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'Too big to fail' banks may try to get smaller

By David Ellis, staff writer

NEW YORK (CNNMoney.com) -- Wall Street appears to have beaten Washington to the punch.

While lawmakers enter the home stretch on regulatory reform with Thursday's Senate vote, the financial industry has already started to shake up how it does business ahead of the proposed new rules.

Just last week, Wells Fargo (WFC, Fortune 500) said it planned to shutter its more than 600 Wells Fargo Financial stores across the country and announced it was no longer going to make mortgage loans to people without stellar credit.

And on Tuesday, Citigroup (C, Fortune 500) said it had struck an agreement to transfer the management of part of its private equity business to outside parties StepStone Group and Lexington Partners.

Neither Wells nor Citigroup acknowledged that the moves were prompted by the proposed legislation which is expected to be signed into law by President Obama as early as next week.

But analysts suggest they could mark the first wave in a series of divestitures and business closings as new rules for the banking industry take effect.

"I wouldn't be surprised if we saw more of that," said Whitney Young, bank analyst for Raymond James.

Of course, regulatory reform isn't entirely to blame. Wells Fargo's consumer finance division has been struggling for some time. Citigroup, on the other hand, has been shedding assets and exiting various businesses over the past year.

Nevertheless, many firms are expected to soon face similarly tough choices about what they hold onto and what they let go as a result of the new laws. It's somewhat ironic that banks may look to downsize as a result of reform, considering that the bill has been criticized by some for not doing enough to tackle the issue of banks being "too big to fail."

Most discussions will center around consumer-oriented businesses or divisions that are linked to financial markets, said Roger Lister, chief credit officer for U.S. and European financial institutions at the ratings agency DBRS.

One key provision of the proposed legislation would require the creation of an independent Consumer Financial Protection Bureau, an agency that would be empowered to curb unfair practices in consumer loans and credit cards.

Many analysts viewed Wells Fargo's decision to close down its consumer finance unit, a business that has been around for more than 100 years, as a response to the proposed federal agency.

The reform bill would also limit just how much banks can invest in private equity and hedge funds. Otherwise known as the "Volcker rule", it has already prompted serious questions about the fate of some of these businesses.

For example, many have wondered what JPMorgan Chase (JPM, Fortune 500) plans to do with its internal hedge fund Highbridge Capital. Morgan Stanley (MS, Fortune 500) has also reportedly been weighing its options for its ownership stake in the hedge fund FrontPoint.

Spinning off these divisions or selling them outright might be viable options. Although with so many similar businesses entering into the market, it begs of the question of who exactly would buy them now that they are in regulators' crosshairs.

"That's more complicated since another person has to say 'I like that business,'" said Lister.

While Citi and Wells are taking action now, the industry is certainly under no significant pressure to act. Firms affected by the Volcker rule will have until 2017 to make sure they are in compliance with the new law. To top of page

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