Morgan Stanley Research and Oliver Wyman published a blue paper today (March 20) titled “Wholesale & Investment Banking Outlook Mis-allocated Resources: Why Banks Need to Optimise Now.” The paper highlights the need for banks to make significant reallocations in their balance sheets to maintain RoE over the next few quarters given looming government regulation and a changing macroeconomic environment.

Investment banks ROE reallocation

Overview — the need for reallocation in banks

The report includes a survey of major investment bank executives and clients. MS and OW analysts Huw van Steenis, Ted Moynihan and colleagues offer an overview of the report below. “Our proprietary client survey for this report underscores the need for reallocation. Our interviews highlight that margins are likely to deteriorate further and that clients plan to polarize spend, paying partner banks and specialists but squeezing the rest. Banks need to pull back another 6-8% of capacity while redeploying resources to areas where client demand is growing or needs are unmet, such as serving multi-asset investors, solutions for financial services, or channeling credit to long-term assets or SMEs”

Regulation leading to a variety of regional business models

The report also emphasizes that regulation is almost inevitably leading to the “balkanisation” of the banking industry. The good news is this means that a variety of business models can be successful, as long as individual institutions focus on their regional advantages.

“Winning business models will be more diverse as banks optimise where they have a real advantage. Balkansation will challenge returns and drive even starker regional choices, pushing more firms to focus more domestically/regionally, and putting pressure on global flowmonsters. US firms have the opportunity to benefit from home market advantages and their progress on leverage. We see outsized returns for banks who focus on where they have real advantage and scale.”

Provide for unmet needs

Analysts van Steenis, Moynihan et al. suggest that banks need to start thinking outside the box in search of new lines of business. The report highlights the multi-asset investing sector as an under-served sector ripe for near-term growth. The analysts suggest that the current $3.5 trillion multi-asset segment “could grow 10-15%” annually over the next few years.

The report also points to credit and risk intermediation as a significant currently unmet need. “We also see huge potential from the credit and risk intermediation needs in the wider economy that today’s service and product structures do not meet – for example, long-term financing, pension de-risking, healthcare, SME lending, and alternative credit.”