Financial services stocks and exchange traded funds, such as the Financial Select Sector SPDR (NYSEArca: XLF), have recently had the wind at their backs. This month, the Federal Reserve helped XLF and rival bank ETFs with its interest rate increase of 2016 while unveiling expectations for three more interest rate hikes next year.
Prior to that, the financial services sector was buoyed by Donald Trump’s surprise victory in the U.S. presidential election in November. XLF’s year-to-date gain now resides just under 25%, good for one of the best showings among non-leveraged sector ETFs.
In addition to corporate tax reductions, Trump is looking to ease the regulatory burdens faced by many of the big name companies in ETFs like XLF.
Trump has said he would “dismantle” financial reform, or the Dodd-Frank financial reforms, that have caused big banks to take on increased capital requirements to obviate another depression event associated with high-risk debt.
However, Trump’s deregulation efforts for the financial services industry have some doubters.
“Everyone agrees big banks borrowed excessively before the 2008 bailouts, and they should have been required to maintain more capital. Critics have said the new capital mandates have been set too high, constraining lending and economic activity. Many Democrats and conservatives disagree,” reports the Wall Street Journal.
At issue for some big-name XLF components is the leverage ratio, designed in the wake of the financial crisis to prevent large-scale bank failures.
“It’s designed to reduce the chances a bank will fail by acting as a constraint against borrowing, or leverage. After the crisis, U.S. regulators required that big banks maintain a leverage ratio of at least 5%,” according to the Journal.
Trump and the Fed have been obvious catalysts for XLF and comparable ETFs. Since Nov. 9, the first trading day after Election Day, investors have allocated nearly $5.7 billion to XLF. That is good for one of the best inflow totals among all sector ETFs over that period, underscoring the point that if Trump moves away his pro-deregulation tone, financial services ETFs could be vulnerable.
Higher leverage ratios could be a drag on banks’ average return on capital, according to the Journal.
For more information on the banking sector, visit our financial category.