Feeling the pinch in investment banking? The drive for cost reduction and the road to shared utilities

The investment banking industry has not traditionally been known for penny-pinching. Yet in recent years as the demands of complying with a wave of regulatory requirements has put heavy pressure on profit margins, reducing costs has become a top strategic priority. In this blog we will look at the steps that investment banks have taken to curb spending across the industry and assess whether these measures will in the end deliver the desired results. One of the options we explore is the increasing use of shared utilities to reduce spending, improve performance and enhance the customer experience.

Short back and sides please

The key driver behind the far-reaching search for cost savings is the expense that comes with meeting regulatory requirements.  From Dodd Frank to MiFID, KYC and AML, the list of regulations requiring banks to implement changes to their back office functions is a lengthy one.  In a move that is becoming typical of the industry BNP Paribas recently announced that it had been forced to increase the number of employees overseeing internal controls by 47% to nearly 10,000[1], bringing with it obvious cost implications.    

A second factor necessitating the recent cost-cutting endeavours has been the lack of revenue growth experienced by investment banks.  Their income derived from pure investment banking activities has been squeezed particularly hard, for example in the underwriting market where uncertainty over the impact of Brexit and elections in Europe has contributed to the total value of European IPOs halving to €28 billion last year.  The value of flotations on the London Stock Exchange alone was down by 60% in the same period[2].  When combined with regulatory curbs on proprietary trading, a long-term decline in trading commissions due to technological advances and increased competition, investment banks have been left with little option other than to cut costs in order to boost profits.

The banks’ response, a new look

A tempting option for banks in this climate of burdensome regulation and sluggish revenue growth has been to cut their considerable wage bills. For many this has meant reducing headcount, particularly in the revenue-generating front office.  Under Jes Staley’s stewardship, Barclays has cut 6,000 investment banking jobs[3] since  2015, primarily due to a hiring freeze.  Similarly HSBC is in the process of shrinking its investment banking wing by a third[4], and even Goldman Sachs cut more jobs in 2016 than in any year since 2008[5]

Headlines have also focused on the swingeing cuts made to bankers’ bonuses over the past few years, most notably with Deutsche Bank targeting vice presidents, directors and managing directors with an 80% reduction to its 2016 bonus pool[6]. This is reflective of a wider trend in the industry, which saw bonuses shrink by an average of 5-10% last year[7].  These flashier high impact cuts have hit the headlines, but almost as much focus has been on small scale tweaks to operating costs.  Expenses for international travel, hotels and client entertainment have been reigned in, and Goldman Sachs made news in March 2017 by ending its policy of issuing employees with a Blackberry and covering their phone bills[8]

New look, new performance?

Given that nearly all banks have implemented cost reduction of some description, the question arises as to which measures have helped and which have hampered performance.  Whilst it may be easy to castigate all job losses as a failure to invest in long term capabilities, the circumstances in recent years have made headcount reduction almost inevitable.  The success of this process has often been determined by the pace at which change is made. 

To illustrate this, let us briefly compare the situations in which Barclays and Deutsche Bank find themselves.  In 2017, Barclays proclaimed that they are “done with massive layoffs”, having gradually and successfully reduced staff numbers over several years.  On the other hand, Deutsche Bank failed to cut expenses related to pay and benefits throughout the years from 2007 to 2015 despite experiencing significant financial difficulty over this period.  This led them to take the unprecedented measures discussed above, with stringent cuts to both headcount and its bonus pool.  These are changes which do not provide a strategic solution to underlying problems, and could exacerbate them due to potential complications relating to staff retention and morale, as well as reputational damage.  Hence we see the rewards to be had in gradual and managed change across an organisation. 

There are also interesting questions to be asked regarding the cost-benefit analysis of small scale changes made to reduce cost.  The move made by Goldman Sachs to cease funding employees’ phone bills is unlikely to have a perceptible impact on their profit margin given the relatively small amounts of money involved, yet it has potential to frustrate bankers who frequently rely on international calls to perform their role.  Whilst a small change in itself, when combined with other such measures it has the potential to be viewed as an unwelcome shortcut to boosting the company’s bottom line. 

We think – it’s time for partners

In order to truly confront their problems investment banks need to resist the tactical solutions mentioned above and invest in cost reduction initiatives that maintain or even enhance their capabilities.  The wave of government regulation is not expected to abate soon, and so the goal at this stage should be a process which is able to handle this regulation at low cost whilst enhancing customer service.

An emerging option is shared utilities which have the potential to drive innovation in the sector. These shared utilities are often discussed as one of the very few options which would bring about the huge cost savings sought by many banks.  However they are largely under-used at present, with estimates indicating that up to 30% of the costs incurred by investment banks are in areas that would be viable candidates for the shared utility model[9], thereby opening the door to billions of pounds worth of potential savings.  While some companies have already begun to make progress in this space (for example both Credit Suisse and Barclays have made use of a shared post-trade derivatives platform)[10], adoption of the model has been unambitious with just 27% of banks saying they have used utilities in regulatory and compliance reporting[11].  

Banks who collaborate when using either their own in-house platforms or those provided by a 3rd party are able to make significant savings by spreading the costs of operating those platforms, and often see benefits in terms of the quality of data available as a result of pooling information.  This in turn can make regulatory reporting easier and quicker. 

Customer is king

The move to shared utilities also offers a rare chance for banks to fundamentally rethink the way in which they interact with their customers.  From a customer perspective, the existing process often requires information to be provided on multiple occasions during the customer journey to satisfy different teams employed in risk, the front office, legal and other departments.  The customer is also likely to be giving very similar information to a string of investment banks with whom they do business.

By sharing a single platform banks can transform the customer experience of their clients to ensure that the number of interactions required is dramatically reduced.  The shared data source will provide banks with the information they require to satisfy regulators and internal departments whilst simultaneously giving clients a quick and easy way to provide the necessary data.  As the model matures this could give clients yet more convenience, with a single view of things such as pending transactions, market research and pricing all within the realm of possibility. 

Banks also stand to gain from such innovations in a way which goes beyond the obvious benefits of keeping their clients happy.  The analytics offered by a shared platform can give an indication of the relative performance of a bank’s products in the marketplace, and give insight to the preferences of their customers too.   In addition, any innovations which are made in-house (usually by bigger firms) can become a revenue-generating asset by leasing the use of these market-leading services to other banks (usually smaller niche players), who in turn benefit from the opportunities afforded to them by superior platforms.  Therefore, it is only those banks who continue to offer a cumbersome service at high cost who stand to be left behind.

The challenges facing the industry are of course significant, and there is no silver bullet to reduce costs and improve profits.  Whilst the traditional cost cutting approaches provide some of the answer we believe the industry as a whole and individual organisations will only be successful if the shared utilities concept is adopted, which not only will lead the way to improved commercial results but, in a sector the consumers remain wary about, also helps rebuild consumer confidence.   

[1] http://www.hitc.com/en-gb/2017/03/22/reuters-top-firm-to-cut-investment-banking-staff/

[2] http://pwc.blogs.com/press_room/2016/12/european-ipo-markets-expected-to-have-raised-28bn-in-2016-as-a-year-of-geopolitical-shocks-comes-to-.html

[3] https://www.ft.com/content/670ca72c-eac3-11e5-888e-2eadd5fbc4a4#axzz42y6EOYj9

[4] http://www.cityam.com/242694/hsbc-to-restructure-global-banking-division-in-bid-to-cut-costs

[5] https://www.bloomberg.com/news/articles/2016-10-26/the-goldman-way-to-fire-bit-by-bit-hundreds-are-given-heave-ho


[7] https://www.ft.com/content/7a09130a-e9c4-11e6-893c-082c54a7f539

[8] https://www.bloomberg.com/news/articles/2017-03-02/goldman-reins-in-mobile-perks-irking-bankers-with-10-for-data

[9] https://www.ft.com/content/244d076e-27d2-11e6-8b18-91555f2f4fde

[10] https://www.thetradenews.com/Sell-side/Credit-Suisse-to-outsource-post-trade-derivatives-ops-to-FIS-utility/

[11] https://www.ft.com/content/48947d96-dca0-11e5-8541-00fb33bdf038

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Peter Edwarde Manager