A February 1st report from Richard X. Bove of Rafferty Capital Markets discusses how the banking industry has been hamstrung by government regulations. Bove argues that long-term near-zero interest rates and the stringent regulatory environment in place since 2008 makes it almost impossible for the traditional banking model to be profitable.

Bank profits low because buying government guaranteed debt instead of making loans

Bove explains that the reasons bank profits are so low is that government regulations and ultra-low interest rates today almost force banks to use virtually all of their “incremental deposits” to purchase government guaranteed debt.

He sets up a chain of “facts” to explain his argument and imply the U.S. banking system has been “nationalized”:

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Fact: Most bank stocks have a lower share price than they did in 2007.

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Fact: Industry profits as measured in pre-provision, net revenues, per share are significantly lower than they were in 2007.

Fact: Mismanagement of bank balance sheets is the main problem.

Fact: Government regulations are forcing the mismanagement.

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Fact: The mismanagement is that almost all of the incremental deposits of the banking system are being used almost solely for the direct and indirect purchase of government guaranteed debt.

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Fact: The net result is that the banking system is supporting government debt and not the private sector, which is a characteristic of a nationalized banking system.

Bove’s recommendations

In his recent report for Rafferty Capital Markets, Bove says that since interest rates are unlikely to increase appreciably for 18-24 months, the only way banks are going to make a profit is to move out of traditional banking and into more profitable businesses such as wealth and asset management, investment banking, and payment services.

Bove highlights four major banks who are doing whatever it takes to remain profitable:

“SunTrust for being in the right place at the right time.

Bank of America for being a strong turnaround story

Morgan Stanley for the successful reconstitution of its business model.

BNY Mellon for being the leader in a genuine growth industry.”

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