Investment banks must choose to invest or quit key areas: report

Sun Mar 25, 2012 7:05pm EDT
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By Steve Slater

LONDON (Reuters) - Investment banks need to make bold decisions to choose to invest in areas where they have a comparative advantage to win business or choose to exit them as the industry prepares for a big upheaval in the next year or two, a report said on Monday.

Analysts at Morgan Stanley (JPM.N: Quote) said wholesale banks could bounce back to deliver returns on equity (RoE) of 12-14 percent in the next two years following structural changes.

That is seen as the level needed to match the cost of equity and deliver profitable returns for investors, but many analysts and investors think they may struggle for some time to get there.

"The gap in returns will widen sharply between banks that manage to scale significantly where they compete and those that do not," Morgan Stanley analyst Huw van Steenis and his team said in a report by the bank and Oliver Wyman.

"Pressure on returns is now critical and marginal change is no longer a viable strategy," the report said.

"Higher fixed costs and more allocated capital mean banks cannot just shrink at the margin to reach adequate returns on capital. Firms now have to choose where they may have comparative advantage and then invest in scale to win in these markets, or exit."

The market is seen underestimating the scale of likely upheaval in the industry as banks adapt to regulatory changes.

Some 15-20 percent of market share could change hands during this industry reshuffle as investment banks reshape their portfolios around three or four winning business models and race to get adequate scale to deliver good returns, it said.   Continued...