An Overview of the US Banking Sector
The banking sector plays a pivotal role in our day-to-day lives as well as in business. At the individual level, banks manage all our monetary transactions. Plus, banks are the backbone for businesses to operate successfully.
In this series, we’ll discuss the sector, its driving factors, and its key indicators and latest trends. Let’s begin by understanding the scope of what banks do.
Deposits and lending
Consumer or retail banking operations primarily include taking deposits from and providing loans to individual consumers and small businesses. This is the most basic and core operation of any bank.
Individuals can deposit their money in savings accounts, CDs (certificates of deposit), and IRAs (individual retirement accounts). Consumers can also deposit funds in noninterest- and interest-bearing checking accounts. Customers can earn interest on most of these deposits. Banks’ fees include account service fees, insufficient funds fees, overdraft charges, and ATM fees.
Banks lend money in many ways, including:
- issuing credit cards
- overdraft protection accounts
- revolving lines of credit
- residential mortgages
- home equity loans
Further, banks lend money and earn interest through direct and indirect loans such as automotive and personal installment loans. If we subtract the interest a bank pays on deposits (and other interest-bearing liabilities) from what it earns on loans (and other interest-earning assets), we get its net interest income.
Notably, Bank of America (BAC), JPMorgan Chase (JPM), Wells Fargo (WFC), and Citigroup (C) are the four largest US banks. These four banks, as well as many other smaller and regional banks, offer wealth management services to high- and ultra-high-net-worth individuals.
These services include investment management, brokerage, retirement products, tax and estate planning, and specialty wealth advisory services. With $1.3 trillion in private client AUM (assets under management), BAC tops the list of wealth management firms in the US.
Corporate and investment banking
Banks offer corporate and investment services to businesses and corporations. These include a broad range of offerings, including:
- lending-related products and services
- working capital management
- Treasury solutions
- debt and equity underwriting and distribution
- merger-related and other advisory services
- securities clearing
- custody services
In addition to the big four players—BAC, JPM, WFC, and C—Goldman Sachs (GS) and Morgan Stanley (MS) are the top players in the investment banking segment.
As banks deal with enormous sums of other people’s money, this sector is highly regulated. The Dodd-Frank Act, which was enacted after the 2007–2009 financial crisis, guides most of the sector’s regulatory initiatives. Additionally, regulators implement stringent global standards, such as the Basel Norms.
The Dodd-Frank Act, implemented in 2010, was implemented “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”
Notably, US banks are also required to follow the risk-based capital requirements of the Basel Committee. The Basel Committee was formed by BIS (The Bank for International Settlements), which is “an international organisation which fosters international monetary and financial cooperation and serves as a bank for central banks.”
The Basel framework includes risk-based capital requirements for credit, market, and operational risks. Plus, it specifies key ratios including leverage ratio, liquidity coverage ratio, and net stable funding ratio for reasonable leverage, liquidity, and the funding profiles of banks. Additionally, the Basel framework establishes standards for margin requirements for non-centrally cleared derivatives.
Regulatory relief from President Trump
In May 2018, President Trump signed a major bill to ease bank regulations in the US. The EGRRCPA (Economic Growth, Regulatory Relief and Consumer Protection Act) eased regulations significantly. Among other provisions, the EGRRCPA eases requirements relating to the leverage ratio, capital and liquidity requirements, and high-quality liquid asset requirements. Moreover, the EGRRCPA exempts entities with less than $10 billion in assets from the Volcker Rule, which prohibits them from engaging in proprietary trading activities.
Notably, one of the factors driving the easing of these regulations is the strength of the sector. That’s because the sector has become a lot healthier globally than before the 2008 financial crisis. According to The Banker, the “aggregate Tier 1 capital-to-assets ratio has strengthened from 5.14% in the 2010 ranking to 6.75% in the 2019 ranking.”
Next, let’s look at the key indicators and the current trends in the sector.
For another installment of Market Realist’s sector overviews, please check out The US Energy Sector: An Overview.