Investment banks lag rivals on profitability, efficiency

Reuters , Sunday 7 Dec 2014

Investment banks have been less profitable, more volatile and had consistently higher costs than commercial banks, according to a study of business models of the past decade.

The Bank for International Settlements (BIS), a global forum for central banks, said on Sunday a study of 222 lenders showed big variances in profitability and efficiency across models, and investment banks had been less efficient and more unpredictable.

The study identified three types of business models: a retail-funded commercial bank, funded mainly by deposits; a wholesale market-funded commercial bank; and a capital markets-oriented bank, commonly known as an investment bank, heavily engaged in trading.

Return on equity (RoE), a key measure of profitability, averaged 10 percent across the banks between 2005 and 2013.

The study said RoE averaged 12.5 percent for retail-funded commercial banks, 8.1 percent at trading banks and 5.8 percent at the wholesale-funded commercial banks.

Trading banks had the most volatile profitability, and their RoE swung repeatedly between the top and bottom of the relative ranking.

Banks are trying to improve profitability and cut costs, but many are struggling to do so in the face of tougher regulations and higher compliance costs that have come in since the 2007/09 financial crisis.

Many firms have cut back trading activities and reliance on wholesale funding, but further restructuring is expected, especially in Europe.

Costs had been consistently higher at the trading banks over the last eight years, the BIS said.

"Compared to the other two business models, trading banks had a persistently high cost base throughout the period of analysis, despite their more mixed record in terms of profitability," the study said.

High costs relative to income had persisted since the financial crisis despite a drop in profitability, possibly due to higher pay at investment banks.

The study said the number of banks opting to keep a trading model was surprising given their sub-par returns. "While further analysis is needed to uncover the clear benefits to these banks' shareholders, high cost-to-income ratios suggest outsize benefits to their managers," it said. 

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