Investment banking industry needs a disruptor

Published Wed, Jun 1 20161:50 PM EDT

Breakingviews

Dominic Elliott

Finance could pick up a useful pointer or two from low-cost airlines. Investment banks that engage in trading and corporate finance have routinely destroyed value since the 2008 financial crisis – much like the aviation sector, which a McKinsey study found made no returns for shareholders over a 13-year period. It took new, no-frills entrants – the likes of easyJet, Ryanair and Southwest – to shake up staid business models. The need for fresh thinking in investment banking is manifest in last year's dire returns. The industry recorded an average return on equity of just 6 percent, according to Boston Consulting Group. That's barely more than half the sector's likely cost of equity. To make matters worse, revenue in the first quarter - typically the most influential in any calendar year - fell to a post-crisis low, according to Coalition data. Some parts of the investment banking value chain are already facing disruption. XTX Markets, a non-bank market-maker, ranked third in Euromoney's latest annual survey of the market shares held by electronic-only foreign exchange spot market participants. Frontline Analysts offers institutional clients cheaper risk management, credit and equity research than bulge bracket firms, by recruiting and training lower-cost analysts in India and various UK locations. Sometimes investment banks themselves use Frontline's services. More from Breakingviews : Salesforce fluffs up cloud business at a high cost Imagine one decided to build the easyJet of investment banking – a low-cost, super-efficient antidote to the industry's endemic value destruction. What would it look like? A newcomer would have one clear advantage from the outset: the lack of a mammoth balance sheet. For bulge-bracket firms, a heap of legacy assets makes it hard to imagine splitting off an investment bank without it facing exorbitant funding costs. An upstart could pursue an agency-only trading model, and operate with next to no inventory. Traditional players like UBS and Barclays that shifted earlier towards agency-first models are starting to see their bottom lines improve. Corporate finance is a different beast - a relationship-driven business, where established players can command stubbornly high fees. As the saying goes, no chief executive ever got fired for hiring Goldman Sachs . Hence a few expensive investment bankers may always work on the largest initial public offerings and blockbuster takeovers. The success of boutique firms like Robey Warshaw and Zaoui & Co underscore the importance that chief executives attach to hiring a consigliere as a sounding board. But there's more to corporate finance than big-name rainmakers. Technology could replace many basic pricing and allocation functions performed by debt and equity capital markets bankers. And, like no-frills airlines, investment banking equivalents may be able to create demand for cheaper services where none currently exists. One objection to the easyJet thesis might be that the lowest cost investment banking divisions right now sit within financial groups with the biggest balance sheets. Research from Barclays shows that among European banks, only HSBC managed to get its investment banking costs below 60 percent of its revenue last year. Citigroup followed by JPMorgan led on that metric on Wall Street. If size helps investment banks, then small startups, however nimble, may struggle. Building a brand would be a bit of a problem too – one that mattered less for low-cost airlines, whose offerings are pretty simple and undifferentiated. Perhaps the incumbent investment banks will also be able to adapt. Unbundling services and charging for them was one tactic aircraft operators used that banks should now consider. Improving the productivity of their employees and assets by scheduling flights more frequently could also translate into the banking world: balance sheets are being trimmed and low-volume clients ditched. But a budget investment bank or two could speed change. Excessive pay packages might finally start to fall. The industry might also use shared utilities with more zeal, for tasks such as know-your-client and money-laundering checks, or cyber security. Here too they might learn something from studying airlines' history. Booking platforms Sabre and Amadeus were originally airline-owned, but were sold off around the turn of the century. With returns this depressed, the investment banking industry could do with radical ideas. A few airline-based case studies could be just the thing. For more independent commentary and analysis from Reuters Breakingviews, visit breakingviews.com

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