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Investment banks should be the long term winners

There’s a distressing tendency among equity analysts to underplay investment banking, especially when it comes to once proud universal banks like Barclays and RBS. CEOs play up their retail banking credentials, but the investment banks will have the last laugh.

Earlier this year, you could have picked up the Barclays investment bank for free. Purchase some Barclays shares, and, along with a credit card business that spews cash, a big book of UK lending, and assorted African exposures, you got one of the top bond houses in the world gratis. That, at least, was the judgment of analysts from Deutsche Bank, commenting on the first quarter of results.

The Barclays valuation, they assessed, attributed no value whatsoever to the investment bank. Analysts at Nomura said at the time that: “Downsizing the IB is the solution to most problems Barclays currently have.”

On the back of more recent results, things are not that bad (fixed income trading has beaten expectations), but the investment bank is still a shrinking part of the story. A year ago, it made around a third of group profits, now it makes a sixth. The bank continues to shrink the more exotic parts of its fixed income business. A clutch of its senior US investment bankers have already left.

At RBS, things are worse still. RBS’s shareholders, especially its largest investor, are still less receptive to investment banking, and the bank’s operations have been cut back vigorously. It is no longer chopping off limbs after dropping advisory, equities, equity derivatives, US securitization, and large parts of emerging markets, but the momentum is in one direction. Risk weighted assets in the investment bank were down 16% this quarter.

Other institutions do not have it so bad – retail banking outside the UK may be less lucrative and shareholders may be more supportive – but the mood music is clear. Even Morgan Stanley prefers to shout about its wealth management credentials when it can.

This is all the more ironic, though, given the deep existential threat to traditional retail banking and even to wealth management. Investment banks have their issues – past conduct and regulatory adaption will be costly for some time to come – but they will certainly continue to exist in 20 years.

The same cannot be said for retail banks, which are, in effect, poorly functioning tech companies with balance sheet.

For most people, most of the time, what they need from their bank is a convenient place to store and access money. Mobile banking puts this in everyone’s hands, but if banks can do this, why not anyone else? Google Wallet, and, more recently, Apple Pay, threaten the basic payments proposition of retail banks.

Digital models also threaten the asset side of the balance sheet – crowd-funding and peer-to-peer lending are two obvious threats, but the basic point is that retail banks, for decades now, have relied on formulae and calculation to dish out loans, not a friendly/unfriendly branch manager looking deep into your soul or assessing whether you’re the right sort of chap.

And if it is big data that confers the competitive advantage, the tech firms are streets ahead. Amazon’s ability to anticipate consumer behaviour is far in advance of any retail bank; why would banks think they are any better at modelling credit risk?

Retail banks rely, now, on a high regulatory perimeter and incumbency to protect their business, but these will not last forever.

In investment banking, however, the opposite is true. Sure, the robots have taken over trading equities, and they may take over trading govvies as well.

But no CEO will want a computer by their side when they take their company public. No treasurer will want to pick their financing options from a pre-determined menu with the click of a mouse. They want, not unreasonably, dedicated individuals that understand their needs, the needs of their competitors, and are deeply plugged into networks made up of other humans, not just credit scores.

Even video conferencing will not cut it, unfortunate for the schedules and carbon footprints of investment bankers.  

Investment banking continues to be a business where seeing the whites of someone’s eyes has value, because it requires a much deeper level of trust.

Look beyond the woes of the investment banks today. Long term, the people side of the business, not the tech side, is the safer place to be.

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