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The tide is turning on Europe’s underloved IBs

Cynicism is infectious, especially in the capital markets, and it has been easy to sneer at Europe’s investment banks. Lacking scale in the muscle-bound world of bond trading, and hobbled by scandal and regulation, the prevailing narrative has been that they should go big or go home.

Banks that have retrenched to profitable niches have been rewarded; those with big (but not big enough) operations have been punished, even when these institutions still have clear pockets of specialist strength.

Deutsche Bank, the only European bank which is still banging the drum for full scale global universal banking, has seen market commentators take pot shots at its ambition, implying that with its skinnier capital base, it will struggle to take on JP Morgan, Bank of America Merrill Lynch and Goldman Sachs.

But maybe the tide is turning. The mantra that there’s no such thing as a bad asset, just a bad price must be borne in mind, but a note from Deutsche picks Barclays and Credit Suisse as its top value investment bank stocks. JP Morgan’s bank team added Deutsche and Société Générale, and ING to its top picks in the sector.

The Deutsche note says: “We also think that European bank market shares are stabilising and even increasing in some banks/product lines. In fact, we see a variety of strategies thriving in the new investment banking environment. Given in general Europe’s banks are adopting more diverse/narrow strategies, we see this as a positive.”

In other words, the big disaster has not happened. European banks might lack scale in certain areas, for example, in the industrial scale movement of US Treasuries and agency mortgage backed securities, but that has not stopped them making money in their niches, even in closely related fixed income trading businesses. Cutting unprofitable long duration structured rate swaps has had little effect on banks’ abilities to make markets in African sovereign bonds, UK RMBS or Slovenian certificates of deposit it seems. It has had even less effect on equity trading or banking businesses.

Conduct risk remains huge. This is the best explanation of why new Barclays shareholders appear to get the investment bank for free, on Deutsche’s read of the present implied valuation. With BNP Paribas’s $9bn fine and Bank of America’s $17bn mortgage settlement fresh in the minds of shareholders, the concern is reasonable.

But this appears to be discounted across the industry. In the wake of the BNP Paribas fine, the outrage of the French (including the president) made it seem like US regulators were picking on European banks.

But the biggest conduct payments have been mortgage settlements from the big US banks, followed by payment protection insurance compensation from the UK banks. BNP Paribas’s sanctions busting $9bn penalty stood out, but the $300m fine doled out to Standard Chartered is more typical.

Other ugly behaviour will doubtless be revealed, but those in the market seem to be putting conduct issues behind them. Trading volumes are low (but will pick up with volatility), while regulation has ceased to be an existential threat and is just an annoyance nowadays.

Most encouraging is Deutsche’s long term perspective on the future. Although regulation, conduct, and technology will all take bites out of the historic profits of the industry, financial deepening, especially in emerging markets, will increase total demand for investment banking and trading.

Deutsche estimates the industry revenues as a proportion of securities in issue were around 31bp in 2007, against around 16bp today. The exceptional swelling of the invetment banks' take has died down, leaving a more sustainable industry behind it. Time to drop the cynical cheap shots. 

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