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Editor’s take: Time to get paid like a retail banker?

Banks aren’t in the business of philanthropy. Investment bankers are paid generously because they make big money for their employers: in 2006 profits per head in investment banking were 26 times higher than in the average industry, according to McKinsey.

With profits now on a downwards trajectory, pay will clearly fall in 2008. The real question is when it will bounce back up. The CEBR is optimistically predicting big bonuses will be back in 2011, but there are signs that a deeper structural shift is taking place. If so, banking wallets may never bulge in quite the same way again.

The bad omens are:

1) Regulation: Fed support for brokerage houses will come at a cost. Tim Geithner, president of the Federal Reserve Bank of New York, is quoted in the Financial Times today complaining that the Fed’s responsibility for financial stability is unmatched by its authority. The gap, says Geithner, needs to be closed.

Regulation will almost certainly involve increased capital requirements and lower leverage, possibly including limits on overnight repo funding and higher capital charges against assets held in trading books. When good times return, banks will therefore be less able to exploit new opportunities. Trading profits will be lower as a result.

2) Shareholder power: Despite superior profitability, investment banks have long traded at low multiples due to uncertainty over the source of their success. With profits now clearly ephemeral, those multiples are now justified. And profligate pay in boom years looks increasingly foolish.

Sovereign wealth funds (SWFs) could also help suppress frothy bonuses. Many SWFs are nursing substantial losses on existing banking investments, but both Barclays and Lehman are planning to tap them again.

Brad Hintz, ex-Lehman CFO and analyst at Sanford Bernstein, predicts sovereign funds will exert an influence behind the scenes: “Sovereign funds are going to go directly to management and ask what’s being done to clean balance sheets, cut expenses and lower headcount.”

3) Fee disputes: Client mutterings about exorbitant advisory fees are turning into full-scale complaints. The Bradford & Bingley rights issue debacle has helped focus minds on whether underwriting fees are justified. In Asia, where M&A activity is still expanding, a high proportion of companies use their in-house advisors to save cash.

There is hope. The Economist points out that banks could always move prop trading off their books and into hedge funds, thereby avoiding tighter capital restrictions from the Fed. But the experiences of UBS and Bear Stearns suggest this may be unwise.

In the meantime, unless investment banks can think of a new way to supercharge their profits, the industry has the potential to become much more pedestrian. Investment bankers could soon join their retail banking colleagues in pocketing bonuses that are fractions rather than multiples of salary – and in driving Mondeos rather than Maseratis.

Comments (1)

Comments
  1. And who will be driving the deals through then, 15 hours a day until completion? The Fed will impose a limit on the leverage in the products and in the positions retained by IB in structured trades but nobody would limit the pay because nobody knows how to do it and would not want to take responsibility. The bankers who add value are worth every penny they get, and everybody knows that…

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