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Congress Moves to Repeal Dodd-Frank: Custodian Banks to Gain

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Of the two major pre-election promises made by President Donald Trump, his supporters are on a roll to ease some provisions of an important financial regulation — the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. This follows the achievement of a major milestone in late 2017 in the form of the Tax Cut and Jobs Act.

The Senate passed the bill on Tuesday backed by majority voting of 67 to 32, promising it to be beneficial for smaller banks. It would now be presented to the House for its requisite approval.

Recapitulation of the Dodd-Frank Act

As a response to the 2008 financial crisis, caused partly by improper lending activities and investments by big banks, strict regulations were imposed on them through this law. Banks with assets of more than $50 billion were placed under stricter regulatory scrutiny, which included an annual stress test to prove that they could survive another financial meltdown.


Further, a new regulatory board, Consumer Financial Protection Bureau, was established in order to safeguard consumers against predatory practices by companies offering mortgages, credit cards, student loans and payday loans.

Such heightened regulations have kept compliance costs elevated for the banks so far. Also, higher capital requirements might have dampened investment to some extent. Moreover, some large institutions moved operations overseas to less regulated jurisdictions in order to avoid high regulatory costs.

How Custody Banks Stand to Benefit From the Proposed Bill?

The Dodd-Frank Act contained a provision that required banks to calculate supplementary leverage ratio, considering cash or customer deposits held with the Federal Reserve at the same level of risk as assets like subprime mortgages or junk bonds. It was aimed at keeping banks from taking big risks without proper plans to handle any downturn.

However, this rule had a major adverse impact on the custody banks like State Street Corporation STT, Northern Trust Corporation NTRS and The Bank of New York Mellon Corporation BK. Custody banks safeguard assets and securities of large asset managers, hedge funds and other banks rather than conducting traditional banking activities. Despite sending these deposits to the Fed for safekeeping, these financial institutions had to factor them in while calculating the amount capital it requires to hold.

The bill proposed by Senate makes an exception to this rule. It allows the custodian banks to set aside the money they received from clients and immediately sent to the Fed or some other central bank for safety. Thus, it would lead to a comparable reduction in the amount of capital they would require to hold.

On the other hand, major banks such as JPMorgan Chase & Co JPM and Citigroup C that perform custodial functions as part of their business have put forth objections. They want the exception to include all those banks that accept custodial deposits. However, this demand has some lawmakers worrying that these tweaks might be used by banks for their own purposes.

Other Key Points in the Bank Deregulation Bill

The most controversial change is uplifting of the SIFI threshold from $50 billion to $250 billion. This would result in a reduction in the number of banks considered “too big to fail” that are closely looked after by the Fed, to 12 from 38. Further, it frees banks with less than $10 billion in total assets from the Volcker rule. This rule was made to prevent banks from placing bets with their own money.

While some Democrats regard the bill to be compatible with the tax act, some consider it to be “extraordinarily dangerous”. Further, the bill along with the changes made so far have to be approved by the House and Senate once again, before being presented to the President.

Conclusion

With this exemption, the custody banks will be able to utilize the excess capital toward expanding their businesses and diversify the product offerings. Also, shareholders of these banks might expect more returns in the form of buybacks and dividends.

Of the above-mentioned companies, Citigroup and Northern Trust hold a Zacks Rank #2 (Buy) while JPMorgan, Bank of New York Mellon and State Street carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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