Financials Face Headwinds

Since the financial crisis of 2008, regulators and lawmakers across the globe have attempted to tighten controls on financial institutions. Many of the newest regulations are aimed toward raising capital requirements among banks. A bank’s capital is essentially a “cushion” for absorbing unforeseen losses, such as the ones seen during the crisis. From a bank’s perspective, however, higher capital requirements cut significantly into profit margins.

In November of 2014, the Financial Stability Board (a group of global regulators) proposed even stricter capital requirement rules for global banks. The proposal will require these banks to beef up their loss-absorbing capacity by issuing equity or long-term debt worth 16% to 20% of their risk-weighted assets, which could mean tens of billions of dollars in additional capital for some banks. If the proposal is passed, regulators hope that if these institutions fail, the costs and failure will be borne by their investors, rather than taxpayers.

With these proposed requirements, the short-term effect will no doubt be higher borrowing costs for banks. Remember – borrowing and lending are the bread-and-butter of the business. Conversely, higher capital requirements will most certainly help to avoid another 2008-like crisis, as banks should be better positioned to absorb losses.

Be sure to also read Controlling Risk with ETFs.

In recent months, the finance industry has already begun to feel some of these short term side effects, with profits coming in well below analyst expectations.

In an effort to buoy profit margins, banks have turned to job cuts, specifically in front-office positions, which include bankers, traders, salespeople, and analysts. Many of these cuts resulted from banks pulling back or completely out of FICC divisions, which include fixed-income, currencies, and commodities trading.

To better visualize this trend, below is a graph from the St. Louis Fed, which shows the monthly seasonally adjusted number of employees in the commercial banking industry from before the financial crisis to January of 2015:

Since peaking in 2008, the banking industry has continued to cut employees. And while employment is currently above the lows seen in 2000, the recent waves of job cuts suggest that this downtrend may continue for some time.

With the combination of higher capital requirements and stricter regulations, banks will likely continue to cut operational costs in an effort to boost profit margins. We encourage you to keep an eye out for the next round of earnings results, as well as any news on additional job cuts. In addition, be sure to check out our list of Financials Equities ETFs, which can offer a great way to gauge financial companies or even an opportunity to make a play on the latest industry trends.

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Disclosure: No positions at time of writing.