Whether in North America or Europe, mid-tier investment banks have struggled to maintain their market positions in the wake of the financial crisis. Increasingly, core investment banking activities have become concentrated amongst a few large players, as economies of scale allow only the biggest players to realize acceptable margins. Large firms such as Goldman Sachs in the United States and BNP Paribas in Europe have effectively captured most of the market share of mid-tier players. And now, according to a recent article from Reuters, these smaller institutions are now seeing increasing pressure from regulators and investors to exit other investment banking activities such as proprietary trading and M&A advisory.
Cost of Regulation Weighs on Smaller Banks
One of the elements leading to the demise of the smaller or regional investment banking players is the cost of regulation. Throughout the financial industry, compliance with a wide range of regulations is a mounting burden for all organizations. The reality is that only larger institutions are able to achieve the scale necessary to maintain a large compliance department while still earning margins sufficient to justify the risk investment banking brings to the overall bank portfolio.
Banks such as Credit Agricole and Natixis, medium-sized French institutions, are examples of this struggle within the industry to post margins that are sufficiently rich to justify further investment from their parent companies. Agricole indicated a weak 1.6 percent return on tangible equity in their most recent financials, hardly enough to justify the risk that the investment bank adds to the overall institution.
Unfortunately, banks like Agricole may find a limited market for the sale of their investment banking divisions. Larger players are seeking to conserve risk capital ahead of the Basel III implementation and smaller players certainly are not looking at expanding unsuccessful outfits. Worst of all, concerns remain regarding the legacy positions in toxic assets held on the balance sheets of many smaller investment banks. Instead of acquiring assets, many of the large firms have looked instead at poaching top talent from their struggling peers.
“Maybe there are some attractive parts, good teams, but the trouble is you would only want the people, not the legacy positions, so rather than buy the whole thing you may as well hire the people,” an unnamed London investment banker told Reuters.
Smaller Players Find Success as Regional Experts
While the situation facing Agricole and its peers looks bleak, they can look to Northern Europe for an example of smaller firms finding success. Swedish bank Nordea has found a unique niche offering regional expertise to local firms within the Nordic countries. Shifting focus to where they hold a sustainable competitive advantage while maintaining acceptable margins has been key for Nordea in keeping competitors at bay. CEO Christian Clausen told Reuters, “We are not a global player, but when I meet with the bulge bracket, they say we are the most difficult competitor regionally.”
Perhaps a return to their local roots where they can offer a unique understanding of the local business culture and climate is the key to the future success of mid-tier investment banking in Europe.