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Wall Street reforms will drive up lenders

Tuesday 29th June 2010

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American lenders will face increased cost of capital as a result of sweeping reforms to financial regulation, with the changes also to be felt in New Zealand because of local banks’ reliance on offshore funding. 

Major American banks are to be slugged with a $19 billion fee to offset the cost of the bill and will have to have to spin-off some of some of their swaps business to an affiliate.  

They’ll still be allowed to conduct interest-rate, foreign exchange and some precious metal swaps but most agri and energy commodity swaps will be prohibited.

Standardised derivates will also be traded through an exchange and customised derivates will be reported to regulators. 

The lenders will also be required to keep 5% of in-house securitised loans on their balance sheet.  

However, Keith Poore, head of investment strategy at AXA Global Investors in Wellington, which manages $4 billion, said overall he is “quite pleased with the bill", and that US financial stocks gained on signs the bill “will be less onerous than expected." 

However, the new bill “is still onerous enough," said Poore.

"There are a lot of details but one thing is for sure, the cost of capital for banks is going to rise, and given New Zealand borrows heavily from offshore banks, so will ours.” 

“We’ll have to wait and see whether U.S. banks will be downgraded, but it seems likely, especially given creditors will now have to face some of the costs if a bank is taken over and liquidated by the government,” Poore said.

“Equity investors have paid the price to date.” 

The financial reforms also up the ante for credit rating companies, with the prospect of being fined or even deregistered by the SEC for bad ratings, and will be open to lawsuits from investors. 

US banks rallied on Friday after negotiators in the US Congress watered down key aspects of the reforms after a 20-hour session. Last minute changes include the softening of a provision on proprietary trading, which the Obama administration had sought to ban.

Banks will be allowed to invest up to 3% of their Tier 1 capital in hedge and private-equity funds. American commercial lenders will also now be allowed to trade swaps, though the trade must now be carried out through subsidiaries.

The Federal Reserve is to create a consumer financial protection agency, with far-reaching powers to police mortgage lending and credit cards.

And a super regulator, the Financial Stability Oversight Council, will oversee Wall Street’s biggest firms, as well as a new federal Insurance office in the Treasury to oversee that industry. 

American Express jumped almost 4%, while JPMorgan Chase climbed 3.7% and Bank of America rose 2.7% on Friday in New York, leading gainers on the Dow Jones Industrial Average.  

“There are necessary improvements in oversight, regulation and transparency but they haven’t thrown the baby out with the bathwater…killed the goose that lays the golden egg,” Poore said.

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