The new new banking model

Remember when banks just took in deposits and used that money to make loans? That's what the future of banking might look like.

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By David Ellis, staff writer

NEW YORK ( -- It's not easy to make a buck in the banking business nowadays.

Citigroup (C, Fortune 500), Bank of America (BAC, Fortune 500) and Wells Fargo (WFC, Fortune 500) revealed last month that they lost billions in the latest quarter, as the U.S. economic climate worsened.

Weary of their abysmal results, attacks from shareholders and the watchful eye of regulators, banks are now thinking long and hard about how they do business.

Some industry analysts predict that more financial institutions will move back towards the traditional business of taking in deposits and using that money to make loans.

"It is back to basics," said Anton Schutz, president of Mendon Capital Advisors, a firm that invests in financial stocks. "Basic banking will prove very profitable."

Banks keeping more loans on their books

While the migration back to traditional banking may seem sensible given the current economic climate, some banks, particularly the larger financial institutions, may do so almost out of necessity.

The securitization market is at a near standstill. So banks that originated loans and later packaged them together as securities to sell to investors are now having to hold the loans on their books. That has forced banks to be a bit more conservative.

But if banks keep more loans, they are also going to need more capital on hand in the future.

There have been calls from industry experts and policy groups like the Group of 30, a non-profit think tank chaired by former Federal Reserve governor Paul Volcker, for regulators to raise capital requirements for banks.

Under current rules, banks are required to keep their so-called Tier 1 capital ratio - a key measure of its ability to absorb losses - above 6%. Some analysts suspect the bar could be raised to 8%, given how desperately many of the nation's largest financial institutions are trying to hold onto capital in the current crisis.

However, some experts fear that a more cautious approach by banks will have consequences for borrowers.

Eric Hovde, chief executive of Hovde Capital Advisors LLC, a money-management firm in Washington that focuses on the financial services sector, anticipates that banks will continue to take a hard look at who they lend to attempt to compensate their risk in the future by charging a premium.

"Rates are going to go up across the board," he said. "If you are a subprime or even Alt-A type credit, you are not going to get credit unless it is at very usurious rates."

But Sam Golden, head of the Financial Industry Advisory Services Group at Alvarez & Marsal, who also served as the former ombudsman of the Office of the Comptroller of the Currency, said that the packaging and selling of loans by banks won't go away altogether since it helps spread out the risk for banks and also provides liquidity for the broader financial system.

"I think the overall model philosophically is not a bad model," he said. "But I think there will be in some case a permanent abandoning of crazy kinds of [investment] products."

End of era for big banking?

Many are already betting that 2009 will be a pivotal year for the nation's banks. More banks are expected to disappear -- either through outright failure or by selling to a rival.

At the same time, there is a sense that Congress and the White House will make greater demands on banks after the government rescued pockets of the industry from collapse last year.

Industry groups like the American Bankers Association are hoping that regulators take a hard look at what they believe to be the drivers behind bank losses, particularly current accounting standards that require banks to mark the value of their assets to market prices.

But many suspect that lawmakers will, at some point, craft legislation that will levy more regulation on the industry.

There is also the fear that regulators could push some of the nation's largest financial institutions to break up into smaller pieces.

The sheer size of some of these companies placed the broader financial system in jeopardy more than once during the current crisis, and regulators had to make tough decisions on which companies were deemed too big to fail.

Some banks are already moving in this direction. Last month, Citigroup unveiled plans to split into two distinct entities, effectively bringing an end to its financial services "supermarket" model.

Others have argued that large financial institutions like Citigroup and peers such as JPMorgan Chase (JPM, Fortune 500) should be restricted from indulging in risky businesses like hedge funds and private equity.

In its report last month, the Group of 30 suggested just that, adding that regulators rein in big banks' proprietary trading business, or investments made with the firm's own money.

Should regulators push hard on shrinking the nation's big banks in the coming years, Citigroup and Bank of America would most certainly be among the leading candidates.

"These companies have gotten too big and too cumbersome," said Hovde. "They are too big to manage." To top of page

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