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Marginal utility

3 November 2015 By Dominic Elliott

UBS’s most recent profit target capitulation confirms what has long been suspected – European banks can now at best only offer utility-like returns.

The Swiss lender represented the last hope for investors seeking a revival of the pre-crisis age of high-return investment banking. It has led peers in terms of consistency of capital-weighted earnings since its revamp three years ago. But on Nov. 3, UBS scaled back its return-on-equity metric for the third time in two years. That was in spite of a near-trebling of third-quarter net profit to 2.1 billion Swiss francs, helped by 1.3 billion francs worth of deferred tax assets.

Chief Executive Sergio Ermotti has company in curtailing his group’s ambitions, which are now to exceed a 15 percent return on tangible equity (RoTE) by 2018 instead of next year. Standard Chartered and Barclays have reined in their aspirations, while Credit Suisse Chief Executive Tidjane Thiam has scrapped return targets altogether on the basis that he cannot control regulators.

Macroeconomic conditions are part of the reason for UBS’s wariness. A protracted period of rock-bottom interest rates has hurt its wealth business, predicated as it is on cranking out a low-risk spread on 1.7 trillion Swiss francs in invested assets. America’s September decision to leave the Fed funds rate unchanged was unhelpful. Extreme stock market volatility in August also reduced transactional volumes among wealthy clients in Asia.

But the real catalyst is a steep rise in capital stipulations – something skewering all banks’ targets. Swiss regulator Finma has for more than a year effectively required UBS and domestic peers to hold more capital, chiefly against mortgage lending and investment banking credit risk. That bumps up group risk-weighted assets by about 25 percent and investment banking RWAs by 20 percent, versus UBS’s expectation three years ago.

Keeping returns high won’t get any easier. Basel-based global banking overseers are devising a new set of more stringent capital requirements that will take effect in a few years’ time.

UBS still has plenty more crisis-era tax assets that it can use up to keep investor payouts high. For everyone else, a dull utility-esque, dividend-first approach is the future. That’s fine, but investors will know that even better capitalised banks are riskier than utilities.


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