For several years now — ever since UBS “did a UBS” in 2011 and 2012, and radically restructured its fixed income business — bank management has been urged to do fewer things, and do them better.
New bank chief executives will come in, chopping entire business areas, cutting thousands of staff, and promising to reallocate capital to a smaller number of higher returning businesses. Banks are closing offices around the world, handing back securities licences, selling off subsidiaries, and reinventing geographies.
In capital markets and investment banking, this tended to mean closing businesses which are sub-scale.
UBS, the granddaddy of this approach, made a big bet on several trends that included the ability to sell non-core assets into a supportive market, and the continued strength of the businesses it chose to prioritise.
The bet paid off handsomely. The market rallied hard in 2012 as the bank sold its riskier assets. Meanwhile, FIG recapitalization, a specialist subject for the bank, accelerated sharply through 2012 to 2015, while the M&A market recovered to near-record levels.
Credit Suisse, with a different set of strengths and weaknesses, closed its European government bond desks and primary dealerships, and recommitted to equities trading and prime brokerage. It has wavered a little on levfin, reaffirming at first and then deciding to restructure after all.
It’s hard to disagree with some of the measures banks have taken. Focusing on a smaller number of products and geographies is the only sensible option when banks have to cut balance sheets. Cutting a small amount everywhere leaves every product line sub-scale and capital-starved, but choosing specific businesses to close gives management more time to focus on what they’re good at.
Firms which are top five in a given product line see a much healthier set of financial metrics than those that are outside the top 10. The costs are similar, and success attracts more success.
But a “focused” strategy comes with the classic investment banking problem of volatile earnings, and that’s exactly what played out in the first quarter.
The more banks concentrate on the fee-based, “high quality” earnings derived from blue-chip M&A and equity capital markets, the more vulnerable they are to market disruptions. There are sound regulatory reasons to avoid building a business around trading a lot of vanilla flow FX and rates, or laying out a lot of low margin lending. But these products tend to keep coming, even when the backdrop is shakier.
UBS, for example, had a shocker in investment banking, with ECM fees halving, and similarly grim results in advisory and solutions. This was in line with the market (and better than Goldman’s 66% drop in ECM), but that’s exactly the point — the market opens and shuts very rapidly, and banks need to keep paying their bankers even when it’s shut.
Banks also have to support higher fixed cost bases than ever before. The bonus cap keeps fixed salaries high, while technology, back office, compliance and risk are costing more than ever before. Corporate finance businesses with their roots in the blue-blooded merchant partnerships of the past have to bear a bigger burden than before.
Meanwhile, banks like HSBC, BNP Paribas, and Santander seem to have done well this time around. Revenues from mortgage lending, consumer finance, trade finance, securities services and cash management in dozens of countries go into the pot. All of these are connected to the broader health of financial markets, but they keep on coming.
For a bank the size of HSBC, it does all these things in so many countries in so many regions that earnings cannot gyrate like they do at purer investment banks.
This is the classic defence of universal banking, but it still has force to it, all the more so when markets are volatile. Focus is an admirable thing in a business, but it doesn’t always win out. Sometimes size really does matter.