Capital Markets: building the investment bank of the future
We believe there is a bright future for the capital markets industry. The long-term market fundamentals are positive,even if the recent financial performance of many global investment banks is disappointing. While aggregate revenues for the largest investment banks in FY15 were in line with pre-crisis revenues a decade earlier, some businesses (such as parts of fixed income, currencies and commodities (FICC)) seem to be in terminal decline.1 Moreover, operating costs and capital requirements have significantly increased. This means long-term success will demand that banks fundamentally reshape their business.
Ever since the global financial crisis, the viability of the investment banking business model has been under scrutiny and banks have been struggling to redefine their roles. They’ve been faced with a litany of challenges: sluggish economic growth, low interest rates, scandals, fines, legal settlements, demands for greater tax transparency and new regulations. Additionally, they have had to contend with the rise of upstart competitors that are unburdened by large overheads and legacy IT systems and can take advantage of regulatory arbitrage. Banks have retrenched and restructured in what has so far been a mostly unsuccessful effort to recapture the double-digit returns on equity of a decade ago. The task is unfinished.
However, the world still needs a wide array of investment banking services. Even in an age of slow growth, businesses continue to need help raising capital, managing risk and facilitating trade. We believe the winners in this environment will be firms that restructure successfully, develop a sharp focus on the things they do best and embrace innovation. In short, investment banks need to fundamentally rethink the way they are structured and operate.
The time has come for banks to focus not on what they don’t want to do, but on what they want to become. Investment banking leaders should be bold and innovative in developing a new vision and strategic direction for their organizations. Then the leaders must radically transform their business models to align with the new vision. We believe banks should concentrate on five goals:
- Reshape the business: Banks will need to restructure operations to be more mindful of legal entity structure and transfer pricing. They will need to make capital allocation decisions and associated footprint decisions regarding products, clients, geographies and counterparties that fit into that new structure. But having a robust decision-making framework and obtaining relevant data to inform strategic decisions will be challenging while markets remain unsettled. Those that seize the initiative and reshape their business will likely do so through disposals, wind‑downs, acquisitions and new strategic alliances.
- Grow the business: To regain profitable growth, investment banks should clearly define their risk appetite, the clients they want to serve, the products they want to offer and how they want to distribute those products, as well as the geographic footprint of the organization. In addition, they should harness the power of analytics to better serve the clients they already have.
- Optimize the business: New operating models should be developed that take advantage of technology, partnerships and industry utilities to improve service and reduce cost. In addition, banks will need to optimize their balance sheet in the face of multiple market and regulatory constraints.
- Protect the business: In the wake of the London Interbank Offered Rate (Libor) and foreign exchange scandals, banks must rebuild trust. The right organizational culture will be a key differentiator for leading investment banks. In addition, given the ongoing threat of cybercrime, banks must take steps to ensure that their systems are secure, that they use technology where possible to maximize the coverage of internal protections, and that their people are adequately trained and supervised.
- Control the business: Compliance and risk management must be a priority; in addition to using technology and training, management tone, transparency and the importance of controls-based reporting should be promoted.
1Revenues earned by the largest 14 investment banks or investment bank divisions of universal banks through FICC trading, equities trading, debt and equity issuance, and M&A advisory services
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