8/2/2019 Robert Wilmers: Regulation and the State of the Banking Industry

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During Berkshire Hathaways (BRK.A, BRK.B) Annual Meeting this past Saturday, Charlie Munger and

Warren Buffett both recommended that investors reading M&T Banks (MTB) recent annual letter,

written by CEO Bob Wilmers. I took the time to sit down and read it today, and they were right (as

usual): it has a lot to say about the US financial economy, and the future of banking. One section in

particular, entitled Regulationand the State of the Banking Industry provides some fantastic insight

into the industry.

In the letter, Mr. Wilmer discusses a couple of factors that he is concerned about, including:

Increased concentration in the financial services sector Outsized-compensation, which draws talents away from professions crucial to economic growth A government regulatory regime which both enables the virtual casino to continue

INCREASED CONCENTRATION

Traditionally, banking has been a regional/community enterprise in the United States, where customer

deposits were gathered and credit was extended for enterprise and commerce. This regional theme isevident in market share figures: in 1990, the six large financial institutions held less than 10% of

domestic deposits and just 14% of banking assets. However, the picture is very different today: as of

September 2010, the six largest banks accounted for 35% and 53% of deposits and assets, respectively.

Along with concentration, as we have seen, comes an increased risk that poor decision making at the

larger institutions can lead to systemic risk. This has become more relevant as the large institutions have

differentiated from traditional sources of income. In a search for higher returns, the largest bank holding

companies have ventured into new activities, including trading in all shapes and forms of derivatives,

credit default swaps, mortgage-backed securities and other even more complex and exotic instruments

(often associated with high amounts of leverage) for which the collapse in value played the key role in

precipitating the 2008 crisis.

To put it into numbers, trading revenues, which exceeded $130 billion at the six largest financial services

institutions over the past two years, accounted for more than 90% of such revenues (trading) at ALL

American banks. Mr. Wilmer eloquently explains the problems this has led to: One can make a case

that trading indirectly contributes to economic growth by facilitating more efficient financial markets.

However, unlike traditional commerce, where success is defined by the creation of new industries and

jobs through entrepreneurship and innovation, too often the core function of trading is redistribution of

wealth to those who have a trading advantage, be it talent or capital, from those who trade out of

compulsion (e.g. distressed entities) or trade with limited knowledge of the instruments being traded.

That such activity is being conducted by bank holding companies which enjoy government protection

represents a profound departure from the traditional banking model that in which lenders and

creditors knew and had to trust one another and built relationships meant to serve our capital allocation

needs.

The issue for someone like M&T Bank is that they (along with other traditional commercial banks) have

been lumped into this category; as Mr. Wilmer says, it is akin to describing dinosaurs as simple reptiles

it is true but profoundly misleading. As such, traditional banks should not be viewed by the public or

regulated by the government in the same way that these financial institutions should.

8/2/2019 Robert Wilmers: Regulation and the State of the Banking Industry

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OUTSIZED COMPENSATION

Trading profit, and the huge importance that it plays in the income statement, is the reason why

outsized compensation packages have become the norm at these big financial institutions. For most of

the 20th Century, financial services wages have generally ranged from 1.0-1.5x of the average non-farm

U.S. worker, usually in the lower end of the range. By comparison, the average 2009 investment

banking compensation at four of the top six banks was at least 6.0 times that of an average American

worker. As a result, the financial services industry is luring bright minds away from science, medicine,

and engineering; thus is the result when financial professionals earn 30-40% more than engineers.

As Mr. Wilmer notes, personal financial gain is not really the issue; there is ample opportunity to

generate even larger profits through vehicles like hedge funds, where the top 25 paid executives

averaged more than $1 billion in 2009; it is of greater concern when we allow the creation of a business

model, predicated on wealth transfer rather than wealth creation, to have access to government

protection and resources and thus linked their risk profile to that of traditional banks; to take activities

that are purely capitalistic endeavors and bring them into a regulated environment under the umbrella

of insured protections is simply not prudent. Would it not be better to let those engaged in such

activities live and die by the pursuit of their fortunes rather than impose a burden on the wholeeconomy.

GOVERNMENT REGULATION

In all the current discussion about increased regulatory oversight regarding the prevention of future

crises, too little attention has been paid to downstream effects, namely the economic burden borne by

traditional commercial banks like M&T, and in turn the customers we serve. As a result, commercial

banks like M&T have seen increased expenses (nearly $90M in additional regulatory compliance last

year) and reduced revenue ($75M on an annualized basis for overdraft fee changes); Mr. Wilmer

believes these compliance and new regulatory developments, had they been fully effective during 2010,

would have amounted to more than 20% of pre-tax income. Inevitably, these changes will lead to ahigher cost of credit for bank customers. In essence, those who will pay for the sins that sparked the

financial crisis will be the small business owners, entrepreneurs, innovators, and individuals who rely on

Main Street banks like M&T.

As Mr. Wilmer notes in his closing, It is always good to report, as I have once again been able to do,

that M&T is doing well. It is much to be preferred, however, for M&T to thrive as part of a thriving

America. That is what we must hope for and work to achieve.

The annual letter is a truly fantastic read; for anybody who is interesting, here is the link.