Investment banks, which have already drastically downsized their trading units since the financial crisis – both in terms of headcount and exposure to riskier business lines – have plenty more to do, according to an influential report.
Banks including Barclays have been making large-scale changes to their trading divisions under new leadership
Analysts at Morgan Stanley – led by Huw van Steenis – and the consultancy Oliver Wyman – led by Christian Edelmann – published their annual assessment of the wholesale financial markets, entitled Wholesale Banks & Asset Managers: Learning to Live with Less Liquidity, on March 13.
In their base case scenario, they said revenues from wholesale banking, including trading and traditional advisory businesses, could fall from roughly $ 225 billion in 2015 to around $ 205 billion in 2016. However, a bear case forecast suggests a drop to around $ 170 billion.
The analysts said low rates, new regulations and thin liquidity had conspired to “structurally reduce the client revenue opportunity for wholesale banks”, adding the industry was still “grappling with this adjustment”.
They wrote: “We do not see the industry achieving its cost of capital through the cycle without another round of heavy pruning equivalent in size to what has been accomplished over the last five years – and an overhaul of the operating model.”
Barclays, Credit Suisse and Deutsche Bank – which have all appointed new CEOs over the past 12 months – have already begun new strategic plans aimed at increasing profitability that include restructurings of investment banking divisions. The moves will affect thousands of staff across the banks, many of whom work in the trading arms. In the US, Morgan Stanley has also announced big cuts to its trading operation on both the fixed income and equities side.
At banks’ trading divisions – including fixed income, currency and commodities and also equities – equity derivatives and credit revenues could each fall by as much as 20% in 2016, according to the Morgan Stanley/Oliver Wyman report. Even the areas of FICC that yielded growth in 2015, rates and foreign exchange, are likely to see revenues remain flat at best this year.
The analysts wrote: “Historically, rates trading businesses have provided countercyclical relief to falling equity and credit markets as interest rate down-cycles and increased volatility have created favourable client and trading conditions. Yet with interest rates close to zero, and with less risk-taking capacity in rates trading businesses, there is less scope for this now.”
They added that “changing the operating model of securities trading will be crucial to success, in our view, and some will need to resort to tough strategic pruning”.
A swathe of new regulations since the financial crisis, ranging from reform of derivatives markets, restrictions around proprietary trading and new capital requirements, have eroded the revenues banks historically earned from trading – both for themselves and on behalf of clients.
Even though wholesale banks have slashed their balance sheets, which support traded markets, by 50% in terms of risk-weighted assets since 2010, more needs to be done, according to the report. “We expect another 10% shrinkage in balance sheets in the next two years”, the analysts wrote.