Global leaders meet this week seeking to deliver the broadest financial regulation overhaul since the 1930s, potentially threatening profits and stock prices of banks from Goldman Sachs Group Inc to Barclays Plc.
US President Barack Obama and his Group of 20 counterparts convene in Pittsburgh on Thursday and Friday to cement a plan to force banks to curb leverage, hold more equity capital and keep a greater pool of assets that can be easily traded. Restraining bankers' pay and narrowing imbalances in trade and savings will also feature on the agenda as officials try to hammer out an accord to prevent a repeat of the worst crisis since the Great Depression and ensure a sustained recovery.
By limiting the scope of banks to invest and trade, governments may check this year's 22 percent gain in the Standard & Poor's 500 Financial Index. That may be a price they're willing to pay to prevent a repeat of the risk-taking that sparked the collapse of Lehman Brothers Holdings Inc a year ago, a worldwide recession and taxpayer-funded bank rescues.
"Regulation will make banks less profitable by increasing the cost of doing business," said Andrew Clare, a professor at Cass Business School in London and a former Bank of England official. "If banks are going to benefit from taxpayer largesse then they need to act in a way that doesn't hurt taxpayers or the economy."
The summit, which will also be attended by UK Prime Minister Gordon Brown, French President Nicolas Sarkozy and Chinese President Hu Jintao, will also debate how to drive the economic recovery, avoid protectionism, improve accountancy and revamp governance of the International Monetary Fund. The officials will also try to devise a framework to generate a more balanced world economy through greater US savings, European investment and Chinese domestic-demand.
Leaders travel to the Steel City amid voter disquiet after governments used public money to bail out banks only to see many of them quickly return to profit and resume setting aside billions for bonuses. Seventy-three percent of UK voters polled this month by YouGov wanted a tax imposed on all bonuses over 10,000 pounds. A Gallup poll in June showed that 59 percent of Americans wanted action to curb executive pay.
Under consideration: forcing banks to augment their capital buffers to better account for risk, retain more earnings and satisfy a leverage ratio, which measures equity as a proportion of total holdings. They may also consider a proposal to tie pay to capital levels from Financial Stability Board Chairman Mario Draghi.
"There has been a culture that rewards short-term thinking, that used leverage to take exorbitant risks that were unsustainable for the system as a whole," Obama said in a Sept 14 interview. "That's the culture I think that we've got to reverse."
The crackdown could lower profitability by a third at Goldman, Barclays and Deutsche Bank AG's investment bank, JPMorgan Chase & Co. analysts led by Kian Abouhossein said in a Sept 9 report.
Deutsche Bank's return on equity will probably tumble the most among the world's largest investment banks, falling to 6.7 percent in 2011 from 10 percent today, the analysts said. Goldman's return on equity will decline by 4.4 percentage points and Barclays' by 4.3 points.
"The amendments to capital requirements will clearly affect the activities of banks in their trading books and securitizations," said Alessandra Mongiardino, a London-based analyst at Moody's Investors Service.
Spokespeople for Goldman, Deutsche Bank and Barclays declined to comment.
Investors may suffer if financial companies have to issue more equity, said Charles Goodhart, a former Bank of England official and now a professor at the London School of Economics.
"Banks will have to raise more capital by issuing more equity so existing stocks will generally go down," Goodhart said. The IMF estimated in April that US and European banks would need $875 billion in extra capital.
To be sure, Goldman has demonstrated that higher capital and lower leverage don't always mean reduced profits.
The company, which set aside a record $11.4 billion for compensation and benefits in the first half, cut its ratio of assets-to-common equity to 16 times in the second quarter from 26 times a year earlier. Goldman still set a new Wall Street profit record this year, making $3.4 billion on $13.8 billion of revenue in the three months that ended in June.