Too Intertwined to Fail
Until a few years ago, global leadership in investment banking (as opposed to retail banking) was in the hands of a few actors dominating the market. JP Morgan, Goldman Sachs and Morgan Stanley in the US, and Barclays and Deutsche Bank, supplemented by Credit Suisse, in Europe, long dominated asset management and high-value-added services in investment banking, known under the acronym of FICC (Fixed Income, Currencies and Commodities Trading and Brokerage).
Following the Lehman Brothers default, regulatory authorities have stepped in and changed the competitive environment. In the US, the Dodd-Frank Act established a legal basis for the dismemberment of financial conglomerates, by imposing a sharp separation between retail banking and investment banking, that is, between loans and deposits, and so-called proprietary trading of financial instruments. In the UK, the Vickers Report, and in the EU, the policy recommendations of the Liikanen Report go in the same direction: in order to ensure financial stability and tame the dangers posed by global financial actors in case of a meltdown, and because of their interconnections with other financial intermediaries around the world, it is essential to separate traditional banking activities from investment banking.
Such regulatory separation has been accompanied by a statutory increase in the amount of capital needed to engage in trading. Banks that are strongly active in the trading of bonds, stocks, commodities and derivatives must now have first-class owners' equity, which in practice means they are now risking their own capital, and this is leading to a decline in shareholders' returns.
The rationale behind the strategic moves recently made by major banks is more clear in light of what has just been said. Barclays, joined by Credit Suisse and UBS, have abandoned the FICC market, because of a sharp drop in profitability coupled with more onerous capital requirements. While the two Swiss giants have refocused on asset management, a market segment long dominated by Swiss banks, Barclays has stated it will reorient itself toward retail banking, through a major reorganization of its transnational network of branches. Today in Europe, only Deutsche Bank remains a commercial bank that is still trading all major asset classes.
On the other side of the Atlantic, Citi and Morgan Stanley have given up trading altogether, while Bank of America Merrill Lynch has limited its exposure to trading, leaving lordship over the global turf to Goldman Sachs and JPM Chase.
If on the one hand such trends determine a new scenario based on "specialization leadership" replacing "enlarged leadership" in the banking industry, on the other hand the new market environment poses a key challenge for financial regulators. There are only a few banks left that are truly global and leaders in all market segments. From the point of view of regulators, this raises a crucial question: isn't the search for financial stability clashing with the emergence of banks that are too big and too intertwined to fail?