All change

IFR Review of the Year 2014
14 min read
Gareth Gore

Investment banks have had to tear up decades-old strategies and rethink their purpose since the financial crisis. Their leaders tell IFR about the shape they are in now, what they think will happen next, and what the industry will look like after all the upheaval.

The seven fat years in the run-up to the collapse of Lehman Brothers, when Deutsche Bank built its investment bank from bit-part player to the biggest show in town, are now a distant memory. For a business that once boasted a €2trn balance sheet, bigger than its rivals and more than the annual economic output of most countries, recent years have been humbling, with cuts – to the cost base, to personnel, to the balance sheet – the name of the game.

At its height, the investment bank pulled in €21bn in revenues a year. But bosses will be lucky to tally €13bn this year, meaning 2014 will probably go down as the weakest since a calamitous 2008. Return-on-equity, which soared above 50% in some of the investment bank’s best quarters before the crisis, will struggle to get out of single figures. At the same time, its balance sheet has been slashed by more than 40% – or €840bn – since its peak.

It’s a story repeated across the industry. In theory, banks should be doing well right now: debt issuance is at an all-time high, equity markets are breaking records on an almost daily basis and bond prices continue to soar. But regulations brought in after the industry virtually imploded have forced almost all banks, including Deutsche, into acute retrenchment in order to meet the dramatically increased levels of capital that they must now hold.

“When there were few constraints on capital and leverage, everyone had the same strategy – revenue maximisation, which meant you were constantly looking for gaps in the market or gaps in your business that you could fill,” said Colin Fan, co-head of Deutsche’s investment bank. “But with the new rules, it is all about optimising your business to deliver the best returns within the new limits of what you can do. Everyone is working with fewer resources.”

For Fan and his peers, that has meant figuring out how to work with far less leverage. Before the crisis, lax regulations and crafty interpretation of the rules allowed Deutsche to run its investment bank more than 100-times leveraged, meaning €100 of assets were backed by less than €1 of equity. Although still high, leverage at its investment bank has since fallen to 47 times. New capital rules have without a doubt made the system safer – but they have also reduced banks’ ability to make money.

The prohibition of certain lucrative activities and the shift of some products to exchanges have also taken their toll: an industry that once earned US$300bn annually will bring in just US$230bn this year, according to Morgan Stanley. Revenues have in effect been pushed back a decade. Banks initially responded with deep cost cuts and tens of thousands of redundancies. But a subsequent decline in fixed-income trading has forced more fundamental overhauls, with most banks re-evaluating each line of what they do over the last two years.


Some bankers say the need to find efficiencies and properly cost the balance sheet is a welcome change after the abundance of the 2000s. “Regulation is now forcing banks to examine the economics of each and every trade and relationship we have,” said Paco Ybarra, global head of markets at Citigroup. “After the years of abundant liquidity, we need to be very selective in what we offer and to which clients.”

Tom King, the man who runs Barclays’ investment bank, shares that analysis. “The world has changed in a fundamental way since the crisis,” he said. “The whole industry has been forced to step back and make judgments in terms of how you generate returns for shareholders under these new rules. We have looked at every single line of our balance sheet and questioned whether it is a strategic use of our capital and whether it is something that can generate the required returns in the new world.”

Barclays has certainly taken some tough decisions, reversing many of the expansionary moves made under the stewardship of Bob Diamond in the late 1990s and 2000s: cutting its presence in Continental Europe and Asia, exiting much of the physical commodities business and rebalancing resources within its flagship macro business to areas where (it hopes) it can make a decent return. Underperforming businesses either lose resources or are cut out completely. The firm’s big global ambitions are gone.

The moves will reduce the firm’s capital bill, making the hill much easier to climb. But cuts to its balance sheet – once bigger than the UK economy at £1.6trn but down by two-thirds since – will severely affect its future earnings capacity. Revenues peaked at £13.6bn during Diamond’s last year in charge in 2010. They will fall to about £7.5bn this year. King’s gamble is that the returns of a shrunken, more focused business will be better than those of a full-scale, bigger investment bank.

But the success of that strategy hinges on whether the current downturn in activity turns out to be cyclical or secular. At the centre of that question is fixed income, which has seen the biggest slump in revenues and now brings in just of half the almost US$200bn of business it boasted at its peak. The problem for most banks is that, unlike equity markets, fixed-income markets are illiquid. Dedication to the asset class requires a big balance sheet – and capital. Riding out perceived cyclicality could prove expensive.

Staying the course

Unlike Barclays, Deutsche believes it is worth staying the course (though it is worth mentioning that Deutsche’s co-CEO Anshu Jain built up the fixed income business, whereas Barclays is now run by a retail man at group level).

Despite the German investment bank’s cuts elsewhere, it is reluctant to make deep cuts to the breadth of fixed-income products it offers. And that decision has come at a cost: it has had to raise €13.5bn of capital (something of an embarrassment, given Jain’s repeated suggestions that it was well-capitalised). But Fan believes the additional capital and fresh ways of working will make the bet pay off.

“What we did as a firm in the 1990s and 2000s in building the franchise was phenomenal – it took us 15 to 20 years to build what it took the big Wall Street firms a century to,” said Fan, who was named co-head when Jain took on the CEO role in 2012. “But at the same time, we recognise we can’t be a dinosaur: we need to learn from the technology companies that are constantly reinventing themselves. We need to adapt.”

But trimming a business around the edges can be counter-productive, according to Didier Valet, who was Societe Generale’s CFO before taking over the investment bank in 2012. During the last few years, the bank has pulled out of certain areas and retrenched in the US in order to focus on its strengths in equity derivatives, financing and advisory.

“Sometimes it is better to make choices to cut certain activities rather than cut a little bit everywhere, which can really hurt the franchise and your ability to compete,” said Valet. “It is very difficult to read through cycles. But at the same time you have to make a call on some products, and very soon we took the view that things like electronification and new capital rules would mean a structural shift in the demand for some products.”


Others have gone even deeper. UBS sent shockwaves across the industry in October 2012 by announcing that it was pulling out of large swathes of its fixed-income platform – including its sovereign bond operation, once considered the linchpin of any serious fixed-income business. Some 2,000 front-office and 2,750 back-office roles were cut in the investment bank – many employees found out the day of the announcement, when their passes stopped working – leaving the business with half the staff it had in mid-2007.

Although on a much bigger scale, the UBS decision was, like SG’s, a return to the bank’s roots. Because of its extensive wealth management arm, UBS had long been a big player in equities. But a belated rush into fixed income in the 2000s backfired massively, contributing to its US$60bn of losses in the crisis. The decision to re-focus on equities and advisory came when both those businesses were struggling, leading many to doubt its wisdom.

But some of the banks that have made the deepest cuts have reaped the biggest rewards – at least in terms of RoE. UBS, which has shed 85% of the assets in its investment bank since the crisis, posted one of the best RoEs in the industry in the first half of the year at around 26% (if the assets carved out into a “bad bank” are ignored). Commerzbank, which has ditched its global ambitions to concentrate on the global needs of its core German clients, averaged about 19%. Meanwhile, SG averaged an RoE of about 17.5% during the period.

Double-digit returns

At the same time, many of the houses that have opted to keep their platforms largely intact have struggled to deliver double-digit RoEs. Nevertheless, many in the industry believe that the UBS approach, while right for the Swiss firm, is wrong for them.

JP Morgan – alongside a small group of others including Citigroup, Goldman Sachs, Bank of America Merrill Lynch and possibly Deutsche – has concluded that it can make the full-scale global investment banking model work. Daniel Pinto, the head of the investment bank, has made deep cost cuts to his business and exited commodities. But he wary of further deep product cuts.

“It is very difficult to make a decent return as a full-service house under the new rules unless you have reach across countries and products, and we decided early on that we absolutely needed to keep that reach in order to make it work,” said Pinto. “Everyone is facing these new higher costs, but we feel that with scale we have found efficiencies to make it work.”


So far his perseverance has worked – the firm is one of the few that earns more now than before the crisis. The business is set to bring in US$32bn this year, up from US$18bn in 2007, although a large chunk of that increase is from businesses since moved into the investment bank. The firm has increased its balance sheet since the crisis, something Pinto is reluctant to reverse. “If you start cutting the balance sheet, you start cutting the franchise,” he said.

Another risk is that, once you get out, you can’t get back in. As the economy rebounds and demand for certain products comes back, banks that went the way of specialisation may feel the need to reverse course. That might force a round of consolidation – which would require regulators to grow more comfortable with bigger banks. Not everyone believes that will happen.

“The cost of operating a global investment bank has increased so much over the last few years that consolidation should be the logical outcome,” said Pinto. “But it isn’t, given the regulatory environment.”

Banks may also have to change the way they offer products, possibly teaming up with rivals or alternate providers.

“Like the car industry in the 1990s, since the crisis banks have been through a period of cost reduction, retrenchment and specialisation,” said Commerzbank investment bank chief Michael Reuther. “Like car manufacturers, I think the logical next step is to begin thinking about teaming up in certain areas or specific services where banks individually perhaps can’t make the economics work. Banks will have to work out a way of doing that whilst keeping the proprietary knowledge and relationships.”

However the industry looks in five or 10 years – whether the changes are temporary or permanent – many bosses are convinced that the industry will come out of this upheaval in much better shape to deliver returns to shareholders. So long as there isn’t another crisis, that is.

“As an industry we have saved huge amounts on the cost side over the past few years, but at the moment shareholders aren’t reaping those gains: much of that money is going towards litigation, fines, ongoing investigation work, implementing regulations and the like,” said Fan.

“It is like having a very good engine that has got some sand in it, which has slowed it down. Once the sand is out, the engine will show just how healthy it is again.”

To see the digital version of the IFR Review of the Year, please click here.

To purchase printed copies or a PDF of this report, please email

All change