April 11, 2013 10:55 pm

Rules threaten global banks, reports say

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Myriad tough new rules will become such a strain on investment bank returns in the next few years that some may struggle to sustain their global operations, according to two reports.

The incoming regulation is fracturing global banking in a way that could make large investment banks un-investible and force universal banks to split, one of the reports – from JPMorgan’s global banking analyst Kian Abouhossein – said.

Mr Abouhossein estimates that various planned rules will stifle investment banks’ average return on equity by more than 5 percentage points in the medium term, pushing it down to 9.6 per cent in 2015.

Morgan Stanley and Oliver Wyman estimate a negative impact on return on equity from regulatory “Balkanisation” of 2 to 3 percentage points in a separate report also published on Thursday.

“The Balkanisation of banking markets is a major challenge to returns of global banks” said Huw van Steenis, analyst at Morgan Stanley.

The reports detail how investment banks are struggling to adapt to radical regulatory and technological changes coupled with persistently weak revenues.

While most have slashed costs by firing staff, shrinking bonuses, exiting business lines and selling legacy assets, they are facing a large number of new regulations as well as increased fixed costs from the migration of trading to electronic platforms.

“Despite the progress made in 2012 and the announced cost saving as well as risk-weighted asset reductions to come in the next few years, the industry is not out of the woods yet,” Mr Abouhossein writes.

He added that in a worst-case scenario, regional funding requirements might undermine the sustainability of the universal banking model.

“Universal banks with tier-one investment banks might have to spin off their investment bank operations as the movement of capital and funding becomes restricted,” the report said.

Regulators around the world are working on rules that force global banks to better capitalise and fund regional subsidiaries locally in a move to make them more easily dissolvable in the case of a collapse.

“National subsidiarisation [is] gathering pace quickly. With diverging national regulatory agendas, it poses a major risk to the global banking model,” Morgan Stanley and Oliver Wyman write in their report.

European banks are expected to be hit harder by the new rules than their US counterparts, which have the advantage of a home market that delivered 55 to 60 per cent of global investment banking profits last year.

Proposals in the US to make the intermediate holding companies of foreign banks subject to much tighter capital requirements will also disadvantage Europe’s investment banks, which are also affected by a planned financial transaction tax and cap on bonuses in their home market.

But Morgan Stanley and Oliver Wyman see a glimmer of hope because cost-cutting and asset reductions pushed average return on equity to 12 per cent last year, the highest in a number of years.

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