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Alex Morris
Alex Morris

Regulation and the State of the Banking Industry

May 03, 2011 | About:

During Berkshire Hathaway’s (BRK.A, BRK.B) Annual Meeting this past Saturday, Charlie Munger and Warren Buffett both recommended that investors reading M&T Bank’s (MTB) recent annual letter, written by CEO Bob Wilmers. I took the time to sit down and read it today, and they were right (as usual): it has a lot to say about the US financial economy, and the future of banking. One section in particular, entitled “Regulation and the State of the Banking Industry” provides some fantastic insight into the industry. In the letter, Mr. Wilmer discusses a couple of factors that he is concerned about, including:

Increased concentration in the financial services sector

Outsized-compensation, which draws talents away from professions crucial to economic growth

A government regulatory regime which both enables the “virtual casino” to continue


Traditionally, banking has been a regional/community enterprise in the United States, where customer deposits were gathered and credit was extended for enterprise and commerce. This regional theme is evident in market share figures: in 1990, the six large financial institutions held less than 10% of domestic deposits and just 14% of banking assets. However, the picture is very different today: as of September 2010, the six largest banks accounted for 35% and 53% of deposits and assets, respectively. Along with concentration, as we have seen, comes an increased risk that poor decision making at the larger institutions can lead to systemic risk. This has become more relevant as the large institutions have differentiated from traditional sources of income. In a search for higher returns, the largest bank holding companies have ventured into new activities, including “trading in all shapes and forms of derivatives, credit default swaps, mortgage-backed securities and other even more complex and exotic instruments (often associated with high amounts of leverage) — for which the collapse in value played the key role in precipitating the 2008 crisis.”

To put it into numbers, trading revenues, which exceeded $130 billion at the six largest financial services institutions over the past two years, accounted for more than 90% of such revenues (trading) at ALL American banks. Mr. Wilmer eloquently explains the problems this has led to: “One can make a case that trading indirectly contributes to economic growth by facilitating more efficient financial markets. However, unlike traditional commerce, where success is defined by the creation of new industries and jobs through entrepreneurship and innovation, too often the core function of trading is redistribution of wealth to those who have a trading advantage, be it talent or capital, from those who trade out of compulsion (e.g. distressed entities) or trade with limited knowledge of the instruments being traded.

That such activity is being conducted by bank holding companies which enjoy government protection represents a profound departure from the traditional banking model — that in which lenders and creditors knew and had to trust one another and built relationships meant to serve our capital allocation needs.”

The issue for someone like M&T Bank is that they (along with other traditional commercial banks) have been lumped into this category; as Mr. Wilmer says, it is “akin to describing dinosaurs as simple reptiles — it is true but profoundly misleading.” As such, traditional banks should not be viewed by the public or regulated by the government in the same way that these financial institutions should.


Trading profit, and the huge importance that it plays in the income statement, is the reason why outsized compensation packages have become the norm at these big financial institutions. For most of the 20th Century, financial services wages have generally ranged from 1.0-1.5x of the average non-farm U.S. worker, usually in the lower end of the range. By comparison, “the average 2009 investment banking compensation at four of the top six banks was at least 6.0 times that of an average American worker.” As a result, the financial services industry is luring bright minds away from science, medicine, and engineering; thus is the result when financial professionals earn 30-40% more than engineers.

As Mr. Wilmer notes, personal financial gain is not really the issue; there is ample opportunity to generate even larger profits through vehicles like hedge funds, where the top 25 paid executives averaged more than $1 billion in 2009; “it is of greater concern when we allow the creation of a business model, predicated on wealth transfer rather than wealth creation, to have access to government protection and resources and thus linked their risk profile to that of traditional banks; to take activities that are purely capitalistic endeavors and bring them into a regulated environment under the umbrella of insured protections is simply not prudent. Would it not be better to let those engaged in such activities live and die by the pursuit of their fortunes rather than impose a burden on the whole economy.”


“In all the current discussion about increased regulatory oversight regarding the prevention of future crises, too little attention has been paid to downstream effects, namely the economic burden borne by traditional commercial banks like M&T, and in turn the customers we serve.” As a result, commercial banks like M&T have seen increased expenses (nearly $90M in additional regulatory compliance last year) and reduced revenue ($75M on an annualized basis for overdraft fee changes); Mr. Wilmer believes these compliance and new regulatory developments, had they been fully effective during 2010, would have amounted to more than 20% of pre-tax income. Inevitably, these changes will lead to a higher cost of credit for bank customers. In essence, “those who will pay for the sins that sparked the financial crisis will be the small business owners, entrepreneurs, innovators, and individuals who rely on Main Street banks like M&T.”

As Mr. Wilmer notes in his closing, “It is always good to report, as I have once again been able to do, that M&T is doing well. It is much to be preferred, however, for M&T to thrive as part of a thriving America. That is what we must hope for — and work to achieve.”

The annual letter is a truly fantastic read; for anybody who is interesting, here is the link:


About the author:

Alex Morris
I am a recent graduate from the University of Florida; I received a finance degree as well as a real estate minor during my time at UF. I will be sitting for Level 1 of the CFA Exam in December 2011, as well as for my series 65 exam. I am a value investor, plain and simple.

Rating: 4.3/5 (13 votes)


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