Wall Street banks bet on deregulation

JPMorgan Chase earned a record net income of nearly $58 billion in 2024, the high point of a long boom in net interest income. Investors valuing Wall Street’s banks are now looking at something else: deregulation. The big money-centre banks are openly preparing for lighter supervision, lower capital charges and a revival of cross-border advisory fees.

How the mood turned

Two years ago the direction of travel was the opposite. The failure of Silicon Valley Bank in March 2023 prompted regulators to tighten supervision, and that July the Fed, the FDIC and the OCC proposed the Basel III Endgame rules, which would have raised capital requirements sharply for the largest lenders. The industry fought back with an unusually public lobbying campaign, and regulators signalled last autumn that a revised proposal would be much softer. The election has now turned a partial retreat into a likely rout. Michael Barr, the Fed’s vice-chair for supervision and the main architect of the tougher rules, said this month that he will step down from that role at the end of February.

Capital relief, thinner margins

At the top of every bank treasurer’s wish list is the watering down, or scrapping, of the Basel III Endgame proposals. Dropping the planned increases in risk-weighted assets would free tens of billions of dollars of surplus common equity tier 1 (CET1) capital for buybacks and balance-sheet growth. The relief would arrive just as deposit betas peak and asset yields come under pressure from a shifting yield curve, and net interest margins would shrink.

The mechanics favour shareholders directly. A bank that no longer needs to hold extra capital against its trading book and operational risks can return the surplus through buybacks, which lifts earnings per share even if total profit stays flat. The same logic applies to the Fed’s annual stress tests, which set a capital buffer for each large bank; the industry sued the Fed over their opacity just before Christmas, and the Fed has already said it will change how they are run. Reform of the supplementary leverage ratio, which counts Treasuries as fully as riskier assets, would add further room to expand balance sheets.

Hoping for more deals

Investment banks are counting on a strong rebound in mergers and syndicated leveraged loans. A looser antitrust regime is expected to release a large backlog of corporate takeovers and private equity exits that were shelved while regulators were more hostile. The expected departure of Lina Khan from the Federal Trade Commission removes the regulator dealmakers most wanted gone. Private equity funds are sitting on companies they have held longer than planned, and a friendlier review process would let them sell, which feeds advisory and underwriting fees.

The fee pool has room to grow from a low base. Advisory and underwriting revenues fell sharply in 2022 and 2023 as rising rates shut the leveraged-loan and IPO markets, and last year’s recovery started from depressed levels. Leveraged finance is where the swing is largest, because banks earn fees for arranging loans and then sell most of the risk to collateralised loan obligations and other investors. If buyout firms return in force, underwriting fees could rise faster than advisory income, which favours banks with large leveraged-finance desks.

Who gains most

The largest beneficiaries are the global systemically important banks, which carry the heaviest capital surcharges and the biggest trading and advisory businesses. Goldman Sachs and Morgan Stanley gain most from a deal revival, while JPMorgan and Bank of America gain most from capital relief on their enormous balance sheets. Regional banks stand to benefit from lighter supervision too, but they remain more exposed to commercial property loans and have less fee income to offset margin pressure. The losers, if there are any, are the private-credit funds that took lending business from banks when capital rules made it expensive for banks to keep.

The last time rules were loosened

The best precedent is uncomfortable. In 2018 Congress raised the threshold for enhanced prudential standards from $50 billion of assets to $250 billion, and regulators eased supervision of mid-sized lenders accordingly. Silicon Valley Bank, which fell into the lighter regime, collapsed five years later after its managers ignored the interest-rate risk building up in its bond portfolio. The lesson is that capital relief tends to look cheap until the cycle turns, and that the costs fall on depositors, the deposit insurance fund and, eventually, taxpayers.

The case against the rally

Bank shares have already risen sharply since the election, so much of the good news is priced. Deregulation also takes time: rules must be reproposed, commented on and finalised, and the banking agencies need new leadership before they can move. Meanwhile credit costs are rising as card charge-offs climb and office loans sour, and falling policy rates will squeeze the yield banks earn on floating-rate assets faster than they can cut deposit costs. Lighter rules will cut compliance costs and free up capital. The multiples on bank shares next year will depend on whether fee growth can make up for rising loan-loss provisions and narrower deposit spreads, and that is far from certain.

What to watch

The signals to follow are the nominations to lead bank supervision at the Fed, the FDIC and the OCC, any formal withdrawal of the Basel proposal, and first-quarter advisory fees at the big investment banks. If the deal revival arrives on time, the largest banks will announce bigger buybacks after the summer stress tests. If it does not, and credit losses keep rising, expect bank shares to give back much of their post-election gain by the end of the year, with the regional lenders falling hardest.