The unsettling return of bullish investment banks

The unsettling return of bullish investment banks

Investment bankers have their mojo back. Profits at the top nine global investment banks hit $78bn last year, topping the level of 2007, before the crisis hit. “Our franchise is much stronger than it was” before the crisis, says James Forese, head of the investment bank at Citi, an institution that needed a $45bn bailout a decade ago. The strongest US investment banks, such as JPMorgan Chase, are outright bullish. Even banks that have had an unsteady decade since the crisis are optimistic. The UK’s Barclays, for example, is making noises about expansion.

The natural reaction to this, for anyone who lived through 2008, can be summed up in one word: sell. A psychological legacy of the great crisis is that expressions of optimism from the banking industry, while they might reflect strength in the underlying economy, feel decidedly ominous.

There may be more to this than the legacy of market trauma. Banking is cyclical, and investment banking more so than banking generally. The advisory and capital markets units are, in particular, creatures of the good times. And on top of the investment bankers’ enthusiasm, there are other indications of a cyclical top. Assets remain expensive worldwide, and in the US business confidence is at a peak, unemployment is very low and tax cuts have delivered a big fiscal stimulus. If there was ever a moment for bankers to take on too much risk, thereby planting the seeds of a nasty downturn, it is now.

One of the more compelling reasons to think that cycle is turning is, oddly, the poor performance of a different set of banks. Sixteen “systematically important financial institutions” in Europe, China and Japan have seen their stock prices fall 20 per cent from recent peaks, putting them in a bear market. The likely reason, according to Absolute Strategy Research, is that this group depends on dollar-based wholesale funding, which is growing more expensive as US interest rates rise and the end of US quantitative easing reduced dollar liquidity. A stronger dollar compounds the effects of the more expensive funding, as these banks lend in non-dollar currencies. Finally, the European and Asian economies, unlike the booming US, show signs of slowing. The slumping big banks may be telling us that the US cannot drag the global economy along by itself.

None of this augurs a repeat of the crisis. A positive legacy of 2008 is much better capitalised banks. Profits may be back to pre-crisis highs, but much higher equity levels mean that returns on equity remain modest. That helps explain why the same banks reporting surging profits are nonetheless focused on using technology to enable big reductions in headcount. “We’ve got 20,000 operational roles,” says Mr Forese of his back-office staff. “Over the next five years could you make it 10,000?” This sentiment has been echoed by leaders at Barclays, Deutsche Bank and Goldman Sachs.

This talk of letting workers go is — ironically — much more comforting than bankers’ excitement about resurgent profits. If higher capital requirements have forced banks to focus on efficiency even when times are good, rather than chasing growth at all costs, then perhaps the crisis has not gone to waste. Whether or not the business cycle is turning now, it will do so eventually. When it does, it will be those banks that improved the return by taking out costs, rather than by piling up assets, that will fare best.

Focusing on operational efficiency will not be exciting for the bankers themselves, of course. But the key lesson of the financial crisis is that boring banks are exactly what we want.

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