Tags: Boston Consulting Group | Banks | regulations | investment

Report: Big Global Banks Need to Shrink to Survive

By Michael Kling   |   Friday, 03 May 2013 08:11 AM

In order to survive onerous regulations and tougher competition, large global banks will need to dramatically shrink, a new report from The Boston Consulting Group (BCG) shows.

While some will be forced to leave the business entirely, others will have to drop some asset classes, downsize or cut unprofitable exposures and investments.

"The capital markets and investment banking industry is in the midst of a multi-year transformation that necessitates tough strategic choices," said Philippe Morel, a BCG senior partner and a co-author of the report.

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"In short, only the fittest will survive."

The days of after-tax return on equity (ROE) levels of 15 to 20 percent are probably over for most investment banks, according to the report. The industry average was in the 10 to 13 percent range at the end of 2012, and will probably drop another 3 percentage points because of regulations.

The financial institutions must make tough choices about their core business models, portfolios and operating models if they hope to achieve ROEs of 12 percent, the minimum that investors require, the report suggests. Only a few will be able to meet that benchmark unscathed.

Revenue growth will probably be modest this year and should remain below pre-crisis growth levels, the consultant predicts. Rapidly developing economies offer opportunities, but they also pose hurdles such as varying client and investor expectations, heavy government influence and market fragmentation.

Although banks are making good progress meeting new regulations and capital requirements, that compliance is damaging ROE. Plus, increasing use of electronic banking is squeezing margins.

BCG predicts that of the 28 global banks, 25 will have to downsize and revamp operations, Fortune reports. Only Goldman Sachs, Deutsche Bank, and JPMorgan Chase will be able to remain close to their current size. But even those banks will have to cut costs by about 10 percent to meet profit expectations. That would mean about 40,000 jobs being eliminated, according to Fortune.

Fortune Senior Editor Stephen Gandel questioned the study's conclusion, noting that regulators would probably not tolerate a financial system dominated by just three huge banks. In addition, BCG's predictions are based on current profits, but many business lines could become more profitable as the economy improves.

And it's not certain that higher capital requirements will force banks out of business lines, he argues. Stanford economics professor Anat Admati has said that higher capital requirements may make bank stocks more attractive to investors who will appreciate their greater safety even if profitability drops.

While new regulations focus mainly on investment banking activities like structured financing, traditional lending should still remain profitable for big banks, Gandel adds.

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