During a recent Q&A session with investors and analysts, Andy was asked, “how much will bank earnings suffer because of the anticipated increased regulatory burden after SVB?” The implication was that more regulation increases expenses and/or reduces opportunities, which, in turn, reduces earnings and share prices.
That seems to be a common, “knee-jerk” reaction or belief for which there is little evidence, and his response was basically, “not so fast. I disagree with the implication that there are only costs associated with increased supervision, and that there are no attendant benefits. Upfront, it’s certainly easier to measure the costs rather than the more amorphous benefits.1 However, recently we’ve had three of the four biggest bank failures in U.S. history, and if nothing else, they illustrate that the inability to meet regulatory guidance/expectations can be very expensive to both investors and other banks.”2
Do you think investors in SVB, Signature, and First Republic who are now holding worthless shares wish that the Fed or FDIC had more rigorously scrutinized those institutions and/or had been more forceful in requiring remediation of known shortcomings in a timely manner?
Similarly, do you think that better-managed banks that have suffered enormous market value declines because of their guilt-by-industry-association status wish that the failed banks’ regulators would have been tougher, and do you think those banks are glad to pay the increased FDIC premiums—estimated to be $16B − $20B—for which is there direct benefit at all?
There certainly seems to be a trade-off. Perhaps earnings will decline but stock prices may rise if investors conclude that increased regulation reduces the probability of catastrophic loss.
In a series of upcoming posts, we’ll describe likely regulatory changes for Category I, II, III, IV, and “Other” ($50B – $100B) banks, respectively. After that, we’ll come back to this topic to consider how regulatory changes might affect the market value of large and mid-sized banks differently.
- If you’re interested in the economic theory and behavioral implications of emphasizing more easily-measured metrics, like costs in this example, then download our old working paper, “Optimal Imprecision and Ignorance,” by Kanodia, Singh, and Spero, which was published as “Imprecision in Accounting Measurement: Can It Be Value Enhancing?” in the Journal of Accounting Research in January 2005. ↩
- BTW, satisfying guidance is a minimum standard of operation, not a best practice. ↩