NOT ALL BANKS ARE CREATED ALIKE / THE WALL STREET JOURNAL OP EDITORIAL ( HIGHLY RECOMMENDED READING )

OPINION

DECEMBER 19, 2009.

Not All Banks Are Created Alike .

By ROBERT G. WILMERS

Congress is moving rapidly toward new financial-services regulation, focused on limiting the sort of "systemic risk" said to have helped bring on the current recession. But we are also in a period where there is great concern about the limited availability of credit to fund companies whose growth could bring down the country's persistent high unemployment.

Any new regulation of the financial industry must distinguish between firms engaged primarily in speculative trading and lenders linked to the real economy of Main Street. The great danger is that regulation of the former might inadvertently strangle the latter.

Today, not all institutions that call themselves banks, or bank holding companies, operate in similar ways. Traditionally, banks take deposits and make loans to small and mid-sized businesses which, if successful, generate jobs. This sort of banking has long been highly regulated—indeed, more than 4% of many banks' expenses are devoted to regulatory compliance.

In addition, these traditional banks have been self-insured through payments they make to cover the cost of Federal Deposit Insurance Corporation (FDIC) insurance. Unfortunately, much of this oversight did not extend to institutions such as Lehman Brothers, Bear Stearns, AIG and others—whose activities did so much to bring on our financial crisis.

The big firms that played a central role in that meltdown, and many others that continue to dominate the financial services industry today, derive far less of their income from deposits and lending than do Main Street banks. Instead, they engage in a range of quite different activities, including trading in loans that others have generated, speculation in stocks and bonds and exotic derivatives.

In fact, 90% of all trading revenues earned by bank holding companies is concentrated in just five firms—Bank of America, Citigroup, Goldman Sachs, JP Morgan Chase and Morgan Stanley. These are the institutions showing the renewed profitability that has attracted so much public comment. But much of this improvement comes from trading and speculation. The vast majority of American banks don't do either.

The five large companies have, through September of this year, generated $30.1 billion in net income. The rest of the bank holding companies combined lost money.

These big five bank holding companies also realize an average of 25.1% of their revenue from trading activities. In contrast, for all other bank holding companies, trading revenue as a percentage of total revenue averages three-tenths of 1%.

The rebound in trading profits at the big five institutions is staggering. Just three of them (Bank of America, Citigroup and JP Morgan Chase) have generated trading revenues of $26.8 billion over the first nine months of 2009, compared with trading losses of $41.3 billion in 2008. Including the other two that were granted new bank holding company charters last year, the entire group of five generated an estimated $57 billion of trading profits through the third quarter of 2009, compared with trading losses of $27.7 billion over the course of last year.

The five firms have swung from an aggregate loss of $14.0 billion in 2008 to $30.1 billion of net income through September 2009. The remainder of the industry, which earned $4.4 billion in 2008, is now showing $9.7 billion in red ink through this year's third quarter.

These large institutions operate in a different world than that of traditional, community-oriented banks. Perhaps Congress, when it enacts new regulations to protect the larger economic system, should focus on an institution's activities rather than its legal form. This would allow us to distinguish between Main Street banking and short-term trading.

The issue would become acute should Congress pass measures that force all banks to bear the cost of protecting those institutions whose activities pose systemic risk. Among the unintended consequences of such an approach would be that consumers and small businesses, starving for credit, would indirectly bear the cost of such fixes.

Former Federal Reserve Chairman Paul Volcker's recommendations regarding the separation of commercial banking from investment banking appear to recognize the potential for such unintended consequences. However, I fear that the financial markets have become too complex and interconnected to really separate the two.

Yet Congress at least should consider requiring that financial institutions account separately for their trading and their traditional banking businesses, so the public can see what's going on. Such transparency would make it clear which institutions engage in high-risk investing—and which should bear the cost of potential clean-ups—whether through special fees or higher capital reserves.
What surely does not make sense is to ask financial institutions that are involved in plain vanilla banking to pay to insure those who buy and sell far more exotic flavors. It is crucial—not for banks or bankers but for the American economic recovery—to get this right.

—Mr. Wilmers is chairman and CEO of M&T Bank Corporation, one of the nation's 20 largest independent commercial bank holding companies.


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