Remember the financial crisis? Bear Stearns and Lehman Bros. — two of the Big Five Wall Street investment banks at the time — are gone. Heck, two of the biggest money center banks from the pre-crisis days — Washington Mutual and Wachovia — are gone too.
No, proprietary trading didn’t cause the crisis — but a total lack of risk management sure did.
The Volcker Rule helps puts the kibosh on banks playing games of Russian roulette — and well that it should. A bank that takes in your deposits — deposits which are backstopped by your tax dollars — shouldn’t be putting those funds at risk, especially if the risk is so great that it can bring down the whole bank.
True, JPMorgan Chase (JPM) was able to absorb the $6 billion “London Whale” trading loss. But plenty of banks can’t.
The Future for Bank Stocks
The Volcker Rule and Dodd Frank Act are hardly perfect, with plenty of gray areas. Banks already are — and will forever be — looking for loopholes. Interpretation and enforcement are just a couple of the unknowns as the new regulations come into effect.
What is certain is that investors in bank stocks have to recalibrate their expectations for the sector’s profit growth in the Volcker Rule era.
Proprietary trading generates a lot of money for banks — profits the Volcker Rule is going to wipe out.
Indeed, a strict interpretation of the Volcker Rule collectively costs the eight biggest banks anywhere from $8 billion to $10 billion in annual pretax profits, according to estimates by Standard & Poor’s.
And it will hurt some banks more than other.
Goldman Sachs — known for its astounding trading skills — could lose as much as 25% of its yearly revenue because of the Volcker Rule, according to research from FBR Capital Markets.
The banking business is changing, for the better if more boring. That’s a good thing.
But the Volcker Rule means investors in these stocks are going to have accept that the days of crazy-fast profit growth are over.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.