Investment banking: a rich industry gets poorer

A rich industry gets poorer


In a fast-changing environment, investment banks are facing a challenge familiar to many industries: how to stem rising costs and plunging profits.

“Investment banking” is an industry synonymous with riches. Its big names, such as Goldman Sachs, J.P. Morgan, Morgan Stanley and Deutsche Bank, summon up images of smart suits, tall buildings and expensive lifestyles.

A March report by Citi estimated investment banking and markets together make up almost 20 per cent of all the profits in the global banking industry.

Yet the world’s richest-sounding industry has also turned into a low performer, hammered by technological change and sluggish economic growth. According to a May report by Boston Consulting Group (BCG), investment banking revenues globally will suffer their fourth consecutive drop this year, an estimated 7 per cent, to a mere – well, lower – US$212 billion.

Next year could be worse. Those numbers are in line with a March report from Morgan Stanley researchers.

Banks have been trying to turn the situation around, but BCG expects the industry’s return on equity to stay stuck at about 6 per cent, well below an estimated cost of equity of at least 10 per cent.

"Investment banking revenues globally will suffer their fourth consecutive drop this year." Boston Consulting Group 

Impact of technology

Among the forces driving the fall, one is particularly familiar – technology, which is increasingly opening up markets to anyone who wants to trade. Worst hit is the investment banking activity known as FICC – fixed income instruments, currencies and commodities.

In 2012, this generated 70 per cent of industry profits; by last year, that had fallen to just 44 per cent. Areas such as bond trading desks, which used to be noisy profit centres, now have a lot less staff. 

BCG argues investment banks must “fit themselves into increasingly electronic, standardised and transparent markets” – a battle that, so far, they are losing.

At the same time, the banks face continued IT expenses to keep up in an increasingly tech-driven industry. Goldman Sachs remains the most profitable of the major global investment banks, and CEO Lloyd Blankfein says of his business that “we are a tech company”.

Like so many other industries, investment banks are expanding their spend on data and analytics. Business Insider reported last year that 9000 of Goldman’s 33,000 employees are engineers and programmers. That’s more than Facebook, Twitter or LinkedIn. 

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Another problem: regulators are demanding the big investment banks hold more capital. The banks are trying harder to sell off more of the assets that require most capital; even so, regulation is cutting heavily into profit. 

On top of that, fines have actually become a serious cost for the industry.

Sluggish economies are also making businesses less eager to raise money in debt and equity markets and to take over or merge with other businesses. These are the primary investment banking functions where banks have traditionally assisted their clients and earned big fees.

Tightening the money belts

Investment banks, like any other business, eventually have to respond to such news by cutting costs.

Investment banking's revenue collapse.“The need for a comprehensive and surgical assessment of business lines and client coverage continues,” says BCG.

It notes that the investment banks have been cutting costs in the primary investment banking functions and other areas of the so-called front office. Morgan Stanley predicts these areas will see revenue drop further, by 10 per cent in 2016. Deal-makers are not getting the bonuses they used to get.

Now, says BCG, the banks are taking a new step and aiming to cut back-office functions such as compliance and risk, where headcounts have been increasing for years amid the post-global financial crisis regulatory changes. 

Many analysts now say that just being a giant bank doesn’t confer the advantage it used to and that the real gains come from leading in particular areas. 

As Morgan Stanley’s report puts it, “scale benefits are increasingly pronounced at the product level, but less clear at the bank level”. For instance, Morgan Stanley somewhat immodestly says the top five banks in global equities trading are Morgan Stanley, Goldman Sachs, J.P. Morgan, Credit Suisse and Bank of America, and they are making good profits.

Related: Banking facing pressure to adapt in changing marketplace

Rivals with less of a speciality in the field are not. That’s leading some banks to point to areas of specialisation. Credit Suisse, for instance, has signalled it will focus on wealth management, especially in Asian markets, where it is still adding headcount.

Exploring other avenues

BCG does see new opportunities for investment banks. Some will grow bigger as their rivals retreat. Some will be able to build their sales of information. Others, though, will need “a change in mindset and approach to explore alternative revenue opportunities beyond their traditional roles”. 

Investment bankers, as it turns out, have the same challenges as everyone else in today’s business world.


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