There were two similar stories in the Wall Street Journal and the New York Times on Thursday about the complexity of large financial firms and what they’re doing to simplify their structures.
The Journal story focused on the number of subsidiaries that many of the largest financial firms have and where they’re located.
Wells Fargo & Co. Chief Executive John Stumpf has described the bank’s business model as “meat and potatoes.” But the fourth-largest U.S. lender has 3,675 subsidiaries, up 8.6% from five years ago, according to an analysis provided to The Wall Street Journal by Swiss research firm Bureau van Dijk Electronic Publishing Inc.
Wells Fargo isn’t alone. In all, the six largest U.S. banks have 22,621 subsidiaries, according to the Journal’s analysis.
While that is down 18% in the past five years, regulators said they are getting frustrated with banks’ slow and uneven progress in streamlining their labyrinths of business units, offshore entities and other appendages.
Comptroller of the Currency Thomas Curry, whose agency oversees national banks, said in an interview that his staff intends to pay closer attention to “needless corporate complexity” and “whether it’s time to start cutting some of the brush out.”
The sprawling nature of the largest U.S. banks will be on display starting Friday, when Wells Fargo and J.P. Morgan Chase Co. report first-quarter financial results. A Wells Fargo spokesman declined to comment on the data provided by Bureau van Dijk “because we do not know its methodology” and said its filings show subsidiaries down by 23% since the end of 2008, to 1,361. The number of legal entities “is not an indicator of risk and Wells Fargo has a long track record of prudent risk management in all our businesses.”
Complexity in the banking sector has vexed regulators since the financial crisis, when troubles at big U.S. firms quickly spread throughout global markets. The U.S. government intervened to prop up the largest firms, prompting calls to break up those deemed “too big to fail.”
Regulators have introduced rules requiring banks to maintain a fatter financial cushion against losses than other institutions, accept strict limits on the biggest banks’ exposure to one another and submit a new set of plans showing how they would be unwound in the crisis.
And according to the Times, some of the largest firms are shifting assets and risk to other parts of the market, which may cause regulators to have a skewed picture of their capital.
Banks have been shedding risky assets to show regulators that they are not as vulnerable as they were during the financial crisis. In some cases, however, the assets don’t actually move — the bank just shifts the risk to another institution.
This trading sleight of hand has been around Wall Street for a while. But as regulators press for banks to be safer, demand for these maneuvers — known as capital relief trades or regulatory capital trades — has been growing, especially in Europe.
Citigroup, Credit Suisse and UBS have recently completed such trades. Rather than selling the assets, potentially at a loss, the banks transfer a slice of the risk associated with the assets, usually loans. The buyers are typically hedge funds, whose investors are often pensions that manage the life savings of schoolteachers and city workers. The buyers agree to cover a percentage of losses on these assets for a fee, sometimes 15 percent a year or more.
The loans then look less worrisome — at least to the bank and its regulator. As a result, the bank does not need to hold as much capital, potentially improving profitability.
Some regulators say they are concerned that in some instances these transactions are not actually taking risk off bank balance sheets. For instance, a financial institution may end up lending money to clients so they can invest in one of these trades, a move that could leave a bank with even more risk on its books.
Critics point to other reasons to worry. Most of these trades are structured as credit-default swaps, a derivative that resembles insurance. These kinds of swaps pushed the insurance giant American International Group to the brink of collapse in September 2008. Another red flag is that banks often use special-purpose vehicles located abroad, frequently in the Cayman Islands, to structure these trades.
Both these stories, while different in focus and tone, tackle the complicated issue of simplifying the banks and determining if they’re making progress toward complying with new laws. As the rules continue to be shaped, coverage of the banks and if they’re working to prevent a collapse will be increasingly important and likely to go on for years.
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Banks have been shedding risky assets to show regulators that they are not as vulnerable as they were during the financial crisis. In some cases, however, the assets don’t actually move — the bank just shifts the risk to another institution.