desire to increase the size of their portfolios with the level of institutional restraint required to pull back from the extension of credit to businesses whenever conditions, terms and risk reach the inevitable peak of the cycle."
A second consequence has been to clamp down on banks' ability to further their core mission of providing capital to people and businesses. The rapid increase in compliance costs, for instance, diverts capital that could otherwise be used to lend. Wilmers cites a 2015 Federal Reserve study showing that 22% of the typical community bank's bottom line is consumed by compliance costs. For M&T Bank, a large but not enormous regional lender, such costs equated to $432 million last year.
Wilmers cites an array of statistics to show that small businesses have been hardest hit by this trend:
- Sales at small firms are still 10% below pre-crisis levels.
- Roughly half of small businesses that apply for credit are denied.
- New business formation is at the lowest level in more than two decades.
- And the companies that do form are employing fewer workers than similar start-ups a decade ago.
To top things off, unnecessarily high compliance costs will only serve to further fuel industry concentration. This follows from the arithmetic fact that the nation's biggest banks, which also happen to be the least interested in financing small businesses, are the only ones with the scale and sophistication to absorb the added costs of a higher, and oftentimes duplicative, regulatory regime. Thus, far from helping to alleviate the too big to fail problem, overregulation may be aggravating it.
In sum, Wilmers makes a strong case in his latest letter that it's time for a détente between regulators and bank industry participants. "It is past time for government and the banking industry to turn the page and begin to work together -- not to serve the narrow interests of lenders or investors but to advance the broader goal of reinvigorating the American economy." Suffice it to say that it's hard to argue with that.