SOURCE: The Boston Consulting Group

The Boston Consulting Group

May 06, 2014 12:00 ET

Revenue Decline Puts Investment Banks at Risk

Return on Equity Is Also Down, With Further Drop Likely; To Rebound, Institutions Must Meet Rising Client Demands, Fill Human Resource Gaps, and Consider Partnership Opportunities, Says New Report by the Boston Consulting Group

NEW YORK, NY--(Marketwired - May 6, 2014) - Investment banks, faced with tough strategic choices in a shifting industry landscape, must take action on multiple fronts if they hope to put return on equity back on a positive trajectory, according to a new report by The Boston Consulting Group (BCG). The report, "The Quest for Revenue Growth: Global Capital Markets 2014," is being released today.

According to the report, total industry revenues fell by 2 percent to $227 billion in 2013, and have declined by 13 percent since 2010. Revenues in fixed-income, currencies, and commodities -- the largest revenue pool -- fell by 16 percent, a decline partly offset by substantial rises in equity and investment-banking division revenues. Total costs have remained fairly stable as compensation cost reductions have been largely offset by rising litigation expenses, which rose from about 3 percent of total costs in 2010 to 8 percent in 2013.

After-tax return on equity fell by 1 percentage point to 11 percent in 2013, still in the range of the typical cost of equity, although the trend toward combined reporting of corporate and investment banking activities may be masking decreasing profitability in pure capital-markets activities. Overall, with significant variation around the average, return on equity has not returned to the levels achieved before the 2008-2009 financial crisis.

"The industry finds itself in a strategic deadlock of overcapacity and flat or falling revenues," said Philippe Morel, a BCG senior partner and a coauthor of the report. "Similar situations in other industries have sometimes been overcome by mergers, but regulation will likely prevent such a solution in investment banking. Successful institutions will be those that focus on market share gains."

The report says that although the regulatory framework of the future has largely been set, the implementation of this structure still has quite a way to go. This situation continues to generate uncertainty regarding both revenues and operating models (as more over-the-counter offerings are being cleared and listed). The report also says that six business models -- powerhouses, haute couture institutions, relationship experts, advisory specialists, hedge funds, and utility providers -- remain viable but that all face serious challenges to success. In order to raise revenues, investment banks must review and rework their approaches in three core areas of their business: clients, people (human resources), and partnerships.

Clients. It is time for investment banks to figure out what it means to be client centric, the report says. The goal is to make relationships more holistic, leveraging greater knowledge of each client's specific, evolving needs and bringing the full capabilities of the bank to bear. BCG expects three key initiatives -- which are still in their formative stages -- to make a difference.

  • Improving Analytics Capabilities. There is a clear competitive edge for banks that provide their front offices with client-related analytical tools and make greater use of big-data solutions. A wide gap has emerged between the highest-spending ($50 million on average) and the lowest-spending ($15 million) investment banks in terms of recent research-technology and sales-technology investments.

  • Exploiting Adjacencies. Investment banks must break down silos and actively address synergies with other businesses -- such as lending, transaction banking, asset servicing, clearing, and wealth management -- in order to achieve greater reciprocity and unlock new revenue opportunities. 

  • Tracking Client Satisfaction. Because investment banks have historically focused on product-oriented quality measures, no sophisticated, industry-specific client-satisfaction measure has yet been developed. Building on the experience of other industries (and acknowledging the uniqueness of their own), investment banks need to create such a measure and use it to identify corrective actions that offer value to clients.

People. Investment banks have increasingly found themselves in a battle to attract talent. Traditional buy-side institutions as well as newer suitors such as social-media and technology companies are doing their best to attract the brightest minds. With a 25 percent drop in the average investment-banking compensation package since 2010, the gap with other sectors has narrowed.

BCG believes that institutions must identify what the investment banker of the future looks like. The next generation needs to possess a broader set of skills (in areas such as technology, data, and regulation), have an entrepreneurial and innovative spirit, and embrace a deep cultural sense of compliance, collaboration, and client service. Investment banks need to radically change their value propositions both to appeal to this new generation of employees and to develop the raw talent they acquire.

Partnerships. According to the report, investment banks have rarely managed to forge fruitful partnerships, whether in shared operating models (sharing infrastructure and costs by setting up utilities to be used by a consortium of banks) or in commercial partnerships. Most partnership discussions hit a snag over such issues as governance, accountability, and legacy systems and processes. 

But a combination of factors has increased the need for banks to reconsider partnerships, with goals such as mitigating the effects of retrenchment in certain regions and products, reducing fixed costs, tackling overcapacity, and -- with many products becoming commoditized -- adapting to shifts in revenue sources. A few vendors are leading initiatives to forge operating-model partnerships across a broad scope of pre- and post-trade activities and a wide range of products. Discussions are accelerating on regional and product-based commercial partnerships.

Ultimately, says the report, each institution must choose its own path on the basis of its legacy, its particular strengths and weaknesses, and its aspirations. But there will certainly be winners and losers.

"At this juncture," said BCG's Philippe Morel, "those institutions that make the right choices could achieve a return on equity of up to 15 percent between now and 2020. Others will struggle to cover their cost of equity -- even in good years."

A copy of the report can be downloaded at www.bcgperspectives.com.

To arrange an interview with one of the authors, please contact Eric Gregoire at +1 617 850 3783 or gregoire.eric@bcg.com.

About The Boston Consulting Group
The Boston Consulting Group (BCG) is a global management consulting firm and the world's leading advisor on business strategy. We partner with clients from the private, public, and not-for-profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 81 offices in 45 countries. For more information, please visit bcg.com.

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    Eric Gregoire
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    Tel +1 617 850 3783
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    gregoire.eric@bcg.com