The Obama presidency took a turn towards increased government intervention in the private sector last week when the president stepped up his campaign against Wall Street and announced a far-reaching proposal for tougher regulation of the country’s biggest banks. Backed by former Federal Reserve Chairman Paul Volcker, Obama put forth a plan designed to limit speculative activities by commercial banks and prevent financial institutions from becoming “too big to fail.”
The latest proposal for reform in the financial sector would revive provisions of the repealed Glass-Steagall Act, which separated the operations of commercial and investment banks. At the heart of the proposal is an effort to limit the ability to take risk of any bank that also accepts customer deposits. Financial institutions that own commercial banks would be prohibited from owning, investing in, or sponsoring a hedge fund, private equity fund, or proprietary trading operations.
Essentially, the regulations would force banks to choose between the comfort of the government’s safety net and the often lucrative business of running proprietary trading desks.
“Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers,” said Obama in a press conference. “If financial firms want to trade for profit, that’s something they’re free to do. Indeed, doing so — responsibly — is a good thing for the markets and the economy. But these firms should not be allowed to run these hedge funds and private equities funds while running a bank backed by the American people.”
This week, leaders from the world’s largest banks will converge on Davos, Switzerland for the World Economic Forum, a year after many financial institutions declined to send executives to a posh ski resort out of fear of a potential backlash. The proposed regulations figure to be a hot topic in coming weeks as investors attempt to sort out the impact of the latest developments on the financial sector.
Bank ETF Options
For investors looking to take either a long or short position in the banking sector, there are several ETF options. Within the financials equities ETFdb Category, there are multiple bank ETFs focusing on different segments of the market, from Wall Street mega-banks to more local community institutions. ETFdb Pro members can read about the drivers of financials ETFs in the ETFdb Category Report (if you’re not a Pro member yet, sign up for a free trial or read more here).
SPDR KBW Bank ETF (NYSEARCA:KBE)
This ETF is designed to replicate the performance of the KBW Bank Index, a benchmark that reflects the performance of publicly traded companies that do business as banks or thrifts. While KBE focuses on U.S.-listed companies, many of this fund’s components maintain operations around the world. The companies given the largest weighting in this fund include many of those that appear to be in the crosshairs as the administration launches the next attack in the “Main Street vs. Wall Street” battle.
Number of Holdings: 36
Price-To-Book Ratio: 0.88
Largest Holdings: Bank of America (8.3%), Wells Fargo (7.4%), Citigroup (7.0%)
YTD Performance: +10.1%
Potential Impact of Regulations: The proposed regulations could change the face of many of the world’s largest financial institutions, forcing them to shuffle their operations and choose to focus on one of two primary areas of operation. It is important to note that any final legislation will likely look far different from the current draft, and that the potential impact on the Wall Street giants held by KBE could be changed dramatically. Despite the bullseye on the back of this fund, KBE has held up relatively well in recent sessions as speculation regarding the future of the U.S. banking industry swirls.
SPDR KBW Regional Banking ETF (NYSEARCA:KRE)
Whereas KBE invests in large, multi-national banking institution, KRE offers exposure to those with a more regional focus. The KBW Regional Banking Index consists of publicly traded companies that do business as regional banks or thrifts. Unlike KBE, the index underlying this ETF is an equal-weighted banchmark, meaning that KRE gives a much smaller allocation to its ten largest holdings.
Regional banks vary in size from a few branches in a single state to dozens of locations across several states. Many of the regional banks included in this fund focus primarily on the less risky side of the banking business, accepting deposits and making loans while maintaining limited investments in hedge funds or proprietary trading operations.
Number of Holdings: 52
Price-To-Book Ratio: 1.09
Largest Holdings: FirstMerit Corp. (2.6%), SVB Financial Group (2.5%), Bank Hawaii Corp. (2.5%)
YTD Performance: +9.9%
Potential Impact of Regulations: Regional banks find themselves in an interesting position as their larger counterparts face increased scrutiny from Washington. If the JP Morgans and Goldman Sachs of the world are ultimately forced to choose between running commercial banks and running proprietary trading and hedge fund operations, it seems likely that many would choose the more lucrative of the two. This could open up a whole new world of opportunities for institutions that focus on commercial banking, setting the stage for components of KRE to grow significantly.
First Trust Community Bank Index Fund (NASDAQ:QABA)
The index underlying this ETF consists of all NASDAQ-listed banks and thrifts excluding the 50 largest such institutions and any firms having an “international specialization” or “credit card specialization.” Community banks are generally smaller than even regional banks, often maintaining a handful of branches in a specific area. Community banks also don’t generally focus on issuing exotic financial instruments, meaning that many of the stocks held by this fund have fundamentally different operations than the mega-banks of KBE. While individual community banks may feature increased operating risk due to the geographical concentration of locations, QABA’s exposure is spread across about 90 companies operating in all areas of the country.
Number of Holdings: 90
Price-To-Book Ratio: 1.11
Largest Holdings: People’s United Financial (6.6%), TFS Financial Corp. (4.6%), Commerce Bancshares (3.9%)
Performance Last Week: +5.4%
Potential Impact of Regulations: Similar to KRE, tougher regulation at the top of the banking industry could create opportunities for the smaller players to snap up cast off segments of the financial behemoths.
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Disclosure: No positions at time of writing.