Fitch Ratings says that it expects to see more banks following UBS AG’s lead in cutting back capital markets exposures to focus on the areas of the business that represent core strengths.
“Further concentration and cost cutting is likely among a dwindling number of banks with more extensive capital markets operations,” the rating agency says in a new report. “We expect more banks to stick to niches where they have strong franchises.”
Third quarter earnings for the large global trading and universal banks has been mixed, it notes, albeit slightly better than in the second quarter and much improved from a year ago. Concerns over the fiscal situations in both Europe and the U.S. continues to depress customer volumes, it notes. And, there’s an ever-increasing focus on costs among the banks, “as revenue prospects are proving even more difficult to predict than ever in a world of shifting regulation”.
Costs are rising for banks on many fronts, Fitch says, including building regulatory infrastructure, segregating businesses, and holding higher capital and liquidity for almost any securities business, particularly fixed-income. This now makes it “imperative” for these banks to focus their business models, it says. “We expect the banks to revise their rationalization plans as regulations evolve and rules are finalized.”
As a result, banks are concentrating on areas where they have a competitive advantage, and benefit from capital efficiency; and, they are cutting back where they do not. “Businesses that will generate insufficient earnings in relation to the risks they incur will be downsized or exited,” it says.
Most of the big investment banks are already undergoing some degree of restructuring, Fitch says. “At the extreme end, UBS is accelerating the downsizing of its investment bank, effectively exiting fixed-income to focus only on advisory, research, equities, FX and precious metals. These are areas where the bank has strength and which have more natural synergies with its substantial global wealth management franchise,” it says.
Conversely, RBS is dropping its cash equities, corporate broking, equity capital markets, and mergers and acquisitions advisory businesses. Others have less dramatic plans, it says. “For example, JP Morgan, Deutsche and Goldman Sachs are targeting costs, primarily their overweight central cost bases. Where investment banks are being kept relatively intact, a broad range of strategies are being pursued, such as expanding balance sheet-light businesses and downsizing non-core operations.”
These strategic shifts are evident in the banks’ year-to-date results, it says, with business exit or shrinkage costs a common feature. “Restructuring costs are hitting profits at the same time as infrastructure investments necessary for the new regulatory environment. We expect it may well take around two years for such investments and restructuring to filter through to lower cost/income ratios and higher returns on equity,” Fitch says.
In the meantime, earnings are suffering from stubbornly low transaction volumes in the securities industry as a whole, “reflecting uncertainty about global economic development”, it says. “We do not see this situation changing until clarity emerges on resolution of the Eurozone crisis.”
“All else being equal, our ratings favour universal banks with a strong traditional banking businesses or wealth management franchise, where the business mix is supportive of more stable earnings and a lower risk profile, over those with a concentration on securities operations,” it concludes.