The Global Bank Regulation Challenge

Good morning and welcome to Global Custody Pro. 

In today’s newsletter I’m taking a look at the global bank regulation challenge being created by the actions of the Trump administration in reducing US bank regulation.

The global custody industry faces a challenge - will US banks seize the opportunity to further increase their scale and profitability or will clients push back on any perceived reduction in balance sheet strength?

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Key Takeaways

• Deregulation Advantage: Regulatory rollbacks in the US under the Trump administration will create competitive advantages for US banks by lowering compliance burdens and capital requirements.

• Global Competitiveness Challenge: Non-US banks face increased regulatory fragmentation, potentially leading to competitive disadvantages compared to U.S. banks, especially in capital and operational costs.

• Risk of Regulatory Arbitrage: Divergent regulatory approaches across jurisdictions could encourage banks to exploit regulatory inconsistencies, undermining the global financial stability efforts established since the financial crisis.

• Impact on Custody Banks: US-based global custodians could leverage reduced regulatory demands to enhance profitability, drive technological innovation, and consolidate market position, but may face shifting client perceptions about risk.

What is the global bank regulation challenge?

The global bank regulation challenge is the simplest way to describe what has changed since the Donald J Trump administration began in January. A high number of rules and regulations have either been rolled back, eliminated, or began the process of being rolled back or eliminated. The overall regulatory posture of the USA is firmly pointed towards deregulation. This means the challenge is for every bank globally that isn’t a US bank. How will they remain competitive if they face relatively higher regulatory and capital costs?

What do regulation changes in the USA mean?

There have been a number of executive orders and changes in regulatory posture from US regulators - the OCC, the FDIC, the Federal Reserve, the SEC, the CFTC, and many other regulatory agencies. Scott Bessent, Treasury Secretary under the Trump administration, is making a significant play to consolidate power over U.S. banking regulators, including the Federal Reserve. His department is drafting recommendations to streamline agencies like the OCC and FDIC, with the ultimate goal of asserting more control over how financial regulations are written to make them less restrictive.

This means that the regulatory landscape faced by US banks is being rebuilt. There are benefits for banks and their shareholders - less focus on compliance, potentially lower capital costs, potentially settlement of long-standing regulatory challenges.

On the flipside there are costs for society - the risk of scandal and disgrace could rise, the treatment of customers could deteriorate in the face of passive or non-existent regulatory scrutiny, and the drive for lower capital requirements could reduce the focus on risk that has been hardened since the Global Financial Crisis and all of the subsequent scandals since that time.

The Basel III endgame, which would increase capital requirements and other associated rules for US banks, is likely to not proceed. This means that US banks will continue to have a capital competitive advantage over their foreign peers.

The wider impact though, is that a number of regulatory demands that have grown over the past few years - climate reporting and disclosures, DEI initiatives, corporate governance reforms - will fall by the wayside with no regulatory driver and potential political punishment for persisting with these programs at least while the Trump administration is in power.

If you reduce regulatory requirements for a bank, they can use that as an opportunity to reduce headcount, simplify operations, consolidate business lines or engage in whatever they see fit to better streamline their overall footprint. The nature of large global banks is that clear processes and controls are crucial - new intiatives must face strict governance interrogation and approval before they proceed. In an increasingly automation focused era, this could lead US banks to rapidly innovative and invest at a much faster pace because the bandwidth of executives will be less concerned by regulatory demands.

What does it mean for global banks?

In response to the actions of the Trump administration, the UK has already pushed back the implementation date of their implementation of final Basel III reforms to 2027. The EU is still proceeding with its implementation and taking a stricter line on risk management. There has been a small delay to the market risk rules, however its unclear what the strategy will be once the final US regulatory posture is known.

In Japan, the Financial Services Agency is still progressing with the full implementation. Although some Japanese banks are exiting climate change related industry groups, there has been no regulatory easing on overall regulatory burden.

In Singapore and Hong Kong, there haven’t been any changes announced to respond to US changes. As global custody hubs, the local operations of US banks will still need to meet all local requirements as part of their operations in the region.

The challenge for global banks is that regulatory fragmentation is against the spirit of the Basel reforms. The whole point was to align global standards to at least a minimum that reduced overall systemic risk. Inconsistencies can lead to regulatory arbitrage which could make crisis resolution more challenging and have flow-on impacts to global markets plumbing.

Overall, the competitiveness of US banks on pricing and risk taking might be relatively stronger than their global peers - however this will likely trigger regulatory responses from home country regulators of other G-SIBs who will face intense lobbying to maintain competitiveness.

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What does this mean for global custodians?

For global custodians, this means that the dominant US institutions (BNY, State Street, Citi, JP Morgan, Northern Trust) could find themselves much freer to operate and innovate under lighter regulatory demands than their overseas counterparts such as HSBC, BNP Paribas, CACEIS and Standard Chartered.

The removal of the Enhanced Supplementary Leverage Ratio could lead US custody banks to reduce their capital and return more to shareholders in the form of buybacks and dividends. They could also use the freed up capital to increase investments in technology and automation, or engage in M&A activity to further grow their scale on their platforms.

One variable to all of this proposed and actual change is the response of clients: how do they think about the risk they face as a client of a G-SIB? If one country starts to look “riskier” and they have very low risk appetite, does that mean the competitive pressure could flow in the other direction i.e. clients start pivoting away from US banks?

The tension between fees and risk perception might start to emerge as large mandates come up for renewal or RFP in the next few years. If the reduced regulatory posture in the USA is accompanied with any scandals or crises, it might not work out the way politicians are expecting given the very low appetite for risk across the client base globally.

What are the tradeoffs for the public if a crisis flares up?

There are a number of tradeoffs from a reduced regulatory posture if a crisis flares up. Lower capital means lower loss-absorption capacity and potentially increased systemic vulnerability.

Given the track record of intervention and support from central banks when crises arise, banks with lower capital reserves could face confidence challenges at greater pace than in previous episodes of market stress.

The wider tradeoff is at a global systemic level - if most of the world has tried to implement reforms to take risk out of the system or better manage it, and a crisis occurs where very different views of the necessity of this sort of regulation are at the table, could scenarios not previously envisaged occur?

The increased uncertainty and complexity in dealing with a recovery scenario of a global bank might face pushback from US domestic political considerations. Imagine this: what if the Federal Reserve didn’t extend US dollar swap lines to another central bank because that would be labelled a “bailout of another country”?

Overall, we’ll be watching the scope and scale of these regulatory reforms closely. The regulatory apparatus that has expanded since the Global Financial Crisis has not eliminated risk but has vastly improved the overall understanding and management of the same. For now, we still live in a hyper-connected globalised world, so if one country is cutting regulation, the cold harsh commercial reality is that every other regulatory body and politician outside of the US will start feeling the pressure of lobby groups to respond.

What’s next?

For the next few Wednesday editions, we’ll keep exploring the global custody industry and sharing our insights. We’ll keep sending our global custody news roundup every Friday. This newsletter was edited by Brennan McDonald.

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