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Banks Set to Cut $1 Trillion From Balance Sheets

Investment banks are to shrink their balance sheets by another $1 trillion or up to 7 percent globally within the next two years, says a report that foresees a shake-up of market share in the industry.

Higher funding costs and increased regulatory pressure to bolster capital will force wholesale banks also to cut 15 percent, or up to $0.9 trillion, of assets that are weighted by risk, a joint report by Morgan Stanley and consultants Oliver Wyman predicts.

In addition, banks are expected take out $10 billion to $12 billion in costs by reducing pay, firing employees and paring back investments in areas that are no longer considered core.

“It is really decision time for investment banks,” said Huw van Steenis, analyst at Morgan Stanley. “The market underestimates the degree to which banks will rationalize their portfolios of activities.”

The report says investment banks have taken out about 7 percent of capacity last year and will cut up to another 10th in the next two years.

Reacting to regulatory pressure and the euro zone sovereign debt crisis, a number of banks have embarked on heavy cost-cutting in the past six months, shedding staff and assets and closing down or selling whole units.

Examples include Royal Bank of Scotland, which is removing £70 billion of risk-weighted assets in its investment bank by pulling out of or downsizing cash equities, corporate broking and equity capital markets operations.

Swiss bank UBS is paring back its investment bank by getting out of some fixed income areas and proprietary trading.

Ted Moynihan, partner at Oliver Wyman, said the shake-up would cause 15 per cent of global market share to change hands in the near future.

“It is like a game of musical chairs. Firms will have to choose which operations they prune drastically and in which they have a comparative advantage and are able to invest in scale to win market share,” he said.

The scale of the cuts would help banks to come back to return on equity levels of 12 to 14 percent in the next two years, up from an average of 8 per cent in the past year, Mr van Steenis predicted.

That is based on the assumption that crisis-depressed revenues have reached their lowest level and could rise 5 to 10 percent annually.

But this forecast contrasts with predictions by other analysts and bank executives. “The banking sector will not be able to reach a return on equity beyond 11 to 12 percent this year and next,” the chief executive of one large continental European bank said.

JP Morgan Cazenove predicted in a recent report that a lower revenue base, tighter regulation and stubbornly high staff costs would push down average return on equity to 6.8 percent by 2013.

Banks