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Will Fed's Cautious Approach to Supervise Banks Be Fruitful?

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The Federal Reserve has put forth proposals for public comments, with the aim of further relaxation of regulations on comparatively small banks rather than for large banks in accordance to their risk profile. The new rules would reduce compliance costs for those holding lower assets while strict oversight on ones with high assets will continue as easing rules on them might pose a threat to the banking system in situations such as financial crisis.

The main motive behind this move is to have a fair regulatory system while maintaining the economic stability earned so far and safeguarding against another downturn.

Proposals Laid Down by the Fed

The regulator has categorized banks into four types per their size, cross-jurisdictional activity, weighted short-term wholesale funding, nonbank assets and off-balance sheet exposure — which together make up their risk profile. The proposals have lowered the liquidity requirements for big banks along with alleviating stress tests for some.

The top-most category consists of Wall Street giants including JPMorgan & Chase (JPM - Free Report) , Wells Fargo (WFC - Free Report) , Bank of America (BAC - Free Report) and other global systemically important banks in the United States. These banks will be subject to similar requirements that were imposed post crisis.

Banks with assets above $700 billion or with $75 billion cross-jurisdictional activity are included in the second category. Northern Trust (NTRS - Free Report) is the sole bank in this level and would be subject to equally strict supervision.

The next category is made up with those that have more than $250 billion in assets. While the liquidity requirements for this level has been toned down, other compliant requirements will still hold. U.S. Bancorp (USB - Free Report) , PNC Financial (PNC - Free Report) and Capital One are some of the banks in this category.

The least risky category consists of banks with assets between $100 billion and $250 billion and are subject to minimal level of oversight. These banks will be conducting the stress tests once in every two years rather than annually. This category comprises 11 companies including KeyCorp (KEY - Free Report) , M&T Bank and Fifth Third.

Which Banks to Benefit From the Proposals?

The Fed’s risk-based approach comes as a tailwind majorly for comparatively small banks. They will be able to use the unnecessary held cash to invest in expansion plans or offer it as loans to customers.

Further, lower liquidity coverage ratio requirement will likely have a favorable impact on the banks’ margins aiding interest income — biggest source of revenue for most banks. Additionally, lower compliance costs will be another positive.

Why Have Bank Stocks Been Losing Glory?

Wondering why despite a favorable environment in the form of rising interest rates, lower tax rate and relaxing regulations, bank stocks not being able to rally?

Well, it seems that the weight of expectations on bank stocks due to favorable changes in economy are likely to have outweighed the benefits. Sluggish loan growth along with rising deposit costs are making investors cautious of the Fed’s hawkish stance to raise interest rates. Moreover, trade war worries and other geopolitical concerns have also been putting pressure on bank stocks due to uncertainty in the market.

Also, while recently reporting third-quarter’s earnings, banks did not provide bullish future growth expectations, which also added to investors’ worries.

Shares of JPMorgan and Wells Fargo have gained 1% and 2%, respectively, over the past six months while Bank of America, Citigroup and Goldman Sachs have lost 7.1% 3.8% and 3.7%, respectively, in the same period.

Six Months Price Performance

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