Investment banks urged to reduce back-office costs

Investment banks, set to book €190 billion revenue this year, still need to cut jobs and costs to make the industry profitable, Deutsche Bank said.

Few will deliver returns above their cost of equity, which averages about 12 per cent, with back-office functions and equities and advisory units most ripe for the knife, analysts at one of the world’s biggest investment banks said.

“To the extent that investment banks are not delivering the profits they should, this is down to industry fragmentation and the related issue of costs being too high,” Matt Spick said in the note published yesterday.

The cost problem was due to overstaffing, rather than excessive pay levels, he said. The industry was inefficient, with too large a back office, and banks provided too much advice when most clients wanted “fast execution at the best prices”.

Investment bank revenue and profitability have been hit hard by weak economies and tougher regulation, and many in the industry say this marks a structural shift that banks have been slow to adjust to.Tumbling revenue from stock trading and a big fall in dealmaking in the first six months of this year dragged industry earnings down, intensifying pressure on banks to cut costs, notably through job cuts.

Deutsche Bank’s report said only a small handful of investment banks, led by US group J.P. Morgan, will deliver a return on equity of 12 per cent or more this year.

There has been little concentration of business in equities sales and trading, and most banks will be loss-making in that area this year, the report said. The top three – Goldman Sachs, Credit Suisse and J.P.Morgan – were pulling away from the second tier, it said.

There was a remarkable retrenchment by banks last year in fixed income, commodities and currencies, a move which has slowed, Spick said.

FICC accounts for the bulk of investment bank income and Mr Spick said the revenue pool could shrink, leading to another round of fierce competition in the next two years between the biggest six or eight firms.