An industry in constant flux
Since the Big Bang of the 1980s, investment banking has proven to be one of the most dynamic parts of the banking sector. Never has this been more apparent than across today’s markets
Investment banking has experienced many regulatory changes: from structures to market share; from the rising prominence of banks from eastern developing nations, to the increased adoption of technology. This has been going on for a while, but even more so in the years since the 2008 financial crisis.
One of the key tasks for investment banks is reducing operating costs while opening up potential for new sources of profit
One of the most interesting recent developments in investment banking has been the increased prominence of American banks in the European market. This started following their 2011 low, when they controlled only 34.7 percent of the market against European banks’ 53.7 percent share. This was the trough, but they started to pick up the pace from 2012 onwards, nearly reaching parity with their European counterparts in 2015, at 44.5 percent of market share.
This surge has been partly cyclical: American investment banks felt the peak of the crisis in 2009 while pain came to European investment banks later, in 2011. On the whole, the US’ investment banks have been performing strongly. In response to the crisis, they quickly downsized, cutting costs by trimming staff numbers. European bankers are, however, now starting to follow this trend – particularly figures such as John Cryan, who recently took the reins of Deutsche Bank as co-CEO.
Click to enlargeUS banks have become more competitive, allowing them to make gains in Europe in terms of market share – and may continue to do so for the next few years. But this competition is forcing European investment banks to trim their costs as well: restructuring and becoming more competitive. It is always the case in capitalism that more efficient market actors engender greater efficiency among their competitors – and investment banking is no different.
American investment banks in general, however, appear to be on a winning streak, with some ranking among the largest banks in the world (see Fig 1, over page). In the US itself, the market share of the top 20 American banks rose from 63 percent in 2014 to 66 percent by the end of 2015. But within the US investment banking market, the rise of Chinese banks can also be seen.
Although Chinese banks themselves only represent a marginal share of the US market, since 2013 they have been on a gradual rise. While they still account for less than five percent of total investment » banking market share, over the past few years their position has steadily grown, making them a genuine competitor in the country.
At the same time, Chinese banks have started to come into their own at home in the Asia-Pacific region. In only one year – between 2014 and 2015 – Chinese investment banks gained roughly 10 percent of the region’s market share, bringing them to collectively control 41 percent of the market. Broadly, this gain is reflective of both increased confidence and growing skill and expertise among Chinese investment banks.
Working together
This gain by Chinese firms in their home region has been at the expense of European and American banks. However, 2015 also saw another interesting trend: the increased opening of Japan’s traditionally closed banking market, with European and US investment banks gaining ground. Japanese investment banks’ share of their own market has generally been in decline since 2010, down to 67 percent from their previous share of more than 70 percent.
Going forward in 2016, investment banks face a number of profit-related challenges with which they must grapple. The raft of new legislation adopted by governments around the world has and will continue to be a squeeze on profits for investment banks. New regulations requiring increased risk management will be an additional cost, as will increased capital requirements. At the same time, investment banks face more restrictions on their operations, with laws in both Europe and the US addressing proprietary trading. One of the key tasks for investment banks is reducing operating costs while opening up potential for new sources of profit.
Click to enlargeInvestment banking has increasingly attracted the attention of financial technological innovation. Investment in fintech has grown exponentially in recent years (see Fig 2) – whether this is a boom or bane to the world’s top investment banks remains their choice. Integrating new technology into their operations potentially allows investment banks to become more efficient and dynamic.
Alternatively, investment banks can shun new, creative fintech solutions in favour of traditional methods and face the prospect of increased competition from fintech dedicated firms, who – as a result of financial technology innovations – already face lower barriers to entry than existed in the investment bank market previously.
One area of technological innovation investment banks in particular are increasingly embracing is blockchain: an open-ended cryptographic ledger that allows transactions to be carried out and securely recorded more easily. Once the preserve of doomed alternative cryptocurrencies such as bitcoin, the blockchain technology that made those currencies possible poses great potential to investment banks, in particular when it comes to trimming overhead costs and improving asset tracking.
JPMorgan Chase and Citigroup tested blockchain technology in successful trials that used it to track credit-default swaps in April. The test was to verify if the blockchain ledger could successfully track transactions – with common access to all – which it was deemed able to do. Both banks are now looking into how the technology could be adopted beyond this.
Further challenges
Going forward in 2016, investment banking will face a number of continued challenges. The adoption around the world of the once unconventional policy of negative interest rates by central banks has had a squeeze on bank profits. With reduced margins for banks across the board, investment banks will have to adapt to the new regime of negative rates. At the same time, global stock volatility in 2015 – emanating from China but spreading globally – has also posed a challenge.
While investment bank activity is growing in China and Chinese market actors gain increased share, there are general concerns about over-borrowing threatening the country’s financial sector as a whole. In Europe, banks are already under the strain of increased regulatory pressure, with concerns over diminished margins.
Investment banks, however, should not despair. Being the innovative industry that it is, it has the means and wherewithal to adapt – indeed many already are. While some investment banks may fall by the wayside – as is the nature of capitalism – the more competitive will emerge the stronger, creating a leaner and more invigorated investment banking sector.
