Who’d be a bank strategist or risk officer at the moment, particularly at a second-line or regional investment bank/CIB with ambitions? The planning environment is in many ways more confusing now than it was during the crisis.
When the market’s in free-fall and everyone’s gripped by panic, natural survival instincts kick in. Banks pull their trading lines, sit on what funds they have, let the phones ring off the hook to avoid having to make markets, stop lending to customers and generally rein in market, price and liquidity risk.
The market situation investment banking professionals find themselves in today, particularly in Europe, is puzzling. Fears of a double-dip recession have given way to something far more dangerous: the collapse of the euro or a sovereign default.
There’s a real sense that market conditions will turn nasty in the event of a default or other major market event. But there are so many economic riders and political “what-ifs” thrown in that it’s hard to know what the right thing to do is – or what the market is already pricing in.
Banks are in the midst of planning their 2011 budgets to meet pre-agreed strategic or tactical goals but are being forced to re-think prior assumptions. Bank CEOs, divisional heads, chief risk officers and strategists are now seriously attempting to model a collapse of the euro into their medium-term plans – and are scratching their heads in attempting to quantify the degree of risk involved and how to manage it.
At an internal strategy session of a major European bank last week, such talk from an executive board member had a large room of senior bank officials reduced to stunned silence. Thinking about it as a possible but unlikely event is one thing; acknowledging it’s part of your risk profiling and planning elevates it to the realm of realpolitik. The challenge posed to division heads at this particular meeting was to factor potential fallout from a euro collapse into product and regional business planning.
Similar discussions are taking place across the industry. In the absence of signposts, though, where do you start? The legal means to exit the euro are not well defined in the Maastricht Treaty. And even if countries do find an exit route, it is by no means certain that the peripheral economies can simply return to legacy currencies as if the euro never existed.
The political and economic consequences of exiting the euro and how the banking sector fares in the mix are profound issues with profound consequences. One report just out reckons that one of Portugal, Ireland, Greece or Spain will be forced out of the euro within three years and the rest will follow in a pernicious domino effect. It recommends that the peripherals negotiate their exit now rather than being ejected, or defaulting on their obligations and potentially setting off an explosive banking crisis.
While the combination of ballooning deficits, spiralling debt service costs and a lack of market access could send some of the eurozone economies over the edge, it just feels a tad too early to play the Armageddon card. But by the same token, it’s hard to rule it out completely.
As if this wasn’t enough, S&P’s Annual European Corporate Credit Outlook is predicting that European corporate default rates will rise from 2012 on the back of “economic headwinds and refinancing challenges”, mainly among 2006 to 2008-vintage LBOs, driving the default rate to 6.5% or even higher. This creates another moving target for banks to take account of.
So where does this all leave the ongoing arms race to capture investment banking wallet share next year and beyond?
Not surprisingly, perhaps, it probably plays into the hands of the market leaders. Coming out of the crisis, there was a real sense that the status quo was changing or could change, that the previous market leaders were potentially vulnerable. This was certainly the case at the individual product and/or regional level.
The mantra of the big strategy consulting firms that are advising many of the investment banking pretenders on the way forward is that there are gaps in the market and that the field is open to new players with fat cheque books and the stomach for a fight.
The advice to second-line players or would-be challengers in this column – and it’s free advice – is simple: don’t go there. The time to challenge incumbents in the current cycle is past. The majors have rebuilt or re-engineered their client and institutional franchises and are almost all back in business.
The best advice to those planning on spending significant sums of money to challenge the existing market hegemony is: save your money and stick to your knitting. It’s going to get bumpy out there and this is no time to be a hero.