Hugo Dixon: UBS exposes myth of full-service bank
During the long upswing, second-tier and even third-tier banks felt they needed to offer every product in every part of the world. That led to inflated costs, unethical practices and now terrible returns. Last week’s bold move by UBS to hack back its fixed income division, with the loss of 10,000 jobs, exposes the myth of the so-called “full-service” firm.
The drive behind creating full-service firms was the idea that corporate and investor clients - say, Vodafone or BlackRock - wanted to get all their financial services from a single source. A further motivation was fear among commercial banks that they would be disintermediated by the capital markets. Corporate clients would finance themselves by issuing bonds to investors rather than borrowing from banks.
The full-service myth probably dates from at least the time of “Big Bang” in 1986, when London’s financial markets were deregulated. Over the past quarter of a century, the financial industry has been bulking up in investment banking either by acquiring rivals or by engaging in hiring sprees. UBS, for example, merged with Swiss Bank Corporation, which had already bought S.G. Warburg, and then acquired PaineWebber. It also made a disastrous push into fixed income trading, which cost its shareholders tens of billions of dollars.
Firms that had even less of a comparative advantage in investment banking, like Commerzbank, RBS and UniCredit, felt they had to be players too. One result was that pay across the industry went through the roof.
Another consequence was that there was pressure on bankers to thrust unsuitable products down clients’ throats. Sometimes, customers just had to put up with another visit from financiers hawking the same old ideas in glossy presentation packs. But the less sophisticated among them sometimes succumbed to the salesmens’ silken speeches, spawning scandals that have sullied the industry’s image.
The basic theory was largely flawed. Large clients find it easy to shop around - borrowing money from one bank, taking advice from another and doing a derivatives deal with a third. And when they did push extra business through a one-stop shop, it was often to the bank’s disadvantage: for example, companies would only use it for merger advice if it also offered loans at wafer-thin margins.
In normal times, the shakeout would have happened earlier. But the long upswing deferred the reckoning. The fixed income business, in particular, boomed on the back of cheap money sloshing around the world in the early part of this century. Banks such as UBS kidded themselves that they were able to be profitable despite having little real expertise and few clients in the area.
What’s more, some of the bosses didn’t see how unhealthy the growth of their industry had become because they personally benefited. Their empires got bigger, they were paid tens of millions of dollars and they surrounded themselves with sometimes sycophantic acolytes.
The reckoning, though, can’t be postponed forever. Not only has the market for investment banking services shrunk; the regulatory noose is tightening. That latter requires banks to have fatter capital buffers, especially if they are big and complex, or if they have large trading operations. Regulators are also pushing for banks to fund themselves more with retail deposits than through the wholesale markets; requiring firms to show how they would be unwound in an orderly fashion if they went bust; and are pushing through plans to force groups to separate out their investment banking or trading operations.
UBS pointed to the market and regulatory outlook as the two main reasons for radically reshaping its investment bank. It is retreating to equities, corporate finance, foreign exchange and precious metals. It won’t just shed 10,000 jobs; it will also cut group-wide risk-weighted assets by a third.
The businesses being run down consumed 14 billion Swiss francs of capital and earned returns well below the bank’s cost of capital. What’s more, by shrinking its balance sheet, UBS will be allowed to maintain a lower capital ratio - 17.5 percent of risk-weighted assets, rather than 19 percent - thereby freeing up more capital. If UBS can persuade its regulator that it is now a simpler and therefore less risky business, there’s even a chance that the required capital ratio will be cut further.
Investors cheered the plan, boosting UBS’s share price by 18 percent last week. The transformation will be painful. But shareholders can now foresee the Swiss bank’s future based around its core wealth management business with a much smaller but viable investment banking operation on the side.
UBS’s shares now even trade at just above the value of its tangible equity. Normally, that wouldn’t be anything to crow about, but most of the industry trades at a fraction of book value. For example, Credit Suisse is valued at 0.83 times book; Citigroup and Deutsche Bank at 0.63; Barclays at 0.53; and RBS at less than half.
All these banks, and others, should take heed of UBS’s move. They won’t be able to copy it exactly as they have different areas of strength and weakness. None, for example, has a wealth management business to match UBS’s. But they all need to abandon the full-service myth and cut back their investment banks drastically.
Doing so will leave them with smaller but stronger businesses. If the whole industry moves, the battle for talent will ease - allowing banks to slash compensation and boost earnings. UBS’s rivals should get on with it rather than wait to be pushed.