First quarter results reveal impact of regulatory pressure on banks to raise RWAs and equity – with a numbing effect on profitability. My latest column for Financial News
A good spring clean is always cathartic. Nowhere more so than at investment banks, which in the first few months of 2012 collectively took out the scrubbing brush, got down on their hands and knees, and spruced up their numbers.
The main reason for this overdue housework was the combination of a downturn in activity and the regulatory equivalent of a cleaning inspection, with banks having to set aside more capital against their trading operations. This, in turn, forces them to spruce up their balance sheets and cut costs. Yet, even at those banks whose spring clean resembled the work of Hercules in the Augean stables, the results are far from sparkling.
Across the board, banks cleared out costs in the first quarter of the year, with an overall reduction of 6% across the industry compared with the first three months of 2011, according to my analysis. Much of this was achieved by cutting staff. A sample of five banks that provide comparable numbers on headcount reduced their staffing by nearly 5%. Scale this up across the industry and you have something close to 20,000 job cuts with the promise of more to come.
A few banks brought out the industrial strength cleaning equipment. At RBS, the decision at the end of last year to pull out of large swathes of equities and investment banking and create a new division called RBS Markets (which looks remarkably like the old RBS markets business before it blew €70bn on parts of ABN Amro) reveals a division that is even less profitable than the old one.
The really stubborn dirt has been caused by the barrage of regulatory reform, most importantly Basel 2.5, which forces banks to increase the risk-weightings of many of their trading businesses and increase the capital allocated to them accordingly. By increasing the equity allocated to the business, all things being equal, banks will have to pedal even harder to make a decent return on equity. To maintain profitability, banks have to reduce their risk-weighted assets (to limit the increase in equity), cut their costs and try to increase revenues. With growth under pressure, their options are fairly limited.
The first-quarter results provided a first glimpse of the impact of these changes. At the investment banks at Credit Suisse and UBS, and Deutsche Bank’s corporate banking and securities division, RWAs under Basel 2.5 jumped by an average 21% in the first quarter, compared with RWAs under Basel II a year ago. And this is after they had shed tens of billions of dollars in RWAs in “mitigation” by pulling out of some markets, selling loans and winding down trading positions.
The net effect of this regulatory pressure has been a wholesale increase in the equity that investment banks allocate to their business, raising the bar for them to hit their ambitious profit targets. Without a lot of fanfare, BNP Paribas increased the equity in its advisory and capital markets unit by 55% to $11.5bn. At Morgan Stanley’s institutional securities business, it jumped 43% and, at Deutsche Bank investment bank, it jumped by 38% (see chart)…