Wholesale and Investment Banking Outlook 2011

Reshaping the model.

There is a fundamental tension in global wholesale markets. Numerous banks are telling investors that their corporate and institutional banking divisions aspire to deliver mid-teens RoE, and yet the market is clearly valuing much of the sector under the belief that these divisions will make little more than their cost of equity.

Our report, written in conjunction with Morgan Stanley, finds that with strong management action many investment banks could earn RoE in the 13-15% range (well above their cost of equity). The market is overlooking the fact that more than half of industry revenues are already relatively "fit" for the new industry regulations and ought to make respectable RoE, including most of banks' equity trading, debt and equity underwriting, advisory, and foreign exchange and government bond trading divisions. However this outcome will depend on sensible changes on some key regulatory issues such that the currently punitive regulatory drag settles at (4%)-(6%) on RoE, our base case.

We do not under-state the scale of management challenge. We estimate 6-8% of costs need to come out of the industry at a time when regulatory change is driving huge demand for investment. Much of FICC will need to be further restructured. There is a danger that the herd-search for growth in areas like Equities and the Emerging Markets will materially drive down returns. The nature of competitive distinction is shifting towards scaleability, client service, infrastructure and outstanding financial resource management and in this regard there is a group of super-globals beginning to re-exert themselves. The Regionals and Boutiques that gained ground post-crisis will have to have strong strategic focus to continue momentum.

Wholesale and Investment Banking Outlook 2011