NewOak Insights

GE Capital Unwind: One-Off Financial Engineering...

…or new non-bank finance trend?

by Ron D’Vari, CEO, NewOak

Mr. is NewOak’s chief executive officer and co-founder. He is responsible for advising NewOak clients in matters throughout the structured products and fixed-income asset lifecycle. Connect with him by e-mail: Reprinted with permission.

Due to rapidly and broadly changing regulatory and credit environments, banks and non-bank financial services providers are re-evaluating their strategies and looking ahead to a new post-crisis phase.

Business line optimization is becoming one of the key strategies now considered by those non-bank financial institutions designated as Global Systematically Important Financial Institutions (G-SIFI) by the Financial Stability Oversight Council (FSOC). The six key elements used by the FSOC for designating a non-bank financial entity a G-SIFI are: interconnectedness, substitutability, size, leverage, liquidity risk and maturity mismatch, and adequacy of existing regulatory scrutiny.

New Capital Requirements

G-SIFIs will be subject to new capital requirements (common equity tier 1 (CET1) based on a percentage of risk-weighted assets, to be finalized in 2015. It is expected that U.S. G-SIFIs will be required to hold additional capital equal to the greater amount calculated based on one of two methods.

  • The first method is consistent with the Basel Committee on Banking Supervision’s G-SIFI capital surcharge framework proposed in 2011 and set to be finalized in 2015. This method calculates the amount of extra capital to be held based on the G-SIFI’s size, interconnectedness, cross-jurisdictional activity, substitutability and complexity.
  • The second method uses similar inputs but replaces the substitutability element with a measure based on the entity’s reliance on short-term wholesale funding.
GE’s decision was partly due to impeccable market timing as financial and real estate assets are being viewed as overpriced again

The loose regulatory environment of the late 1990s to 2008 generated an extraordinary credit expansion that led to the formation of many finance companies and fed their rapid growth, but that period is over.

A Shift In Focus

The current climate has inspired many larger commercial and investment banks to alter their focus, re-evaluating business lines and restructuring them to foster growth, manage scale and facilitate tighter oversight for competitive advantage and higher profitability. GE’s announcement that it will jettison most of its finance business is a prime example.

GE Capital at its peak generated 57% of GE’s revenues, but has since dropped to 25% and is expected to fall below 10% of total revenues. GE’s decision was partly due to impeccable market timing as financial and real estate assets are being viewed as overpriced again while GE’s own stock has languished. Nonetheless, the decision must also have been driven in part by the higher scrutiny and capital requirements it faces as a designated G-SIFI.

Indeed, less is more for over-regulated G-SIFIs unless they commit to build super-efficient and highly integrated capital planning, risk and compliance management. This requires well-designed, documented and validated processes and infrastructure that serves the needs of multiple stakeholders, while standing up to scrutiny by federal, state and international regulators. Building such systems requires a significant investment that may no longer be justifiable by an institution’s present position and size in the marketplace.