News over the weekend had it that one of
the world's biggest universal banks is essentially
shuttering a significant portion of its investment
banking operations. UBS, the giant
Switzerland-based bank, was reacting to changes in
the marketplace as well as tighter regulations for
capital adequacy as they came along.
The
Financial Times reported that UBS will cut 10,000
of its 63,000 global jobs over the coming years;
the bank will also put a large part of its trading
fixed income, currencies and commodities under the
stewardship of its one of its old co-heads of
investment banking with a view to shutting down
the business over the next few years.
In
essence, the "non-core" part of the bank will be
seen as a
separate entity that
houses the assets considered overly risky by the
rest of the bank, which will then be free to focus
on private banking, wealth management and
investment advisory services as well as a swathe
of more traditional investment banking (mergers
and acquisition advisory, traditional corporate
finance advisory and the like).
If the
news is confirmed in coming days, it marks the
withdrawal from "holistic investment banking" of
one of the more hallowed names in the world of
banking.
UBS was no slouch in these
businesses, and despite suffering an embarrassing
series of gaffes in the business since 2008 when a
giant book of problem assets was identified in a
little-known hedge fund inside the bank to more
recently the scandal around fake equities trading
that cost the bank over US$2 billion, the rest of
the investment bank still held a strong market
share in a number of areas and was considered
particularly excellent in a few of these.
There are multiple reasons that account
for such a withdrawal and certain lessons we can
draw from this trend; while the main ones are
generally positive for the world of banking, there
is one issue that will gnaw at the purse strings
of policymakers and markets over the next few
decades that bears close watching.
Regulators, in particular the Swiss
National Bank, can feel some joy that their
attempts to rein in "casino banking" has by and
large succeeded with the UBS announcement and
before that the changes of strategy echoed by
Morgan Stanley, RBS and Barclays. Arguably,
disputes of this kind lay behind the surprise
firing of Citibank's chief executive a couple of
weeks ago when the US bank announced barely-there
earnings for the third quarter of 2012.
They increased supervision of these
operations, insisted on more management
accountability and lastly pushed for significant
increases in the capital allocated to such
activities as proprietary trading and holding
fixed income assets.
The sum total of
these changes was to make the business deeply
unprofitable for the major banks; after those
changes, the regulators (at least in Switzerland
and the United Kingdom) stepped back and let the
markets deal with the banks: which they did
promptly by forcing CEOs to directly address both
compensation and capital efficiency (return on
capital employed).
The cyclical nature of
investment banking as well as the capital effects
of the banks' favored strategy for
counter-cyclical earning smoothing - namely
inflating the balance sheet and piling on more
assets in an attempt to capture higher returns
against their borrowing rates - both run counter
to what is now being demanded by both regulators
and shareholders.
The second major reason
for the UBS withdrawal is the fact that excess
competition has pushed down fees and made the
business simply uneconomic for most players in the
middle of the last decade.
In the first
instance, banks bulked up their balance sheets
going into the 2007 crisis. After the crisis,
central banks, fearful of a mass dumping of
assets, pushed liquidity through the system,
thereby creating conditions for a more gradual
withdrawal of balance sheet activity.
As a
number of assets have now started accelerating
towards maturity, banks following that strategy
have been exposed as the proverbial "swimmers
without bathing trunks" in the Warren Buffet
aphorism.
As readers of this column know,
I believe that this excess liquidity created by
central banks is an erroneous strategy that will
eventually have deleterious consequences on the
financial system. One of those consequences was
the excess employment in the financial sector from
2009 and the other was the lack of accurate
marking of distressed assets; all a bit like the
old Soviet joke about "we'll pretend to work and
you'll pretend to pay us".
The continued
provision of liquidity has not gone to the pockets
of homeowners but rather has lined the pockets of
banks; it is this subsidy that allowed banks to
absorb the financial impact of all the dud assets
on their books. But with a zero-interest policy in
place for so long, the flip side started hurting
the banks - namely, the lack of returns on assets
and equity over the course of latter half of 2011
and over the course of 2012.
Thus, the
score stands at 1:1 between regulators and well,
regulators; in the sense that while some moves to
supervise the banks and get a better handle on
risks have been worthwhile, the efforts were
waylaid by the excess liquidity generated
elsewhere in the central banking system. In
effect, global banks weren't any more under the
control of their regulators in 2012 than they were
in 2009.
This is where the third
development over the past few years has become
important not just for central bankers but also
for the wider appreciation of new risks in market
capitalism.
Since the crisis, it has
become increasingly clear that the size of the pie
- that is, the fee and revenue pool - has been
declining for investment banks. The primary reason
is that large global companies have become
immensely cash rich, and as such are not so
dependent on banks for funding. Given the murky
economic outlook, they haven't been focusing on
M&A either, so there haven't been a lot of
high-fee days for bankers.
The Asian
model Meanwhile, a number of owner-managers
have started exerting more control on their firms,
in essence bringing the "Asian" model of business
into the global market place.
This hasn't
always been intentional but must be understood in
the context of two factors - firstly that banks
have lent businesses a lot less (putting their
cash into buying assets from the central banks
instead), which has increased the pressure on
businessmen to support their firms.
Secondly, the absence of real returns in
most asset classes - bonds and other fixed-income
instruments primarily - has meant that wealthy
folk have had to either take big risks or else
accept mediocre returns. That's why a number of
businessmen have been ploughing money back into
their businesses or funding growth with their
corporate platforms.
Curiously enough,
businessmen borrow money from their banks - the
private banking side - to fund some of these
investments. Hence the rising profits of the
private bankers even as investment banks have seen
their profits tumble. That's why the likes of
Morgan Stanley and UBS have refocused away from
investment banking towards private banking.
When banks deal with these businessmen,
they often find it easier to provide them
assistance through their personal portfolios
against a diversified portfolio of property,
companies owned by the family, valuable artworks
and so on.
That's different quite often
from lending within the corporate umbrella, where
the main exposure is to the corporate assets. In
any business downturn, these assets will lose
value and expose banks to losses; which is why
diversifying their "collateral" through other
assets that may not be correlated (eg artworks).
Why is this development troubling? Quite
simply, because in this world of asset-based
rather than credit-based lending, a lot of things
could be going wrong fairly quickly. Documents are
murkier than in the case of lending to companies;
and in most cases there is no disclosure of the
facilities required in annual accounts because
private banks are bound by confidentiality
requirements and their customers are private
individuals without any reporting requirements.
When I wrote last week about regulators
failing to spot changes in technology (see Regulators
fail the nerd test, Asia Times Online, October
27, 2012), the same is also true of banking.
Once again, markets have proven to be
stronger in pushing for changes, with or without
regulatory realities. Alongside though, an
increasing if not large part of the world of
banking has gone private, beyond the disclosure
requirements of the corporate world.
It's
not that the road ahead is particularly narrow or
treacherous; it just that the lights have been
switched off.
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