The global investment banking business needs comprehensive strategic reform if it is to flourish in the years ahead as it’s faced with declining profitability, rising costs and increased competition, says a new report from consulting firm Ernst & Young Global Ltd. (EY).

The EY report calls the investment banking business an “industry in turmoil” as returns have fallen precipitously from pre-crisis levels, revenue remains stagnant and costs are rising. For example, the report indicates that the return on equity (ROE) for the world’s major investment banks has dropped to less than 8% in 2014 from almost 20% in 2006. Over the same period, regulatory and litigation costs have risen by about 25%, it reports. And, the report notes, boutique firms are also taking an increased market share.

In addition, the investment banking business is also suffering from a lack of client trust amid a series of recent scandals and a cultural crisis, the EY report suggests, “with little evidence banks have taken all the necessary steps to address controls issues and change employee behaviours to prevent future charges of misconduct.”

Although various investment banks have tried to address these issues, the EY report says they still have a long way to go. Indeed, it argues that investment banks “will have to be more strategic and sharply focused on transforming their business.”

The report details four factors that EY believes are going to distinguish the successful investment banks of the future: These firms will be businesses that optimize their use of capital, liquidity and leverage; build leading compliance and risk control capabilities; improve service and efficiency with superior use of technology; and develop reputations for exemplary conduct and putting clients’ interests first.

“Only by adopting a more transformative approach will it be possible for the industry to thrive once again,” the EY report suggests, noting that the industry’s current approach to change is too timid. “It is not enough to rebuild the industry. We believe the industry should be able to achieve sustainable ROE of 12% to 15%, but delivering this will require an unremitting focus on transforming existing business and operating models.”

Andre de Haan, EY’s financial services leader, recommends the same reform recipe for Canadian investment banks as well: “To once again achieve 12% to 15% ROE, Canadian investment banks must optimize both assets and operations to ensure they’re maximizing efficiency and returns. They must also become client-centric. Only by bringing an end to current operating models, can banks bring an end to the common perception that they tend to put their own interests before those of their clients.”

The EY report also proposes changes that investment banks can make now to put them on the path to improved returns.

1. Compensation models could be reformed to reward a focus on improving culture.
2. Firms should focus on their top 20% of clients, which drive 80% of profits.
3. Investment banks should also improve their data, models and regulatory processes to further optimize their risk-weighted assets by 15%-20%.
4. Firms should reallocate 5%-10% of staff costs to technology spending; they should also make major technology investments to beef up their cyber defences.

“Recently, Canadian investment banks have made some changes around profitability and trust,” de Haan says. “But it’s time to move away from piecemeal reforms and undertake a comprehensive transformation so investment banks can prosper again.”