How populism threatens banks

The impact of the financial crisis on politics has been immense and ongoing, with far-reaching banking industry consequences.

Voters’ trust in institutions, including banks, has weakened. This is fueled by income inequality, stagnant wages and the lingering anger over government bailouts.

On the right, this was reflected in the “surprising” 2016 election results, which have been positive for banks. Yet this in turn has given rise to numerous populist proposals from the left such as the return of the Glass-Steagall Act and other efforts to break up large banks. These proposals, although unlikely to pass in the current political environment, may be a taste of things to come in the next election cycle. Bad policies trickle down, as was demonstrated by the Dodd Frank Act. Consequently, smaller banks are unlikely to escape this development. Current strong bank earnings and continued deregulation are likely to increase voter banking hostility in both parties. The industry may be winning battles, but it risks losing the support of the voters. We are not seen as doing “God’s work” by many voters.

Yet a number of industry observers remain mired in parochial issues like regulatory reform and fintech. They risk missing the “black swan” of increased political risk. The crisis has radicalized the electorate on both the left and right. Political uncertainty is now a form of systemic risk — one not seen in the United States since the Great Depression. This is unlikely to end soon regardless of the November election results or even after the current administration leaves office. Remember, last century’s populist wave lasted over 25 years.

The likely impact will first be reflected in stock prices. Investor risk premiums will rise to reflect the nationwide political volatility. This especially true for banks given their perceived role in the crisis. Earnings will be discounted at higher rates, pressuring stock prices and triggering investor anxiety. This is currently reflected in the relative underperformance of bank stocks despite excellent operating results. Populism will, at best, serve as a headwind to bank stock prices — at worst it represents a serious threat should anti-bank proposals become law.

Additionally, investors are focusing on how banks incorporate political risk into strategic plans and initiatives. Particularly concerning are large investment initiatives that may become problematic if the political environment changes. The emphasis going forward will be on banks making smaller investment bets and having the agility to capitalize on political developments. Responsible rather than rapid growth is favored.

Investors will also expect banks to incorporate the views of non-shareholder stakeholders in their plans before it is forced upon them through initiatives like Sen. Elizabeth Warren’s proposed Accountable Capitalism Act.

Let’s face it, banking is in a de facto partnership with the public. Taxpayers will be called upon again to support the industry in the next crisis despite political comments to the contrary. These stakeholders will impact compensation, sales practices and dividend and stock repurchase decisions.

The indirect effects of populism on banking are likely to be even more concerning. Chief among these is the move to increase competition on private banks. This includes laws favoring credit unions and especially efforts to establish public and postal banking alternatives. An example is the bill sponsored by potential 2020 presidential candidate Sen. Kirsten Gillibrand. The bill would create a postal banking depository alternative to private banks. The partnering of public-owned banks like those in North Dakota with the postal service would a formidable nationwide banking competitor to privately owned banks. This may be just one election cycle from becoming reality.

Everything will not go back to the way it was before the crisis. The unlikely is likely to become more likely — especially, the active intervention by politicians into decisions formerly deemed off-limits. It is best to try to get in front of these trends rather than fight it. Opportunities exist for bankers understanding and capable of capitalizing on populism. This not the new normal. Rather, it is the search for the new normal. Institutions ignore this at their peril.