Dramatic regulatory changes and capital requirements have undeniably changed the landscape for banks. The short-term impact has been lower profits and revamped business models. While most market participants are shorter-term thinkers and might come to the conclusion that things have changed for the worse forever, I’d argue against that. While certain businesses such as proprietary trading are gone, traditional banking profit centers such as mortgages, credit cards, and auto loans will continue to generate solid profitability. Banks have had to dramatically cut costs to offset lost revenue from initiatives such as Dodd-Frank and Durbin. These changes take time but will ultimately result in significant improvements to the bottom line. Net-interest margins are near all-time lows further exasperating the short-term economic impact of these other issues.
Banks rely on capital and people and the benefit of that model is that it is possible to adjust the functions of people and capital to more productive arenas. When the macro-economic environment improves in combination with the more efficient cost-structure I’d expect alternative uses for people and capital to come through providing further expansion of profits. Higher capital levels should decrease the associated with greater leverage, ultimately leading to a better valuation on a safer business. Of course less leverage means lower returns on equity, but I believe that banks will still be very solid businesses and will ultimately come down to management. I don’t really agree with most of Goldman’s recommendations as they acknowledge that nothing is more beneficial than these companies buying back stock at such large discounts to tangible book value.