Investment banks are at a crossroads. The culture remains geared towards bonuses, despite regulatory and political pressure to curb this, reputational issues abound and shareholders continue to complain about return on equity that refuses to budge upwards.
Something has to change. Many have pointed this out, and in a wide-ranging report on the future of investment banking, EY has come up with a list of suggestions on how the industry needs to develop. Needless to say, this has implications for employment prospects and pay packets.
1. Competition is on all sides
Investment banks are competing with hedge funds for both traders and trading revenues, they’re facing competition from private equity firms for talent and boutique investment banks for advisory work. Needless to say, this has led a number of investment banks to review their business models and pull back from certain trading functions – what EY dubs “protect and survive” mode. This means fewer trading jobs, particularly in fixed income, currencies and commodities, but potentially more jobs in advisory functions.
2. Expect more banks to follow Deutsche Bank’s front office nearshoring model
Not surprisingly, EY has called for banks to assess which tasks need to be performed internally, and which can be either pooled, decentralised or outsourced entirely. Both back and front office roles can be moved out of expensive financial centres and into lower-destinations, a trend that is likely to “accelerate” in the coming years.
EY suggests that 80% of investment banking profits come from just 20% of clients and raises an interesting point about nearshoring more front office functions. Currently, banks focus on ‘high-touch’ services to a select group of clients, while shifting attention to ‘mid-tier’ clients could actually bolster revenues.
Deutsche Bank’s operation in Birmingham in the UK houses so-called ‘low touch’ traders, booking trades for over 500 smaller clients but giving them closer attention by employing cheaper staff in lower cost destinations. This has been successful so far, so expect more banks to follow this model.
3. Investment banks need to start attracting a different type of person
J.P. Morgan and Goldman Sachs have both reacted to rhetoric over investment banking compensation by saying they will continue to pay for performance. In spite of the fact that pay incentives have been linked to recent scandals in the investment banking sector, few banks are shifting compensation towards ‘softer’ performance factors.
EY says this needs to change from the outset. Don’t throw more money at juniors to convince them that investment banking is a good place to launch their career. Instead “institutions should explore other incentives, including internal recognition programs, mobility, secondments, education and training, as well as the time and opportunities to develop innovative ideas or work on cross-functional teams.” Good luck with that.
4. Investment banks will differentiate themselves through technology, not people
Finance is all about human capital, or so the conventional wisdom goes. Get the right people on board and they’ll bring in the business for you. This message is changing – investment in technology is the way forward.
“In a more commoditized risk-averse future, the capacity of staff to innovate to drive revenues will be limited. Instead, cost-to-serve, speed of execution and quality of service will distinguish the leading investment banks,” says EY.
Given that investment banks are increasingly shifting tech roles to lower cost destinations, or turning to off the shelf solutions to keep costs down, this isn’t great news. Three quarters of tech costs are spent on maintenance of existing systems: “the scale of the challenge for investment banks is so great that they will continue to be forced to do more with less,” says EY.