Investment banks around the world have been reeling from a cyclical downturn in underwriting and trading profits and from long-term structural shifts that have made their core business less attractive. These are the firms that underwrite securities, trade a variety of financial instruments and currencies, and provide associated advisory services - for Instance, in mergers and acquisitions. In today's environment, most Investment banks are reassessing their strategies for growth and their management of internal operations, but nowhere is this soul-searching more intense than in Europe.
A specific set of difficulties afflicts the players in this region: a broad but undistinctive product offering, a high level of costs, and a lack of the International distribution network that is essential to true global success. Worse still, such is the state of the Industry that even addressing these shortcomings will not guarantee an attractive role for European investment banks. More creative solutions will almost certainly be required.
The root of the current predicament for European investment banks lies in their failure to respond to the changes that have taken place in their external environment over the past decade. the globalization of capital, the growing sophistication of issuers (such as governments and corporations) and Investors (such as Insurers and mutual funds), and the central role of the dollar in global investment flows.
The global marketplace
The globalization of capital markets has made it possible for users of capital to lower their funding costs by tapping into multiple markets, and for investors to earn better returns by diversifying their holdings across many countries and currencies. As a result, it has become much more important for investment banks to offer issuers and investors products that span the global market. Indeed, those banks without global capabilities will find it difficult to offer a tailored "solution" to an institution's financial problem. As in most Industries, solutions carry far higher margins than products.
Despite the global spread and growth of such large product markets as government bonds (Exhibit 1), few of Europe's banks have developed the distribution channels they need in order to offer and trade in these instruments worldwide. Even those European banks that have invested significantly in developing International products have not been able to build true expertise. The result: a broad but undistinctive product line, and the global cost base that these products require.
The unbundling of services
Investment banks have been forced to enhance their product offerings as issuers and investors have developed more sophisticated needs. It is common for customers to shop for the best deals and to work with several banks, each operating in an area where it has particular expertise. A company might select one bank for M&A advisory services, another for securities Issuance, yet another for commercial banking services, still another for interest rate management, and so on.
In practice, large corporations' purchase patterns might look like those illustrated in Exhibit 2, which shows a leading European multi-national's usage of banks: a clear example of a "horses for courses" selection policy. The rising importance of expertise has inevitably led to a decline in banks' ability to leverage their relationship in one product family, such as lending, into another, such as bond or stock underwriting.
A similar change has occurred among Investors. Pension fund managers, insurance companies, unit trust and mutual fund managers, and other large investors are unbundling their purchasing decisions to meet the specific risk/return characteristics of their different clients. This specialized purchasing behavior, which often includes the need for global research in specific industries or topics (for example, currency outlook) on the part of institutions, has left those banks that lack the necessary range of expertise at a serious disadvantage. …