Pre financial crisis, investment banking revenues and profits were at records and exceeded expectations regularly. Post 2008 crisis, the same investment banks that were exceeding records are either struggling to remain profitable or out of business altogether. But by far the worst pain is being felt by European investment banks.
Below are some data comparisons:
- Investment Banking Fee Gap: Europe, Middle East and Africa have a market share of global investment banking fees of 24 percent as of first quarter of 2013. Meanwhile, the U.S. has close to 50 percent market share of global investment banking fees.
- Markets Revenues: Revenues in fixed income, equity, and investment banking have dropped 13 percent between 2006 and 2012 for the top U.S. investment banks excluding Lehman Brothers but down 22 percent among the top five European investment banks, according to company reports and analysis by William Wright, investment banking commentator for Financial News.
- Pre-tax profits: U.S. investment banks had a 14 percent decline in profits relative to 2006. In contrast, European investment banks saw profit losses of 61percent.
- Costs: Across the top U.S. investment banks, costs are down 3 percent while deep cuts and pullbacks from cost business drove a 9 percent decline in Europe.
- Return on Equity: U.S. investment banks saw this measure decline by 49 percent but European counterparts saw it plunge by 74 percent.
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What are some drivers behind the data? Economic conditions in the U.S. are more benign to U.S. based investment banks as capital markets are deeper and economic growth is consistent. The European economy, in contrast, is extremely fragmented as evidenced by the sovereign debt crisis and it does not have deep capital market activity that the U.S. enjoys.
A quick and decisive regulatory response to the crisis and the collapse of two top U.S. investment banks (Bear Stearns and Lehman Brothers) forced the remaining U.S. investment banks to recapitalize, cut costs, and bear the losses from their losing bets. The faster reaction from U.S. investment banks planted the seed for a speedier recovery. In contrast, European investment banks are still suffering from losses produced by securitized assets that experienced higher defaults. Combining this with the challenge of integrating the fragmented European economy is straining European investment banks.
Future regulation will likely shape the investment banking industry outlook. In the U.S., the Dodd Frank bill poses a considerable challenge for U.S. institutions but at least the regulation is closer to completion relative to equivalent regulation in Europe. The continent is experiencing interpretation fragmentation from guidance from the European Union, as national regulators add their input. Two of the largest components of European investment banking, the U.K. and Switzerland are struggling to implement some of the draconian measures their regulators have pursued. Big players in these two countries – Credit Suisse Group AG (NYSE:CS), UBS AG (NYSE:UBS), and Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) (AMS:RBS) – have trimmed their investment units the most.
European investment banks have the ECB’s long term refinancing operation going for them. The program provides inexpensive three year liquidity. The US implemented the Troubled Asset Relief Program in 2008 to support banks and the early crisis timing of this program accelerated the recovery of investment banks.
American investment banks have now opportunities to expand market share as European investment banks shrink. Until the economic fragmentation and regulation uncertainty in Europe subside, U.S. investment banks will still have an advantage over their European counterparts.