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European banks battle old enemies and get it wrong again
I hate to say this, but European banks have a penchant for adopting similar strategies—and usually strategies that deal with yesterday’s problems instead of tomorrow’s opportunities. The recent flight from investment banking is a case in point. Swiss, German, French and British banks all have cut back their investment banking operations sharply. Some of them are embracing instead the mantra of “wealth management”.
Rich folk, it appears they believe, will pay up for service, even though there is little magic to so-called wealth management. Wealth management is little more than portfolio diversification, combined with good tax strategies for passing wealth to succeeding generations. Asset allocation, low-cost mutual funds, and a good tax accountant or lawyer are what is called for. High management fees are not required, though perhaps the rich are willing to pay them on the theory that you get what you pay for. And maybe some like to boast about which gold-plated bank has their money.
I do admit that a profitable part of wealth management is lending wealthy customers money they do not need. The customer wants a new Rolls, no problem. The customer wants a new yacht or an expensive painting, why spend money? Credit is available, so long as there are securities in the vault.
There used to be another aspect to European wealth management: Tax evasion through placing funds in secret accounts and tax haven jurisdictions. There still is some of that, and it never will be entirely eradicated. But the world is moving away from permitting such shenanigans, and in twenty or so years, the jig likely will be up. It is pretty much up for U.S. taxpayers already.
Too many banks focusing on wealth management is likely gradually to reduce fees and profitability for many of them. Building a boutique bank like Julius Baer based on wealth management still may make sense. A Credit Suisse based on wealth management will have to be a much smaller Credit Suisse.
But if we look to the future of European finance, we can see that Europe is going to need stronger and more diversified capital markets. That is the direction in which the world naturally progresses. Traditional banks are relatively inefficient intermediators. It is naturally inefficient or dangerous to engage in spread lending and its attendant maturity transformation. That is why traditional banks have had to be subsidized—and somehow recapitalized when they fail.
Capital markets, by contrast, match investors and borrowers/equity sellers, usually in less leveraged ways. Capital markets lenders and borrowers lose money or fail without systemic consequences.
Yet what is happening in Europe is that the banks are impairing their ability to participate in capital markets and the authorities are trying to impair European capital markets by regulating “shadow banks”. Thus, by learning what they see as the lessons of the last crisis (they are wrong even on that, by the way), they are impairing the ability of European businesses and consumers to obtain funding. And the banks are reducing their future profitability.
The American banks and investment banking boutiques will be only too glad to fill the void and to try to get around whatever rules the Europeans make to try to prevent efficient funding mechanisms.
In wondering why the European banks are shooting themselves in the foot, I am guessing that they have not understood that the investment banking business as practiced in the 2000s was really two very different businesses: Trading, on the one hand, which is capital intensive and, being a zero sum game, is dangerous; and the combination of broking, underwriting and M&A that is highly profitable, uses relatively little capital, and has dangers only to the extent that personnel costs are high. Managements must understand that simple distinction. But if they do, then I do not understand why they would abandon a capital-efficient, potentially highly profitable business, unless they just think they cannot compete with American aggressiveness, even on their own turf.