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Banking Regulations Shifts Risk To The Buy Side

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For all the deleveraging that banks are doing, new regulations aren’t reducing the amount of risk in the financial system so much as shifting it onto the buy side, says a new report from financial software firm Misys.

“Western banks initiated the process of de-leveraging their balance sheets in advance of implementation of many of these capital metrics [such as Basel III] and are far more focused on the compliance issues associated with such regulations,” write consultant Will Dombrowski and Misys senior risk advisor Bradley Ziff. “De-risking activities still continue today, as Eurozone banks are currently on track to unload as much as EUR 100 billion in unwanted loan portfolios during 2014 alone and remodel their businesses in the face of growing regulatory pressures.”

Risk: Large banks shifting to more traditional activities

The idea that regulatory arbitrage can shift risk around without actually eliminating it certainly isn’t new, but the Misys study takes in the opinions from a huge chunk of the financial sector, with participants representing $9.5 trillion in global bank assets, $12.4 trillion in assets under management, and another $4 trillion in client advisory services.

The Misys study found that 80% of bankers are overwhelmed with the amount of regulation that they are facing (not bad news for third-party financial services firms like Misys), and 90% of the study’s participants agreed that the most heavily regulated banks have more work to do assessing the profitability of their different lines of business, and could continue to pare back their business activity.

“Generally, these institutions are likely to take on more traditional activities in less risky assets and businesses, committing less balance sheet capital and acting more on an agency basis (versus taking a principal role in the transaction),” says the report.

Dealing with regulations unintended consequences

The Misys report chalks this up to ‘unintended consequences’ of government regulations, pushing banks out of risky businesses and leaving a void to be filled by hedge funds, private equity, institutional investors, and others, possibly creating liquidity issues in some markets and making corporate financing more expensive. While getting too-big-to-fail banks to stop making risky investments doesn’t sound half bad, there is the danger that it simply pushes problems out of sight so that they can be forgotten about until the next crisis.

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