Market opinion | Bob McDowall
Responding to regulation More expansive legislation translates into additional regulation and increased powers for financial regulators. Increased capital requirements and investment in resources for risk management and financial reporting demand that banks seek additional fixed and working capital. Fixed capital has to come from existing or new investors, Working capital will require a contribution from investors or through review of the operating businesses and their performances. Business and operating reviews may result in cessation, contraction, consolidation or disposal of some of the lines of business.
Value to investors Banks represent low returns and high financial and reputational risk in the current operating environment. National legislative programmes and the Political agendas for banks do not raise the prospects of better times ahead for the sector. As such the sector does is not attractive to investors. The risk premium for investment is higher than it is for other commercial sectors.
Demographic & asset management The demographic changes in Western Europe are such that the wealth is vested in the over 50’s. Their focus is on preserving or increasing returns on their wealth in a financial environment of artificially low interest rates and increasing inflation. Accordingly the more profitable areas of the banks are likely to be fees generating asset management divisions.
Geographic areas for growth Until the recent global financial and economic contraction exacerbated by the continuing Euro- zone crisis, the Asian Pacific and selectively South America have been the major areas of growth. Any resumption of growth is likely to start in the Asia Pacific and South American Regions. Although Universal Banks from the Western Hemisphere have been operating in those regions with increasing success, it is by no means certain that they will adopt the Universal Banking model. Concurrently domestic financial institutions are
Best Execution | Autumn 2012
starting to provide competition in core banking services and asset management.
What will take its place? Universal banking institutions will remain the key banking constituents for financial growth in mainland Europe supported if necessary by continued Government investment. Universal Banks in mainland Europe have their roots as institutions which funded and directly invested in commercial and industrial enterprises in the economic regeneration of Europe after World War II. However, their scale of ambition is likely to be contained to Europe unless their European customers require servicing in other geographic regions. Banks that continue to employ the universal banking model will pay a premium for capital and funding as rating agencies and investors ascribe a higher risk rating to that business model The cost of capital and limitations being placed
on proprietary trading have encouraged banks to focus on fee based business such as asset management and corporate advisory businesses. That trend is likely to continue for the remainder of this decade. The banks which are setting this trend will become smaller in terms of people and capital bases through disposal or cessation of more resources and capital intensive businesses. Smaller, niche or boutique style asset management and corporate advisory businesses are already emerging as a result of teams leaving larger institutions and attracting clients who a more individually serviced approach which focuses on fees for success.
While limited trading facilities will always
be required for providing liquidity in financial instruments capital for major transactions is likely to be provided on a transaction by transaction basis from other financial institutions through some broadly based standby facilities.
The Universal bank is unlikely to be the mainstay of investment banking in future. Fragmentation of the industry will lead to more specialisation by smaller institutions. There will be a parade of shops rather than a ‘one stop shop’. ■ Bob McDowall, is consulting associate to commercial think-tank Z/Yen –
www.zyen.com
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