Investment Banking: An Industry in Structural Decline

One of the most aggressive and swollen segments of the financial industry is investment banking. If AI, technology and cloud seemed to pose a threat of replacing the workforce in other segments, investment bankers would benefit significantly from smart machines and sophisticated algorithms. Greater access to market information and better analytical capabilities of technology applied to investment banking are expected to open new frontiers for professionals and make the rich even richer.

According to the report by BCG on global capital markets published this days, growth in electronic exchange trading and the use of central clearing will mean that their share of the capital markets revenue pool will grow to 19% by 2020, representing an estimated $125 billion (significant rise from 8% in 2006). However, evolving technology facilitates harsh competition, and companies will need to evolve to stay relevant. In addition to highly competitive environment, market condition and seasonality can play a major role in predicting the revenues.

According to estimations, global investment banking revenues declined to $228 billion in 2015, down 16% from $271 billion in 2010. The factors that hit revenues the most are believed to be the relatively weak performance in secondary trading and the high business overall costs.

Although operating expenses YOY were reported to fall by 2%, they were mostly driven by reductions in headcount, operational spending and lower litigation expenses. Nonetheless, since 2010, despite cuts of roughly $8 billion in operating expenses, the overall cost of doing business for investment banks has risen by 4%.

Speaking of the state of the industry in Europe, James Chappell, an analyst with the private bank Berenberg, used the phrase "an industry in structural decline."

As Mr. Chappell commented, "Each weak quarter is seemingly greeted with an excuse that it could have been better if not for the wrong type of volatility, client uncertainty or central bank intervention. Q1 2016 saw the absence of one-off profitable events that have protected revenues in the past. We have perhaps had the first glimpse of what core profitability in the investment banking industry really is (ROEs in the mid-single digits at best) and it could be even worse if the traditional seasonality occurs."

While investment banking in the US isn’t quite working on the principle that there should be no bank too big to fail and no individual too powerful to jail, this might not be the case in Europe. European banks are reported to be losing more revenue that their US competitors in Q1 2016. For Europeans, investment banking revenues went down by 24% while it shrank by 23% in the US.

On the bright side, some estimations suggest that Europe’s investment banking is accountable for a larger market share in the global investment banking market than North America’s. Analysis from the Chicago Tribune suggests that in the past five years, EU and Swiss banks’ market share in total investment banking market have dropped from 35% to 30%. For North America, the numbers went from 28% to 22% for the same period.

Analysts from the WSJ also report that not only is 2016 likely to be one of the weakest years for investment banking and trading businesses since before the crisis, but some senior bankers are concerned that 2017 and 2018 aren’t going to bring much of a pickup either. UBS’ example doesn’t bring any relief since UBS’s investment banking revenues were reported to fall by 29% YoY in Q1 2016.

Another bank, RBS, has also felt a significant unload of investment banking revenues going from more than $5 billion in 2013 to $1.5 billion in 2015.

Among other reasons pertaining to the decline of global investment banking, industry professionals also list the regulatory environment. As reported by The Telegraph, the global investment banking sector is shrinking as tighter regulations and intense competition means that banks are struggling to turn in sustainable profits.

Characterizing the potential outcome of the coming recession with regard to investment banking, one senior banker commented, The new regulatory order means we’ve had to reassess where we are genuinely competitive. Everyone has had to do some soul searching. There will be a few global investment banks, then some which are closer to being national champions.