US President Barack Obama did quite a number on the markets yesterday when he called for an overhaul of the banking industry. Wait, let me reword that. Obama, in his speech yesterday, declared a full-on war on commercial banks.
Remember that, in the middle of the recent global financial crisis, the US government provided its banks with cheap credit using taxpayer money as part of its stimulus package. Yesterday, Obama said that the risk taken by commercial banks is too much, and this is putting taxpayers’ money in too much danger. While the US’s financial sector has improved greatly, there really weren’t any major changes to rules and regulations that govern it.
With that said, Obama wants two things to happen:
1. Prevent financial institutions from engaging in proprietary trading and investing activities which would have no benefit to its customers
2. Limit the growth of liabilities large financial institutions undertake
First, allow me to explain what proprietary trading means. Proprietary trading is the use of the banks’ own money to trade and invest in the financial market for their own profit. While this activity is not a major source of their profits, disallowing them from doing so would still squeeze their income.
Moreover, Obama’s second proposal to limit the growth of bank lending will have a direct impact on operations of banks as this would force them to be a little more tight-fisted with lending. Remember that banks mainly operate by acquiring deposits from consumers and lending these funds out to borrowers for profit. Also, since banks would no longer be able to profit from complex financial dealings, they might charge higher rates on their loans in order to compensate.
Take note that Obama is pushing for these proposed reforms with the American public in mind. The President is hoping that banks would go back to the basics and K.I.S.S. (Keep it simple, stupid!): Pay a certain rate of return for deposits, charge an interest rate for loans, and do away with those complicated financial securities that gives the average Joe headaches.
Since banks would no longer be allowed to trade complex and risky products which contributed to the financial system’s near collapse, the reforms would make the banking system much safer for ordinary Americans. Consumers would also be protected against banks that use their hard-earned money in deposits to make speculative investments.
The question now is this: How will financial markets react if these proposals do push through?
A look at yesterday’s trading session shows that these proposals could put some muscles on risk aversion. Since such rules would limit risk, I suspect investors could be forced to unwind their positions in riskier assets. We saw this yesterday, when investors and traders alike ran back to the safe havens. The yen went on a rampage across the board, carried by the strength of the down move in the USDJPY.
Based on the initial reaction, it seems that the yen would be the clear cut winner. However, given how bleak Japan’s outlook is, I don’t think we can count out the dollar just yet. In the end, it may be a question of timing. If and when these proposals are passed into law, will the global economy still be unstable? Or will they have recovered, giving investors other options to run to? Only time will tell.