A recent study by a JPMorgan research team predicted profits at large investment banks such as Goldman Sachs, Morgan Stanley, and Citigroup could fall by a third. While I haven't seen the report, I can't envision any way financial regulation wouldn't have a drastic effect on bank earnings. Three forces will be especially powerful:
1. Higher capital requirements: Over the last decade, the balance sheets of the five biggest investment banks have surged 16.3% annually, rising from $1.27T to $4.27T. This rise in total assets was aided by innovative forms of regulatory arbitrage that will no longer be viable. Higher capital requirements as well as crackdowns on loopholes will shrink banks' total assets. As assets generated income of some sort, earnings will decline.
2. Changes to Off-Balance Sheet accounting: the FASB's crackdown on SPEs will limit banks' ability to bypass capital requirements. It will also force banks to bring derecognized assets back on their books at the end of the year, using up more capital and decreasing leverage.
3. Regulation of OTC derivatives: OTC derivatives are blockbusters on Wall Street. The fees are high but corporations still like OTC derivatives because collateral requirements are low, depending on credit rating. But if interest rate swaps, credit default swaps, and other standardized derivatives are moved to exchanges, banks stand to lose a lucrative cash cow. Fees are lower on standardized deals, plus exchanges have higher margin requirements, making derivatives less attractive to corporations. The notional value of these deals are huge. Interest rate swaps alone have grown from $29T to $328T in the last decade and account for 55% of total contracts outstanding, according to the BIS.
