Banks appear to be moving toward reallocating and optimizing their resources, after a prolonged period of stasis.
Morgan Stanley Blue Papers, a product of our Research Division, involve collaboration from analysts, economists and strategists across the globe and address long-term, structural business changes that are reshaping the fundamentals of entire economies and industries around the globe.
As the banking industry leaves crisis mode behind, slow but stable may be giving way to bold and decisive. Many merchant and investment banks, those that serve corporations rather than individuals, may finally be ready to act on an often-repeated, but not quite accepted, maxim of the industry: There is no going back to the way things were. Fixed income, currencies and commodities (FICC) trading, once a major force for profits, continues to retreat. The margins from the equities business have narrowed. Institutional clients are more selective of whom their trusted bankers will be.
The financial services industry has fragmented, with banks staking out territories in niche services, regions and client industries. As banks take stock of where they stand, they will need to make even harder choices about where to allocate limited resources. But with those choices come opportunities for real growth and transformation.
Regulatory uncertainty has been a big reason why many banks have been cautious about change. The regulatory framework has been in flux, post-financial-crisis, with the extent of the changes differing from one region to the next. Banks have far more visibility about what the final rule changes will be, and what they need to do to be in compliance. With regulatory clarity comes greater resolve and confidence about the road ahead.
Banks’ need to reallocate resources is strongest in FICC trading, given changes in market structure, new leverage rules and disappointing revenues. Returns from bond trading are likely to remain challenged unless banks cut capacity even more and shrink their interest-rates business in line with new credit provisions.
The equities trading business also faces challenges, even for banks with scale, or are specialists. “The old equities service model, which called for giving clients everything up front and hoping they would pay, evolved during rapid growth,” writes Huw Van Steenis, head of Morgan Stanley's EMEA Bank and Diversified Financials teams at Morgan Stanley, in a report. At existing volumes, the cash equities business simply doesn’t meet the cost of capital for most banks. As clients become more discriminating about research and distribution, market share accumulates with banks that offer the most differentiated content and integrated coverage.
While FICC revenues are falling, and challenges remain in equities, opportunities are beginning to pop up elsewhere—particularly in the corporate banking sector, which could drive growth over the next few years. Many corporate-banking clients are bullish on their growth prospects, but stiff competition to lend to and cover this sector, coupled with leverage and funding constraints, means that many banks won’t see outsized returns, unless they find narrower niches in which to compete and monetize.
Not every bank can be everything to every client—nor do corporate clients necessarily want a one-stop bank anymore. Instead, many corporate clients increasingly are looking to partner with core banks and firms with specialties, reducing their spending on midtier providers. Banks must allocate their resources where they have real advantages, thinking hard about where to offer full service and where to compete in a more limited way.
Strategic investment in technology represents another potential area of optimization. Many banks project an image of cutting-edge technology to their clients, but, in reality, struggle with old and complex legacy systems that are often difficult and expensive to maintain, and even harder to replace because of potential operational disruptions and regulatory hurdles.
Updating and optimizing technology can yield operational efficiencies and reduce risks by improving the speed and reliably of internal operations. An evaluation of in-house IT processing and support may also determine that some technology needs can be better met by external specialists. Spinning some of the technology support and infrastructure costs out of the banks could release billions of dollars in new value.
To be sure, the remaining super-global banks seeking to partner with clients in every region will have the advantage of scale that could serve them well; at the same time, they risk getting caught flatfooted by disruptive change. Midsize banks, on the other hand, will need to reshape themselves and specialize along regional or product lines, aligning their core infrastructure strengths and franchise objectives with internal wealth and corporate clients, while letting go of clients who promise little in return.
Morgan Stanley Research and Oliver Wyman, a global management consulting firm, jointly produced the Blue Paper, “Wholesale & Investment Banking Outlook: Misallocated Resources: Why Banks Need to Optimize Now” (Mar 20, 2014). Explore more Ideas and Research, or contact your Morgan Stanley representative for the full report. Find a Financial Advisor to discuss your investment goals and strategy.