Tighter regulation has impacted banks' profitability: MAS

Singapore

PROFITABILITY of several large banks today is below the cost of capital and is worrying, said Ravi Menon, Monetary Authority of Singapore managing director.

One of the factors which have impacted banks' profits is tighter regulation following the 2008 global financial crisis, he said in a speech in Washington DC on April 20.

There is a case for fine-tuning regulations but regulators must avoid pendulum swings that could undermine the gains in financial stability that has been achieved, not to mention prolong and add to the uncertainties facing the financial industry, said Mr Menon at the OMFIF City Lecture.

Regulatory changes of the last eight years are substantial, especially when taken cumulatively, and have made the financial system more robust and resilient, he said. "It is incumbent on us as regulators to be accountable for these changes, to evaluate objectively their intended outcomes as well as any unintended consequences."

Also with memories of the crisis fading and the compliance burden of new regulation continuing to grow, pressure has begun to mount to unwind some of the reforms.

"Any adjustments to be made should be grounded in an objective assessment of the impact of the reforms," he said, adding that the effectiveness of the reforms is encouraging - as large banks are now stronger, more liquid, less leveraged, less complex.

The financial system has remained resilient through several episodes of market stress, ranging from the 2014 US Treasury "flash crash", and the 2015 Swiss franc de-pegging, to the 2016 Brexit vote.

On the overall effects of the reforms, Mr Menon said that answers are less clear.

There are concerns that liquidity has declined in some markets and preliminary evidence indicates there is less depth and potentially less resilience under stressed market conditions, he said. Some blame the emergence of more automated trading, which has little to do with regulation.

But other factors - such as less market making by dealer banks and increased post-trade transparency in corporate bond markets - appear to have stemmed from regulation.

"The profitability of several large banks today is below the cost of capital. This is worrying," he said. "Unprofitable banks are a potential source of instability. Banks also need to be profitable to be able to support the real economy. They have to earn a decent return for intermediating credit, otherwise they will do less of it.

"Bank profitability has come under pressure from a combination of the three realities of the post-crisis financial landscape: slow growth, easy money, tight regulation. More work is needed to discern the impact each of these factors is having on bank profitability."

The cost of risk management and compliance has exploded and this is something regulators need to be alert to, said Mr Menon. He also posed the question of whether regulatory reforms have contributed to strong, sustainable and balanced economic growth. "This is much tougher to answer, but this is the central question."

Across most countries, overall credit provision to the economy has been stable despite higher capital and liquidity requirements. The cost of financing has remained low, although this has had to do with highly accommodative monetary policies, which are not permanent, he said.

Emerging market and developing economies are concerned that global banks have been reducing their activities in these markets as they review their business models in light of the new regulatory environment.

"We have rightly focused our regulatory efforts to minimise the risk of another financial crisis. But we must continually ensure that we do so without minimising economic growth and opportunity."

In fine-tuning regulation, he said that regulators must be careful to avoid "pendulum swings" that could undermine the gains in financial stability that have been achieved, not to mention prolong and add to the uncertainties facing the financial industry.

"That regulations have imposed costs on the economy is in itself not sufficient reason to unwind them. These costs have to be weighed against the benefits of a more stable financial system to support sustainable economic growth."

Deregulation has its own costs, he said. "Having said that, some fine-tuning may be necessary to reduce the unintended effects of reforms while preserving their benefits. Regulatory policy must continually seek the fine line between discouraging excessive risk-taking and encouraging innovation.

"We should not be afraid to adjust and fine-tune where necessary."