Basel Endgame Will Have Huge Impact on Market Liquidity

Daniel Pinto, president and chief operating officer of JPMorgan Chase, warned that increased capital requirements for US banks will have a huge impact on market liquidity and lending.

Pinto spoke at the Financial Times Global Banking Summit on 28 November in London. He said the implementation of Basel III, as currently proposed, would have the biggest impact on the bank's lending and markets businesses.

"We would have to recalibrate those businesses," said Pinto. "The top five markets banks are in the US, so if they all recalibrate their businesses, the impact on liquidity will be huge."

The Basel Committee on Banking Supervision (BCBS) finalized revisions to its risk-based capital standards, known as the Basel Endgame package, in 2019 in order to achieve greater global standardization of risk-based capital requirements. National regulators have been making proposals to implement the package with US regulators jointly publishing their proposals in July this year.

Jamie Dimon, chairman and chief executive of your JPMorgan Chase has also been outspoken about the US implementation of the Basel Endgame and said US bank stocks would become uninvestable.

Pinto continued that the implementation would push more activity into the non-bank financial sector.

"If nothing changes and it is implemented as it stands today, our risk-weighted assets will go up by 30% and our capital requirement by 25% for the same activities," said Pinto. "The US economy has the most developed capital market system, so destroying secondary activity will imply higher spreads, less activity and really hurt the amount of financing that is being done."

Pinto argued that applying the European interpretation of the Basel Endgame would decrease the banks's capital requirement by between 10% and 15%, so there will also be no harmonization.

Colm Kelleher, chairman of UBS, also spoke at the Financial Times summit and said non-bank financial intermediaries, or the shadow banking sector, now represent $239 trillion of assets and warned that regulators have no insight into risks that are building up in that sector.

Kelleher said that he is fully supportive of having a shadow banking system, as there is a clear purpose for alternative forms of credit.

"The reason we are not having a commercial real estate blow up is so much is now being managed away from the banking system," he added. "I am not saying that we shouldn't have shadow banking, but I am saying that we should be aware of risks in that system."

Shadow banking has become so large, and is not properly regulated, so risks could build up that could trigger the next crisis according to Kelleher. He highlighted that the risk does not have to be systemic to trigger a fiduciary crisis and he gave the example of the bubble in crypto.

"Crypto was $3.6 trillion at its peak and if it had become mainstream investment then, maybe, it would have triggered a fiduciary crisis, so in many ways we dodged a bullet," he added. "There are many other asset bubbles building, and clearly in private credit, and just one could be a trigger.

His argument was that regulators need to know where the risks are to have an idea of where the next criss may originate and that the regulated banking sector will increasingly lose some control of assessing risk and asset bubbles if regulators keep increasing banks' capital ratios.

"The loss absorbing capital at banks have increased at least 20 times since 2008, but Credit Suisse's failure was not due to a lack of capital, but instead a lack of access to liquidity and an unviable business model," Kelleher added. "The Basel III proposals are fighting yesterday's war."

Kelleher continued that the single biggest risk of rescuing Credit Suisse was cultural contamination.

"That hasn't turned out to be the case, mainly because most of the bad actors left," he added. "Credit Suisse would not have been in that position if the investment bank had been run properly."

David Solomon, chairman and chief executive of Goldman Sachs, also spoke at the Financial Times summit about Basel III and said the Federal Reserve is clearly listening to comments from the industry, end users and Congress.

"I don't think that materially increasing the capital in the banking system is changing safety and soundness in a way that matters, compared to the cost which will be transmitted into the market," Solomon added.

He argued there will be three fundamental changes if the rules are implemented as proposed – the cost of capital will increase for all businesses, more activity will be chased out of the banking system and US capital markets and banking will become less competitive.

UBS

Kelleher took on his current role at UBS in April 2022 and in March the following year was negotiating the rescue of the Swiss bank's former local rival Credit Suisse. He was previously president of Morgan Stanley until retiring from that firm in 2019, overseeing both the institutional securities business and wealth management and was also the US bank's chief financial officer during the great financial crisis in 2008.

One lesson he learnt in 2008 is that banks have to prepare for all eventualities. Therefore, UBS has been preparing for the risk of Credit Suisse collapsing. In March this year some banks had failed in the US and other potential acquirers were also under huge pressure so it became obvious to UBS on 15 March that it was the only game in town or it was a resolution.

"Resolution would have worked, but it would have been incredibly messy and not good for the global financial system," he added. "It was down to UBS to come up with a deal that would be acceptable to the Swiss taxpayer and UBS shareholders and I do think the deal that we signed on 19 March was in the best interests of all stakeholders."

One month after the rescue of Credit Suisse, Sergio Ermotti was appointed as group chief executive, replacing Ralph Hamers. Ermotti had been group CEO between 2011 and 2020 and re-joined UBS from Swiss Re, where he was chairman until April 2023.

Kelleher said the Credit Suisse deal resulted in a significant amount of re-engineering and the chief executive needed to have a huge amount of investment banking and wealth management expertise.

"Sergio would never have come back to his old job but he saw the firm as the united bank of Switzerland and said it was a call of duty," Kelleher added. "He hit the ground running and knew half the board, so we saved ourselves a lot of time in the integration by having him back."

Ermotti is due to present his strategic plan for the group in February 2024. Kelleher said that, so far, UBS has over-delivered on the integration but the easy part is the initial job losses and 2024 will be the first year without these easy wins. For example, Credit Suisse had many legal entities that need to be shut down, and their data transferred before UBS can get rid of their associated control functions and costs.

One area of focus going forward will be succession planning. Kelleher said he would like a process similar to Morgan Stanley where the bank announced that co-president Edward (Ted) Pick will become chief executive, effective 1 January 2024, replacing James Gorman who will become executive chairman. The bank also announced that co-president Andy Saperstein will become the head of wealth and investment management, and that Dan Simkowitz will become co-president and the head of institutional securities.

"James did a phenomenal job in developing a bench and I think this was a rare bloodless coup on Wall Street," said Kelleher. "I would love to get to the stage where UBS can run the same playbook and have a foreseeable and credible succession with a range of candidates."

Another area of focus will be the US, where Kelleher said UBS is the fourth largest wealth manager and the only foreign bank that owns a wire house, Paine Webber, that it acquired in 200.

"Paine Webber has never been integrated properly and that is a major focus for Sergio and his team," said Kelleher. "That is a complete rerun of Morgan Stanley Dean Witter. If we execute properly, I think we will see a significant rewriting of UBS as a stock and also as a global player."

The rescue of Credit Suisse by UBS also led to $17bn worth of Credit Suisse AT1 bonds being wiped out and bondholders have launched litigation. Kelleher said: "UBS had nothing to do with the AT1 bonds, which was a decision by FINMA [the Swiss regulator]."

UBS re-entered the AT1 market in November 2023 and sold $3.5bn of bonds, after generating $36bn of demand according to Kelleher. He added: "We got the coupon significantly down from the initial estimate, which tells you that is yesterday's battle."

Goldman Sachs

Solomon said the complexity of the relationship between US and China and its implications for global growth make it significant for all businesses.

He added: "I would say we have a more conservative posture with respect to the financial exposures we have in that part of the world. Five years ago we were probably executing a much more 'growth at all cost' plan in China, and today it's a more conservative approach. We have pared back some of our financial resources as there is more uncertainty."

In addition, Solomon said foreign direct investment has slowed as investors are looking to deploy capital elsewhere.

Goldman Sachs held its first ever investor day in 2020 and identified four areas of growth – asset management; wealth management; transaction banking and consumer banking. In October this year Goldman Sachs said it would be reducing the consumer business by selling the GreenSky platform and associated loan assets to a consortium of institutional investors.

Solomon admitted that the bank would not be able to operate the consumer business at scale d quickly as it had thought, and the regulatory environment changed in the US.

"When we looked at how much the consumer business would move the needle versus the other growth opportunities, we decided that it was right to pivot," he added. "That leaves us focused on our two big core businesses – global banking and markets and asset management."

In global banking and markets, Solomon said Goldman Sachs has increased market share by more than 300 basis points over the last five years by allocating more capital to serving clients, particularly in trading. Five years ago in asset management Goldman Sachs had less than $5bn in management fees, and Solomon said the firm is on its way to $10bn in management fees, which was a target for the bank.

"We are changing the capital intensity of asset management," added Solomon. "We used to do a lot of it on-balance sheet and we are freeing up a lot of capital by reducing that."

Global banking and markets and asset management now comprise 99% of Goldman Sachs. Solomon argued that the bank's differentiators in asset management are scale and its ability to provide customization.

"We are the fifth or sixth largest asset manager in the world and supervise close to $2.7 trillion in assets," he added. "We are pretty unique in that we have active fixed income, we have a top five position in active equity, a top 10 position in alternatives and we are truly global."

There have been media reports of staff attrition and Solomon said attrition is lower this year than in a long time.

"There were definitely people that left this year that I would have liked to stay," said Solomon. "I guarantee you that next year there will be people that leave that we would like to stay, but that is how we operate our business."

There have also been media reports of criticism of Solomon performing as a DJ and he replied that he has stopped doing this in public, as it has become a distraction.

"My job is to lead the firm and make sure that we deliver for shareholders," he said. "Our share price performance over the last five years is second for our peer group and first over the last three years. We have grown the firm, grown the market cap and grown the dividend."