With jobs once again on the chopping block, banks are among the companies doing mass layoffs. While this is a sign of tough times ahead for the industry, it's also an indication that the financial sector that caused the financial crisis is beginning to shrink down to a more appropriate size relative to the rest of the economy.
What's more, some of the cost cutting seems to be related to new regulations. That doesn't mean the regulations will have the desired effect, but it does indicate that the regulations are having some effect.
Now the bad news
Regulations aren't the only reason banks are pinching pennies. Weak loan demand, especially from consumers, and a sluggish economy are also playing roles. That has bankers focused on improving productivity, an ominous shift for the industry because it confirms their lack of confidence in loan growth.
Even though banks have reported what appear to be improving earnings, at many big banks, as much as half of the improvement has been due to a reduction in provisions for loan losses. It's not a sustainable source of earnings. Banks know that and have been counting on improvement in the economy, the housing and securities markets, and, now, layoffs.
We were warned
Less than two months ago, Moody's put its credit ratings for Bank of America (NYS: BAC) , Citigroup (NYS: C) , Wells Fargo (NYS: WFC) , and Bank of New York Mellon (NYS: BK) on watch for a possible downgrade. Among other concerns, Moody's noted that "these banks still have sizable residential mortgage exposures; their credit costs could therefore spike if the US economy were to contract again." Moody's already had other banks on a negative credit watch: Goldman Sachs, JPMorgan Chase, Morgan Stanley, and State Street (NYS: STT) .
An analyst at Deutsche Bank Securities recently wrote, "We believe banks should be increasingly focused on cutting costs." He ought to know; he analyzes banks for a living and gets an insider's view by working for a bank.
Cleveland-based regional bank KeyCorp (NYS: KEY) seems to agree. Its CEO said last week that its "Keyvolution" cost-cutting program has become a "part of our normal operating rhythm," according to TheWall Street Journal.
US Bancorp's (NYS: USB) CEO emphasized, "Until we see sustainable, repeatable growth in revenue, we're going to continue to be very careful on our expenses and be very watchful."
Too-big-too-fail TARP recipients are also trimming expenses. Bank of New York Mellon's CEO recently said it needs to cut costs and will disclose a plan later this year. The bank has indicated actions may include eliminating buildings and IT systems and moving employees to lower-cost locations, but it did not comment on the potential for employee headcount reductions.
Wells Fargo stated on its recent earnings call that it plans to reduce costs by 12% by the end of next year. The company has already shut a business that specialized in mortgages used by lower-income households and reduced the number of regions in its wealth management business from 12 to seven. That suggests consumers at both ends of the income spectrum are using fewer financial services.
Bank of America has been closing branches and taking other cost-cutting measures. Nonetheless, last week management indicated that the bank is less than halfway through its cost-cutting program. It expects to reach the halfway point soon. B of A has not stated how much it plans to cut, suggesting the amount may be a moving target.
Wall Street is not exempt from the carnage. Goldman Sachs recently announced plans to cut 1,000 employees. In June, archrival Morgan Stanley -- which was enjoying a surprisingly strong quarter -- stated it may let its retail broker headcount slip. That's on the heels of a February comment that Morgan Stanley is trying to cut $1 billion in annual costs within three years through non-headcount-related actions such as cutting travel costs.
Spare no one?
Overseas banks are also trimming. Earlier this month, UBS announced plans to reduce costs by about $1.3 billion. The cost cutting is expected to involve significant job losses over the next three years. UBS also ratcheted back its long-term profit outlook.
Credit Suisse Group's investment bank was ahead of UBS, eliminating about 600 jobs in June. Barclays' investment banking unit also cut its headcount in June, by about 100. That followed the elimination of about 600 jobs in January.
Banks were counting on improvements in the housing market, economy, and securities markets to offset other headwinds. Their renewed cost-cutting plans are not a reaction to a surprise about short-term conditions. They're an acknowledgement that the outlook over the next several years is bleaker than expected. The investment implications extend well beyond bank stocks. They suggest investors should be positioned for a tough economy. For that, my favorite stock is IBM.
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At the time thisarticle was published Fool contributorCindy Johnsondoes not currently own shares of any stock in this story. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. The Fool owns shares of and has opened a short position on Bank of America. The Motley Fool owns shares of International Business Machines. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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