The new investment banking mantra – that it’s no longer about revenue but about returns – is already becoming old. Always the contrarian, I’ve been thinking about what that means and whether it’s for real.
My bold conclusion: it’s a phenomenon that has flowed naturally from the economic, monetary business, political and regulatory cycles that have been in place since the global financial and eurozone sovereign crises. I sense current industry thinking will morph into something more akin to the growth-oriented strategies of the past, albeit with more control.
The recent cycle has certainly supported the new status quo. Growing top-line revenues sustainably when markets are so uncertain is a tough call, particularly when the tendency of clients is to sit on their hands and try to ride out the dips without losing their shirts. Second, growth is patchier and will perhaps be more uneven than current forecasts suggest. Third, emerging markets will remain vulnerable in the short term to the US rate tightening cycle given their huge stock of dollar debt and dependence in varying degrees on foreign inflows, so some fall-out is to be expected. Finally, we’re in the midst of a regulatory execution phase.
But what will the status quo morph into when we’re through this (probably) short-lived volatility phase? What happens when we’re through the regulatory execution phase (another two to three years)? What happens when we hit a pattern of more durable growth and people figure out that the China story is not a harbinger of Armageddon? What happens when we reach the next phase of the commodity price cycle? What happens when banks are through deleveraging and pressure on earnings subsides and business opportunities beckon? What happens to the investment banking story at that point?
The medium-term future is on a lot of leadership and management agendas today. And it should be. If you think about it, of the major IB players only Barclays, Deutsche Bank and Credit Suisse are hamstrung by ongoing strategic and operational challenges and remain heavily immersed in internal recalibration discussions today.
Future growth…
The US banks in particular are through it, and most European players are there or are getting there. What that means in many cases is seeking out future growth opportunities. Case in point, I read the other day that Citigroup is making a concerted play for a greater share of hedge fund business in equities as its leaders spot an opportunity to take up some of the slack left by rivals that have cut back and build out an area that hasn’t necessarily always been a strong calling card.
And that’s my point: banks are the ultimate opportunists and while scrutiny over capital and capital allocation will remain, I suspect the pressure to want to grab market share in core product, client or geographical areas will be difficult to pass up as a brighter future beckons. I suspect most banks will ditch the ‘returns-at-all-costs’ story and revert to form to start tentatively eyeing targeted revenue opportunities again. They won’t necessarily shout it from the rooftops but I sense an inevitability about it.
Returns and profits broadly speaking have been edging up and are regaining or have regained pre-crisis levels (if you adjust returns for lower levels of operating leverage) as bad bank/non-core strategies hit their stride amid a buoyant period for portfolio and business division offloads, and as banks push ahead with operational efficiencies in areas such as IT, middle and back-office solutions and focus on controlling their cost bases.
And don’t forget that those returns are improving even as banks are forced to raise ever-more capital and sit on some pretty chunky capital stacks. I note by the way that Barclays upgraded the pan-European banking sector to ‘overweight’ on August 27: “Our view is that it will provide above-average excess returns and significantly below-average volatility in the second half of 2015”, the bank’s analysts wrote, taking into account improving asset quality, CET1 ratio uplifts and other factors.
Where we are is staring at an industry that is actively dealing with its cost base and improving its returns profile and getting close to or already exceeding its costs of equity. Revenue growth is the missing piece that will increasingly scream for attention and a piece I think will increasingly get attention over time.
The problem with a purely returns-based strategy is that it by definition emasculates the notion of size and ignores critical mass. Critical mass is still important in investment banking if you have aspirations to be a player. I’m not sure what generating good returns on a business that has shrunk to boutique proportions is actually telling us.
As banks hit their deleveraging targets, what then? The only way is back up again and banks will look to book assets that fit their new-found target client profiles. And what of those firms, like UBS or Morgan Stanley, which have worked so hard to fix their crisis-damaged fixed-income businesses that are now a fraction of the size of the likes of JP Morgan? Or what of those firms that have cut back IBD capacity only to watch M&A and capital markets activity drift ever onwards?
I’m not for a moment suggesting that we’re going back to a ‘one size fits all global all things to all people model’. What I am saying is I think we will get to an Investment Banking 2.0 strategy cycle in the medium term and that if size isn’t everything it will get pushed up the priority agenda and revenue growth will stop being a dirty phrase.
