Ever since the financial crisis in 2008, analysts have pondered whether investment banks would return to their days of glory or languish in decline for the foreseeable future. In a recent Economist piece on the issue, the author suggests that the worst is yet to come for the big institutions, as global economic trends and regulation continue to work against the industry.
Primarily, it comes down to return versus risk. While investment banks regularly posted returns on equity in the low to mid-twenties up until the crisis, these returns are now half of their peak levels. Worst of all, this decline in return comes at a time when risk within the financial industry has grown substantially. For diversified banks, it’s becoming harder and harder to justify setting aside funds for investment banking activities when their other division can post equal returns, though at substantially less risk. Accordingly, the industry has seen a number of institutions dramatically shrink their investment banking operations since 2008, with some banks exiting the business altogether.
This comes as financial regulators weigh more heavily on the industry. Higher capital standards will force banks to further reconsider investments in riskier business lines, as these activities quickly eat up available capital under new guidelines. Risk taking as a result will be substantially scaled back, with real consequences for some firms. In some countries, regulators are considering a full scale split of investment banking divisions from traditional commercial and retail activities, further endangering some of the industry’s biggest players. These regulatory changes are being driven by politicians that are simply unwilling to accept the public backlash that would come along if another round of taxpayer funded bank bailouts was needed.
In the midst of all this doom and gloom, it is important to note that the Economist admits that it has made negative claims regarding the industry before, and ended up being dead wrong. Fifty years ago, it described British banks as the “world’s most respectable declining industry.” However, these same institutions rallied with decades of consecutive growth, at least up until the financial crisis. While the outlook today may be fairly bleak, the industry has proven itself resilient and innovative in overcoming hurdles in the past. It is always difficult to permanently count out teams of the best and the brightest, even when they’ve been beaten down.
Jamie Dimon, Chariman of JPMorgan Chase, is one of the industry insiders that remains bullish on the future of investment banking. With staggering growth seen in emerging economies and the increases in international trade to go along with it, Dimon believes the “underlying trend [for investment banking] is up… Over time it will grow.” And there may be some history worth paying attention to when it comes to Dimon’s statement. In the past, financial-services revenue has increased with high correlation to global GDP. If this correlation was to return to past form, investment banking would certainly have a very optimistic future.
With strongly contrasting views from those on both sides of the argument, it remains unclear just what the future has in store. However, one thing can be certain. The landscape will radically change for investment banking over the months and years to come. What the industry looks like coming out the other side of this evolution remains anyone’s guess.