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Investment banking once delivered juicy profits. No longer
Sep 15th 2012 | from the print edition
THE best countercyclical indicator of the health of capital markets is when
investment banks cut staff, says a senior banker at a large American
investment bank. We always cut just before the cycle turns. But what if the
cycle doesn t turn? An industry that once seemed to offer banks the opportunity
to earn juicy returns and expand internationally is now in retreat almost
everywhere.
Some of this withdrawal has been going on since the crisis the fees paid to
banks for trading in capital markets as well as for advising on takeovers and
sales of shares and bonds have been falling for a few years now. But lately
retreat has turned to rout. Early this month Nomura, which had made a gutsy bet
on expansion when it bought the European and Asian businesses of Lehman
Brothers in 2008, in effect pulled the plug on its global investment-banking
business. Peers express little surprise. Nomura was dead before it started,
says the boss of one large bank. It was a totally ill-conceived foreign
expansion.
Yet other banks are pulling back hard, too. Deutsche Bank, Germany s banking
champion, plans deep cuts to its investment bank, a part of the business
responsible for much of its growth. Barclays is said to be considering slimming
its investment bank by as much as a fifth, reversing a decade-long expansion of
a business that contributes more than half of total profit. Both Barclays and
Deutsche are lowering their targets for returns on equity, in Deutsche s case
to just 12% after tax, well down on the 25% pre-tax target it once aimed for.
There are two main reasons for the sharp falls in profitability at investment
banks everywhere. The first is that their clients are simply doing a lot less
business with them. Income from trading bonds, currencies and commodities (an
area of activity known in the industry as FICC) has fallen as slowing economies
and turmoil in Europe have discouraged institutional investors from trading and
companies from buying one another or issuing shares. Equity issuance worldwide
dropped by about 30% in the first seven months of this year from a year
earlier; in debt markets, bond issuance has fallen by about 8%, according to
analysts at Mediobanca, an Italian bank. Number-crunchers at Deutsche Bank
reckon that revenue from investment banking around the world will total some
$240 billion this year, down by almost a third from 2009 (see chart).
The second reason is that regulations on capital and liquidity are starting to
bite. These are reducing returns earned by banks as well as forcing them to
shrink their balance-sheets and cut back on trading. Many banks are also
starting to position themselves for proposed rules that are not yet in force,
such as America s Volcker rule, which aims to stop banks trading for their own
account, and regulations that will shove over-the-counter derivatives, which
command fat margins, onto clearing-houses and exchanges.
Not everyone is gloomy: J.P. Morgan reportedly says investment banking has
never been stronger. But most other banks seem to have lost their mojo. The
most visible consequence of this is in headcount. London s financial industry
will have lost about 100,000 jobs by the end of this year from a peak of
354,000 in 2007, according to CEBR, an economics consultancy. New York s
financial comptroller reckons Wall Street employs almost 20,000 fewer people
than before the crisis.
Slashing variable costs is only half the story, however. The industry is
reshaping itself in other ways, too. First, there is the decline of stand-alone
investment banks, and the concomitant resurgence of universal banks, which
combine investment banking with the simpler commercial- and retail-banking
sort. Diversified, deposit-taking universal banks can maintain higher credit
ratings and can borrow more cheaply than specialist investment banks such as
Morgan Stanley or Goldman Sachs. As credit has become scarce, moreover,
universal banks have been able to demand a larger share of lucrative
investment-banking business from their clients in return for offering loans.
In response, investment banks such as Goldman Sachs and Morgan Stanley are
trying to expand into corporate lending, private banking and retail
stockbroking. This week Morgan Stanley reached a deal to buy out Citigroup s
49% stake in their Smith Barney retail-broking joint venture.
The second shift in the investment-banking landscape is a hollowing-out of the
midsized banks as the very biggest in the industry grab a greater share of
trading revenues. This is partly because the titans can afford the best trading
systems, but also because a bank with a large share of trading has the
liquidity that further increases its attractiveness as a trading counterparty.
Analysts at Deutsche Bank reckon that the five leading banks in FICC won 40% of
the market s revenue in 2011, up from 36% in 2007. Smaller banks that once
aspired to be global are expanding in markets closer to home instead.
The more open question is whether the industry s geographical centre of gravity
will also move, away from London and towards Wall Street and Asia. London s
natural advantages of time zone, law and language are not easily bettered. But
Asian and American banks have big deposit bases to call on to finance
expansion; European banks generally do not. And London s reputation has been
sullied by recent regulatory failures over issues such as the rigging of LIBOR
interest rates, as well as the political backlash against investment banking
that arose as a result. London hit Ctrl-Alt-Delete in terms of wanting to be a
centre of global finance, says the boss of one large universal bank.
Singapore and New York will be the new hubs of global finance and you can t
open enough coal mines to make up for that.
from the print edition | Finance and economics