Global finance has not been en vogue since the bankruptcy of Lehman Brothers in 2008, and that is slow to change. But banks across the globe are nevertheless evolving, step by step, in order to adapt to the post-crisis environment.
In the United States
In the United States, banks (XLF) are still cutting costs and raising equity. Bank of America (BAC), for instance, has announced it will shed 16,000 jobs by the end of the year, mostly in its commercial banking division. Its Chief Executive Brian Moynihan has sought to transform the company into a smaller and more efficient platform, in part through an increased focus on investment banking. Among all North American firms, Bank of America is the organization which is slimming down the most -a drastic reversal of the pre-crisis consolidation strategy that led Bank of America to expand rapidly in all corners of the banking industry.
Even J.P. Morgan Chase (JPM), widely thought to have navigated throughout the financial crisis flawlessly, announced large trading losses earlier on this year.
The majority of large firms are letting go of employees, in both investment banking and commercial banking divisions. The slow and uneven economic recovery, the seesaw markets hindering equity and debt issuances and the new regulatory requirements (linked to the Basel III rules and the Volcker rule) are to be blamed for the industry's decrease in revenues and/or its need to recapitalize. In particular, restrictions on lucrative derivatives trading businesses are foreseen to impact banks' margins.
Furthermore, U.S. banks are still dealing with the fallout of the housing market crisis. Less lawsuits from the U.S. government can be expected in the future, after a series of large settlements and fines were paid. But the industry is ensnared by lawsuits from bond investors. The total bill banks are facing from the mortgage crisis is therefore still unknown. For instance, a group of powerful bondholders including BlackRock (BLK), PimCo, TCW and Goldman Sachs (GS) is seeking to force Wells Fargo (WFC) and Morgan Stanley (MS) to repurchase soured home loans. The bondholders are claiming to have been victims of misrepresentations with regards to the quality of the securities.
To the exception of issues relating to the American mortgage crisis, European banks are suffering from similar headaches as their counterparts from the other side of the Atlantic. However, capital markets and the economic outlook have been worse on the Old Continent, what has amplified the challenges European institutions are facing.
Layoffs, pay cuts and asset sales have thus been more important in Europe, so important that it has been questioned whether London will be able to remain a center of global banking, or whether its business will move to New York and Asia. By the end of 2012, the City is forecasted to have lost 100,000 financial jobs. The number of financial services employees peaked for London in 2007 at 354,000.
The euro crisis has, needless to say, had an enormous impact on European banks, which have been forced to dispose of assets at fire sale prices. Credit Agricole is expected to spend between 600 and 700 million euros on its failing Greek unit Emporiki before being able to sell it -perhaps for the price of 1 euro.
As of lately, the political backlash against banks has been stronger in Europe than in the U.S., in part because of accusations that investment banks rigged the LIBOR interest rate in London. European officials are also seeking to pass a tax on financial transactions, which will further eat into banks' profits.
Both Barclays (BCS) and Deutsche Bank (DB) have lowered their targets for return on equity (ROE), and experts expect ROEs for investment banks to hover around 7-10% in the future, versus 20-25% in the past. Nomura, the Japanese bank which bought the European and Asian assets of Lehman Brothers when it failed, is giving up on its global ambitions and is shrinking its investment bank in countries where it sought to gain market share a few years ago.
While the transformation of global banking is under way, some time is still needed for the industry to complete its overhaul. The stand-alone investment bank model will most likely fade, at least somewhat, as financial institutions become increasingly risk-averse and diversified, combining investment banking divisions with less volatile commercial banking ones. Firms such as Goldman Sachs and Morgan Stanley are seeking to further expand into corporate lending and private wealth management (Morgan Stanley recently announced that it will buy out its partner Citi's (C) 49% stake in their commonly-held Smith Barney retail brokerage business).
Given the trend toward risk aversion on the part of all market actors, one can expect the global banking industry to keep consolidating, thereby leading to fewer midsized banks. Banks with the strongest balance sheets will be seen as the safest trading counterparties, and will gain market share. The midsized banks should become more akin to niche players, focusing on one particular product or geography.
Nevertheless, the global banking industry has always proven to be extremely innovative. One can expect industry leaders to be resourceful once again, and a wave of new financial innovations could lift global banking out of its slump and change again the dynamics of the sector.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.