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The rally in the banking sector since the election has boosted the likes of Goldman Sachs and Citigroup. However, we are yet to see any details on the new president’s tax plans or his efforts to roll back regulation. In the short term, we could see some of the euphoria unwind, but in the longer term there is a clear set of reasons why bank stocks may be winners in 2017.
Firstly, the tax cut plan as Donald Trump has suggested that US corporate taxes will be cut from 35% to 15%, with the possibility that this will come faster than looser financial regulation. Data from Bloomberg suggests that US banks paid around 28% of their earnings in tax in 2015, compared to 14% for other big firms in the US. It’s likely that Citigroup, which garners a large proportion of its earnings from outside the US, and Bank of America, which already pays a lower tax than its peers due to existing deductions would benefit less, but Goldman Sachs, JP Morgan and Wells Fargo could be big winners from tax cuts.
The other side of the bull case is the expected reform of financial regulations. This would likely see a relaxation of lending rules, based on the president’s view that the American financial sector is not providing sufficient credit to small and medium-sized businesses. In addition, there have been suggestions about repealing the ‘Volcker rule’, which prevents banks from engaging in proprietary trading.
However, repeal or reform of regulation takes time. The new treasury secretary, Steve Mnuchin, has already said he prefers modifications to the Volcker rule rather than outright repeal, while Federal Reserve chair Janet Yellen signaled after the election that she believed regulation had made the banking system safer.
It will not be easy to alter regulations, and it may also take some time to get tax cuts through. However, lower taxes and concomitant higher earnings, plus a wider playing field for banks, could be the tonic the sector needs. We will likely see corrections in the banking sector during the year, but this is definitely one to watch in coming months.