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A new report on the state of global investment banking identifies two things that are about to get smaller: the number of risk-weighted assets held by banks, and the bottom lines of non-North American banks with operations in the U.S.
The projections are outlined in the Wholesale & Investment Banking Outlook released by Morgan Stanley and consulting firm Oliver Wyman on Thursday. For those interested, the document can be found here. But be warned: it's a wonky read.
If you'd rather not dig through the whole thing, we've summarized the key points.
Risk-weighted assets
Across the industry these assets have already been slashed by about 25 per cent by reworking legacy credit books and being much more disciplined. (Royal Bank of Canada is one of the major banks involved.) But the authors expect another 15 per cent-to-20 per cent reduction to come in the next few years.
"We think the challenge now is even more about costs and improving portfolio returns," they said. For each security – equities, rates, fixed-income – there are three or four banks who dominate the space, and those with sub-par returns can't afford to allocate capital to failing business lines any longer. In effect, they "are forced to rationalize and focus on areas where they are competitive to improve return on equity."
This trend could have a dramatic effect on the equities business. "Our analysis suggests only the top three to four players in equities generate return on equity above cost of equity given fixed cost base, making the business more geared. Also, given the overcapacity and the low returns for many players we expect further restructuring or downsizing to come unless equities volumes pick up substantially," the report said.
Regulation
It's no secret that regulators are cracking down on the way banks operate. But some institutions are better suited for the changes than others. Chiefly, the report stresses that the proposed U.S. foreign banking organization proposals will dramatically hit non-North American banks. If implemented, foreign banks will have to comply with the new standards of the Dodd-Frank Wall Street Reform and Consumer Protection Act, even though they are technically governed by their home regulators.
This proposal is particularly important because Morgan Stanley and Oliver Wyman calculated that the Americas represented 47 per cent of global revenues in 2012 and 55 to 60 per cent of global profits.
The authors argue that Deutsche Bank will be particularly affected because 37 per cent of its balance sheets is devoted to its U.S. subsidiaries. "We expect [the regulations] to be addressed through substantial balance sheet shrinkage (e.g. by one-third at DBK) as well as filled by "CoCo" and/or hybrid [bond] issuance rather than by straight equity," the authors said.
This is good news for major U.S. banks who "will be able to take advantage of the exit or downsizing of European players from the attractive U.S. market as they face higher regulatory standards and funding costs than in the past," they added. "US players will also have the opportunity to acquire portfolios that European banks may be pressured to sell (i.e. recent sale of loan portfolios by RBS, BNP)."
OTC derivatives
The report devotes a lot of time to the changes to this market, in large part because of the new rules for centralized clearing. However, the expectations are mixed. Over the next few years the authors expect revenues to fall by $10-billion- to-$15-billion (the market's total revenue from these products is $80-billion), but then a few years out it expects $5-billion-to-$8-billion to be clawed back after everyone has adapted to the new environment. So the effects are still quite murky.
(Tim Kiladze is a Globe and Mail Reporter.)
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Tim Kiladze