Time to seize the opportunity of the banking crisis

These should be ideal conditions to redesign the industry, writes Philip Augar

May you live in interesting times” runs the Chinese curse and for the world’s banks, as Citigroup’s announcement of 11,000 job cuts and a $1bn restructuring charge shows, the times do not get much more interesting than this.

Thanks to self-inflicted wounds and consequential external pressures, the leveraged business model that defined the universal bank is broken. Regulators require extra capital, less proprietary trading and more transparency of their charges. Liquidity is “in”, leverage is “out”.

Citigroup is not alone in laying off staff and redesigning its operating model. RBS and UBS have pulled back from equities and fixed income respectively. Credit Suisse has ringfenced its investment bank. Barclays’ strategy review is set to conclude in the new year and investors are questioning the size, shape and position of its investment bank. Across Wall Street, as senior executives decide how to allocate reduced bonus pools, the year-end compensation review is bringing an added focus to strategic discussions.

The banking industry is facing the most testing circumstances since the Wall Street crash of 1929. How it responds will determine whether it can shed its pariah status. The good news for the banks is that they have the chance to seize the moment and reinvent themselves as financially viable and socially responsible institutions. All is not lost.

From currently depressed levels, banking is a growth market. Investors are in desperate need of advice and corporate balance sheets are in urgent need of repair. There are massive imbalances in the world economy. The emerging economies are maturing as capital markets and require sophisticated financial institutions to operate them.

Such turmoil creates opportunities for smart players, particularly in the discredited investment-banking sector. Here, the withdrawal of competitors creates openings for survivors. The labour market is differentiating between those with genuine talent and those riding on their coattails. Shareholders are becoming more realistic about risks and rewards. Technology continues to redefine the business of trading. Regulators are rewriting the rules.

It is hard to imagine a more chaotic set of circumstances and, as every trader knows, chaos equates to opportunity. Far from sounding the death knell on investment banking, these should be ideal conditions to redesign and restructure an industry in dire need of regaining its moral compass and its role in the modern economy.

For top executives, the key is to ask the right question. The wrong question would be “what can we do to get back to the glory days”? Bankers should forget it. The world does not want that any more. Leave that game to the hedge funds and the private equity houses.

The right question to ask is what kind of financial products and services do clients need. This question enables a bottom up analysis of what type of organisation is required to serve those needs and what profit opportunities are available.

The sequence of product first, shareholder value second opens up the possibility of creating a sustainable, ethical and economically useful business. A sequence of shareholder value first, product second risks replicating the mistakes of the past in reproducing self-serving organisations that would do anything to make a fast buck.

The outcome will inevitably be investment banks that are different in size and shape but it is premature to read the industry’s last rites. Investment banks are the mothers of reinvention and they have retained one critical advantage: their defining feature, the integrated model.

Modern investment banking developed after the deregulation of Wall Street in 1975 and the City of London in 1986. Liberalisation enabled financial institutions to combine the previously discrete activities of advising corporations and trading for investors. These new, integrated investment banks were able to use this privileged position to connect issuers and investors, expand secondary trading of equities and bonds, and then develop derivatives as new markets emerged.

The integrated model has been bruised and battered by scandals, by fast technology that has rendered old trading methods obsolete and by the current banking crisis.

But investment banks retain the permission of regulators and clients simultaneously to serve issuers and investors. This gives them protection from disintermediation and an information edge over other market participants. The challenge for today’s investment banking leaders is to use this opportunity and re-emerge as the cutting edge of the financial services industry.

The writer’s latest book is ‘Reckless: the rise and fall of the City’

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