One of the biggest concerns that is belatedly dawning on the financial world and its regulators is that a crackdown on the way banks are supervised is pushing dangerous risks into the unmonitored realm of “shadow banking”– a new generation of lightly regulated funds and non-bank lenders that could be sowing the seeds of the next crisis.

But are the world’s banks – only too happy to point the finger at their newly empowered rivals and the dangers they pose – ignoring the build-up of risk created by changes in their own operations?

By any standard measure, virtually all banks in the developed world are less risky institutions now than they were in 2007. Leverage has been reduced, both by a shrinkage of balance sheets and a boosting of capital; structured finance has been simplified; and off-balance sheet vehicles have been wound down. Regulatory changes have prohibited or at least disincentivised business lines with risky reputations – from general proprietary trading and hedge fund investments to many subsets of the fixed-income spectrum.

The new regulatory architecture has underpinned the natural inclination of many banks, and their chief risk officers, to retreat from businesses in which they have recently lost money. The result is a wholesale withdrawal of capacity from various areas of fixed-income trading and derivatives, for example.

In other words, most banks are doing just the same thing they did in the run-up to 2007 – behaving like lemmings. Then they were piling into subprime mortgages and collateralised debt obligations in a desperate bid to keep up with each other’s booming profitability. Now they are frantically “de-risking”.

If there is one epitome of the new model, it is UBS. The banking group has been burnt by the crisis and by two other big home-grown disasters – a US tax scandal in its wealth management business and a rogue trading scandal in London – and Sergio Ermotti, its chief executive, is now shrinking the sales and trading side of UBS’s investment bank and shifting the group’s emphasis towards advisory-based revenue. It signalled the change with bravura, recently poaching Andrea Orcel, the former Bank of America Merrill Lynch banker and one of the best-known names in the world of mergers and acquisitions, as the division’s co-head.

Other groups, big and small, have made similar moves. Jefferies, a second-tier US group, recently bought up Hoare Govett, the UK advisory business of Royal Bank of Scotland, in an effort to boost its business in the area of M&A and corporate finance.

Compared with some of the herd-like shifts the banking industry goes through, this is a low-risk business to gravitate towards. Relative to a £2bn rogue trade, or a capital-heavy investment in fixed-income derivatives, the potential losses are small.

The snag is that the potential profits also look small at a time when banks, and their investors, still hark back to the pre-2007 heyday of trading-inflated returns on equity that ran to more than 20 per cent – twice the typical level for 2011.

M&A is just as exposed as trading to the vagaries of market cycles, with boom times that tend to be brief and bleak ones that drag on. And even here, regulators are cracking down. Last week Ian Hannam, a top corporate financier at JPMorgan Cazenove in London, quit his job after being accused by the Financial Services Authority of leaking information about a client – an action that critics of the FSA saw as overzealous but which nonetheless reflects a toughening of the environment for M&A bankers.

The bulls of the M&A world insist there is money to be made and swear there is a bulging backlog of pent-up deals just waiting to be done if only markets would recover sufficiently to pin a decent valuation on the sellers’ stock.

For now, though, the truth is that the M&A business is looking weaker than it has for a long time. Fees from M&A and equity and debt capital markets slumped by a quarter in the first three months of 2012, according to Thomson Reuters, dragged down by a fifth successive quarter of falling M&A volumes.

If M&A picks up in the next few quarters, banks such as UBS are going to look prescient. But it is hard to see any rebound being dramatic, given the continuing bleak mood in the eurozone and the impact of that on global sentiment. In the meantime, the more banks that decide advisory banking is the future, the tougher the competition for a shrinking pool of revenue is going to be. Profitability can only suffer – and that may be the biggest risk for banks and their investors in the post-crisis world.

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