Wind-down time

When investment banking doesn’t pay

Wall Street
The sky is still the limit on Wall Street. Source: Justin Lane/EPA/dpa

Everyone insists it’s a routine request, but the timing couldn’t be more awkward. Over the weekend, it was reported that the European Central Bank asked Deutsche Bank a few months back to calculate what the damage would be if it pulled out of investment banking for good.

Deutsche was the first major financial firm to be asked, but likely won’t be the last, according to Germany’s Süddeutsche Zeitung, which first reported the ECB’s request. Such exercises are common in the US, Switzerland, and Britain – even Deutsche itself last year did a similar exercise for British authorities, according to sources in the bank. The ECB, which supervises the largest banks in the euro zone, wouldn’t comment on Deutsche specifically but said it is merely being cautious and has no interest in dictating what kind of business model a bank should follow.

The test “is about a – theoretical – orderly retreat, so no new business but also no distressed sales or accelerated wind-down,” Deutsche Bank’s Chief Financial Officer, James von Moltke, told Handelsblatt. “This is an analytical exercise, not at all connected to any request by the ECB to shrink our trading business.”

Nevertheless, the fact that Deutsche is the ECB’s guinea pig is worth noting. Mr. von Moltke said Deutsche was picked because its capital markets business is especially large. But it’s also true that Germany’s largest bank has faced more speculation than any other in the past year about whether investment banking still makes sense.

Last week, Deutsche CEO John Cryan was unceremoniously replaced by Christian Sewing, who hails from the retail banking side of the business. That decision has only added more fuel to the fire of speculation that Deutsche might pull the plug on investment banking. Even the ECB – separately, as Mr. von Moltke admits – has been pressuring Deutsche to reduce its investment banking exposure in the US over the past two years.

Analysts believe that cracking their US competitors will be next-to-impossible in the foreseeable future.

The ECB’s request also belies another problem: Europe’s investment banks have been lagging behind their US rivals ever since the 2008 financial crisis. Does it really make sense for any of them to keep going?

For Mike Stewart of Credit Suisse, the answer is definitely yes. The Swiss bank has “more than enough resources to re-enter the top five” of the world’s investment banks, Mr. Stewart, the bank’s boss of equities trading, said in a recent interview. Over the past six years, Credit Suisse has tumbled from third to seventh place. It’s a trend Mr. Stewart thinks can be reversed.

He’s not the only optimist. After years of shrinking, Europe’s investment banks think they have a chance to score again this year, and even make up lost ground on the competition. Volatility in global markets – a bad sign for the economy, but good for investment bankers – has returned amidst the geopolitical uncertainties and talk of a trade war.

Analysts, however, believe that cracking their US competitors will be next-to-impossible in the foreseeable future. US financial firms still have a litany of built-in advantages: Strong business in the world’s largest economy; their overall size; a stronger capital base; and better investments in new technology.

Much of this is historical: US banks cleaned up their act far quicker in the aftermath of the 2008 crisis, while a better regulatory environment and a quicker economic rebound in the United States gave them a further tailwind, according to Amrit Shahani of the London analyst firm Coalition.

Those structural advantages continue to this day, Mr. Shahani added, as the Trump administration has cut corporate taxes and eased up further on financial regulation. All of this has allowed US banks to continue offering a broad portfolio of products, while European banks concentrated on niche products that bring in profits less consistently.

US investment banks cleaned up their act faster than European rivals after the 2008 crisis, and structural advantages continue to this day.

The many changes in leadership and strategy at Credit Suisse, Barclays and Deutsche (the latter is now on its fourth CEO since the 2008 crisis) haven’t helped either. Employee morale has been suffering. Restructuring requires patience, follow-through, and many years to work – time which these banks don’t have, according to Citigroup analyst Andrew Coombs.

Meanwhile, JP Morgan, Goldman Sachs, Citi, Bank of America and Morgan Stanley have all come to dominate the investment banking landscape, both in the trading business and in mergers and acquisitions. Trading may not be as lucrative as before the crisis, but it’s helped that these banks could snatch away market share. According to Berenberg, an equity research firm, these five US banks have increased their share of global investment banking revenue by 50-60 percent since the 2008 meltdown– most of it stolen from the three European banks mentioned above. The core capital ratio at these US banks averages 7.5 percent, compared to 5 percent for European investment banks, according to a separate analysis from EY.

The exception to the rule is France, where Societe Generale and BNP Paribas have “managed to hold their share of global revenues stable,” according to analysts at Autonomous Research. Mr. Shahani said he even expects the French banks, buoyed by a strong domestic market in retail and private banking, to expand their investment banking offerings in coming years.

Deutsche Bank, by contrast, has less of a home base to fall back on. Unlike in France, where a few banks dominate, Germany’s domestic market is extremely complex and competitive. Back in the 1990s, investment banking was supposed to be the area that brought Deutsche lucrative profits. The fact that it even has to explore shuttering the division altogether is a sign of just how difficult the situation has become.

Christopher Cermak is an editor with Handelsblatt Global based in Berlin. Katharina Slodczyk is a financial correspondent for Handelsblatt in Frankfurt. To contact the authors: Cermak@handelsblatt.com and Slodczyk@handelsblatt.com

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