Rising interest rates and a favorable regulatory environment are among the catalysts seen supporting exchange traded funds such as the SPDR S&P Bank ETF (NYSEArca: KBE) and the SPDR S&P Regional Banking ETF (NYSEArca: KRE), the largest regional bank ETF.

Importantly, some analysts believe the Trump Administration’s efforts to ease the Dodd-Frank legislation will not be credit negative for smaller banks. Efforts to scale back Dodd-Frank are viewed as more helpful to smaller banks, regional banks and trust banks than large- and mega-cap money center banks.

“A bill easing financial regulations for US small to mid-size banks is not likely to be a near-term ratings issue, but over time could have negative credit-profile implications for banks particularly as it relates to capitalization, liquidity, risk management and governance,” said Fitch Ratings in a note out Thursday. “Regulators have already signaled willingness to ease or modify regulations for less-complex banks; we view robust regulation as supportive of bank creditworthiness, therefore, broad-based legislative deregulation could be negative for ratings depending on how banks respond.”

What Does the Fed’s Increased Interest Rates Mean?

Earlier this week, the Federal Reserve raised interest rates by 25 basis points with bond market participants expecting up to three more rate hikes before the end of this year, a theme expected to benefit bank stocks and ETFs. The financial services sector could be working its way into a period of long-term out-performance. The recent rally in the sector could still be in the early innings, according to some market observers.

Higher interest rates would help widen the difference between what banks charge on loans and pay on deposits, which would boost earnings for the financial sector. Regional banks are among the stocks most positively correlated to rising interest rates because higher rates improve net interest margins.

A more favorable regulatory environment could help the financial services group, the S&P 500’s second-largest sector weight, as well.

“Banks between $50 billion and $250 billion in assets may see some meaningful benefit, as mid-size lenders would see alleviated stress tests burdens and exemption from enhanced prudential standards,” said Fitch. “Banks with less than $10 billion in assets would be exempt from the Volcker rule restrictions on speculative trading, and banks originating less than 500 mortgages annually would be exempt from some of the record-keeping requirements of the Home Mortgage Disclosure Act. The Volcker rule exemption would not aid large banks, which must still demonstrate compliance with the rule.”

For more information on the financial sector, visit our financial category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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