Friday’s announcement by the FDIC buoyed the markets and opened a new era of potential FinTech investment. How will FinTech and current investors benefit? Can banks handle the pressures of their newly found source of returns?
Late last week, bank regulators gave financial markets and the financial services sector a badly needed shot in the arm. Contrasting the Federal Reserve’s restriction on dividend payments by U.S. banks, the FDIC and the OCC among other bank regulators (including the Federal Reserve) approved the roll-back of provisions to the Dodd-Frank Act (a.k.a. The Volcker Rule). In addition to reducing the amount of cash banks have to set aside as collateral against potential swap losses, it opened the door for them to invest in private equity funds (including venture capital) and credit funds. Flush with previously restricted cash and new investment mandates, this could signal a new era for the relationship between emerging FinTech companies and the financial institutions they count as clients and partners.
What is the Volcker Rule?
In the aftermath of the Financial Crisis of 2007-2008, it was determined that a key proponent of the collapse of the financial services industry was the combination of dizzying degrees of leverage (during the crisis, bank leverage climbed from 12:1 to upwards of 30:1 in some instances) and a slow and steady increase in risk appetite. This increase was borne of a low-interest rate era sparked by the bursting of the 2000 Dotcom bubble, the September 11 attacks and an ensuing recession from 2000-2003. As in any low-interest rate environment, the banks sought ways to maximize their Net Interest Margin (NIM) to maintain profitability and share prices. Concurrently, banks were enjoying the first years of the Graham-Leach-Billey Act, which repealed the Glass-Steagall Act and enabled the rise of the financial superstore. Merging commercial bank balance sheets (and cheap deposits) with investment bank know-how would help the financial system (and the clients it served) realize untold synergies powered by the ability to cross-sell. Citigroup was the poster child for this era as it bundled the Citibank global franchise with its Salomon Brothers capital markets expertise and Smith Barney retail presence— not to mention Travelers Insurance and its Diners Club businesses among others.
As Fed Funds neared 0% and the rest of the yield curve flattened, financiers created sophisticated investments that not only enabled faster origination of assets, but also allowed banks and investors to earn their needed returns, mostly with increased leverage. Given the reduced amount of oversight on the sector and the overlap of the government to promote growth (via home sales) and the banks to generate Returns on Capital…