The past decade has been kind to America’s biggest banks. This week’s earnings round showed that for all the worries about regulation, low interest rates, and technological disruption, the largest universal and investment banks have more than doubled their collective profits since 2009.
The main contributor to this prosperity has been the long expansion of the US economy, a trend now in its 11th consecutive year. Bank profits are largely a function of the economies they operate in, and the benign environment in the US has pushed loan losses so low that JPMorgan chief executive Jamie Dimon recently described it as unsustainable. The Trump administration’s corporate tax cuts have not hurt, either.
The big banks have also taken market share from smaller ones, particularly in deposits. Bank of America and JPMorgan, for example, increased deposits by 4 per cent and 6 per cent respectively in 2019, even as economic growth slowed.
There are a number of reasons that size is winning: bigger banks can spread the cost of complying with post-crisis regulations over a bigger revenue base and have more money to spend on new technology.
“The moats around the largest banks are as deep as they’ve ever been,” said Mike Mayo, an analyst at Wells Fargo. “That’s due to technology and marketing skills, but also due to new regulations that require a good degree of overheads.”
Remarkably, banks’ return on equity remains near the levels of a decade ago, despite rules requiring them to hold much more capital. Cost-control initiatives have played a key role in this. Bank of America is again a good example: its overhead costs last year were $65bn, $10bn lower than five years earlier, despite higher revenues.
A decade ago, too, there was much concern that financial start-ups and big tech companies would invade industry territory. But marketplace lenders, social media platforms and other tech groups have, for the most part, ended up partnering with banks rather than displacing them; witness Goldman Sachs’ partnership with Apple on the Apple card. Established banks are hard to dislodge.
It is striking, though, that shares in the pure investment banks Goldman Sachs and Morgan Stanley have underperformed the diversified banks so dramatically. The explanation is twofold. Firstly, higher capital requirements are particularly tough on the investment banks’ core trading businesses. Secondly, investors burnt by the crisis are simply less willing to pay for market-sensitive businesses such as trading or merger advisory. They will pay a premium, on the other hand, for boring, steady businesses like retail banking.
And why has JPMorgan outperformed all the others by such a large margin? It came out of the crisis with fewer holes in its balance sheet than Citi or Bank of America, and unlike Wells Fargo, has not had any major scandals. In banking, more capital and fewer mistakes are a potent combination.