How much does bank regulation cost?

Regulation mania has swept over the financial sector since the crash, but just how much is this costing?

Regulatory costs can be capital requirements or tougher fines, but it’s also an issue that matters to individual banks as they assess the total cost of ownership (TCO) of their IT infrastructure. 
Piggy bank broken with plaster and coins

Overhauling IT systems to better meet regulatory shifts - and to future proof systems so they can withstand further changes by the regulators - is one of the biggest knock-on costs. For example, what is the cost of building a new data management system to comply with BCBS 239?

Ultimately there is a wide range of costs associated with regulation, but with the sheer complexity involved trying to get an exact figure is harder.

Regulations unbound

Banks are being asked to pay more to be supervised. The largest banks in Britain, for example, must pay annual fees of £257.8 million to fund the Bank of England’s Prudential Regulation Authority - up four per cent from last year.

The higher bill is for the “ongoing regulatory activities and recovery of transition costs”, as well as “the need for additional resource in relation to the PRA’s expanded responsibilities and implementation of new policy initiatives”.

These initiatives include the Implementation of the Senior Managers Regime, as well as the new Senior Insurance Managers Regime. Preparation for the Solvency II is another cost - £13.4 million this year alone. Other costs come from the implementation of the Capital Requirements Directive IV for banks, building societies and designated investment firms.

Costs double post-crisis

In the US, it’s estimated that the costs of regulation on the six largest banking organisations hit more than $70 billion between the end of 2007 and 2014 - a doubling in value that is down to the huge increase in regulation since the crisis.

Looking at Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, Morgan Stanley, and Goldman Sachs, the Federal Financial Analytics report quantified the cost of new capital regulations, interchange-fee restrictions, higher FDIC deposit-insurance premiums, and supervisory-assessment fees.

Karen Shaw Petrou, managing partner of Federal Financial Analytics and the study’s principal author, commented: “Costs may well be necessary to secure financial stability, but bank management must nevertheless strategically adapt to them.

“This can significantly change product pricing and availability, competitiveness, and the transfer of certain activities from banks to less-regulated institutions that do not bear comparable costs.”

But even here the report says it’s impossible to truly gauge the cost of banking regulation; something that was echoed by a FDIC study into community banks.

This tried to address how regulatory costs have changed for community banks over time. Unfortunately, the data just wasn’t good enough to really measure what was down to regs and what wasn’t.

The FDIC conducted interviews with nine community bankers to better understand what drives the cost of regulatory compliance at their bank.

“Most interview participants stated that while no one regulation or practice had a significant effect on their institution, the cumulative effects of regulatory requirements led them to increase staff over the past ten years,” the report stated.

“Moreover, the interviews indicated that it would be costly in itself to collect more detailed information about regulatory costs. As a result, measuring the effect of regulation remains an important question that presents substantial challenges.”

But we know it is costly; so reducing the bill makes sense.

Reducing costs

An IMF report from 2012 noted that regulatory costs would result in higher lending rates being passed on to customers. But not all the costs can be passed on and the study made a number of assumptions based on banks being able to reduce spending to absorb the higher regulatory burden.

It argued that “there is considerable room to cut expenses if necessary” and that in addition to “reductions in expense ratios at individual banks, there are likely to be market share gains by the more efficient banks, lowering the average expense ratio for the industry as a whole”. For individual institutions the message was to cut costs or fall behind.

The IMF also suggested banks could take specific actions, such as improving data collection and modelling efforts to justify a lower risk weighting under the internal modelling approach.

This is exactly where TCO reduction comes in, by helping the bank to pinpoint where it’s spending lies so it may better meet new regulations and cut costs at the same time.