A new report from Rafferty Capital Management suggests that the excess liquidity in the financial system together with the current regulatory environment means that wealth management services are only way banks can make real profits today. In an investment report dated September 17th, Rafferty’s VP of equity research, Richard X. Bove, outlines his argument that “regulated banking companies in the United States and some other western countries have a problem.” Although, we would guess that Paul Singer disagrees.

The problem with banks

Wealth management

Bove points out that most of the balance sheet-oriented business of financial institutions have been nationalized by the government. Moreover, bankers are limited in how much they can expand their balance sheets or if they will be permitted any balance sheet growth at all.

He also argues that banks are being told how to allocate the assets on these balance sheets and how to invest the assets within each category. Moreover, they are even being told how to fund these assets by category. last bit not least, Bove notes that banks have no control over base pricing, that is, interest rates. Bove goes on to say the “net result is that in the past six years FDIC-insured banks have added:

  • One dollar in capital for every five dollars in assets for an incremental equity to asset ratio of 20%; and
  • They now have $3.4 trillion more in deposits than they have in loans. The result is an industry, which one might argue based on history, is both overcapitalized and drowning in liquidity. The only time U.S. banks have been in this position in the past was during the Depression and World War II. The loan to deposit ratio in that period actually got as low as 17.0% in a nation starving for private funding.”

Current conditions forcing banks into wealth management

Bove extends his argument to say that banks almost have to expand into wealth management in order to make a profit in the current environment. He says bank managers have to reduce their dependence on effectively nationalized balance sheet-oriented businesses and move on to areas that are not as regulated as traditional banking today.  He goes on to say the only real solution to the problem is to develop a wealth management business. The WM sector is lightly regulated, requires minimal capital, and can produce good returns on both revenues and capital together with investment management.

Bove concludes his report on a cautionary note: “Therefore, just about every bank in the countries I follow– the U.S., Canada, and Switzerland – have decided to build wealth management businesses and to build them in the United States. To me, this means that this business that has been relatively immune to rigorous competition for the past 7 years is about to experience a significant change. Competition for sales people is about to go up. Prices for services are likely to go down. The profitability of the business is about to change.”