ugim98

7/29/2019 ugim98

1/16

T he uglyimplications

of EM U

PICTOR INTERNATIONAL

7/29/2019 ugim98

2/16

THE McKINSEY QUARTERLY 1998 NUMBER 1 67

THE SCEPTICS SAID IT WOULD NEVER HAPPEN.But in May 1998 Europes heads of govern-ment will select as many as 11 countries to

adopt the euro, which will become an oficial cur-rency in 1999 and be phased in over three years(Exhibit 1). Although a last-minute crisis scupperingthe plans cannot be ruled out, it would seem wiseto assume that European economic and monetaryunion (EMU) is about to become a reality.

Astonishingly, many banks remain ill prepared.Although they have tackled the IT and operationalchallenges raised by a single European currency, theyhave failed to address the more dificult strategicissues. Put bluntly, they have not considered howthey will prosper once a single currency wipes outgreat chunks of profit in their traditional wholesalebusinesses of foreign exchange, corporate banking,and government bond trading.

Today, these businesses account for between 40 and80 percent of a European banks revenue. To Euro-pean banks as a whole, that revenue is worth approx-imately $100 billion; in less than a decade, it could

FINANCIAL INSTITUTIONS

Its the same story in foreign exchange, corporate

banking, and government bond trading big chunks

of profit are about to disappear

For would-be global players, a key question is whether

to build a position in US securities

For small players, the only option may be retail

Jonathan Davidson is a principal andAlison Ledger is a consultantin McKinseys London ofice; Giovanni Viani is a principal in the

Milan ofice. Copyright 1998 McKinsey & Company. All rightsreserved.

Jonathan A. Davidson

Alison R. Ledger

Giovanni Viani

We would like to thankBogomil Balkansky,Claudia Motta, VittorioTerzi, and Stefano Visalli

for their contributions tothis article.

7/29/2019 ugim98

3/16

be slashed to $77 billion.* Unless the banks can restructure their cost base, theoverall decline in profits could be even steeper.

EMU will, of course, also create growth opportunities. If the political,economic, and monetary objectives of monetary union are met, the eurocould come to challenge the US dollar as the worlds primary reservecurrency, while the pooling of Europes national securities could create acapital market to rival North Americas (Exhibit 2).

WHOLESALE BANKING: THE UGLY IMPLICATIONS OF EMU

68 THE McKINSEY QUARTERLY 1998 NUMBER 1

Figures in this article are based on McKinsey estimates of the capital markets of the 15 EUcountries: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy,Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom. The estimateof the size of the corporate lending and deposit markets is an exception; here, we focused on the

United Kingdom, Germany, France, Italy, Spain, the Netherlands, Switzerland, Sweden, andPortugal. Figures represent market size at the end of 1996, while projections are in 1997 dollars.

Exhibit 1

Timetable for introduction of the euro

Regulatory,organizational,and logisticalframework forEuropean Systemof Central Banks to be published by EuropeanMonetary Institute

TARGET testingbegins

Year for whichconvergence data

will be assessed

Participatingmemberstates chosen

EuropeanCentral Bankestablished

Irrevocable

locking ofconversionrates

Decision about howECB will operate

Testing of systems

Euro becomes a currency in its own right

Single monetary policy commences

ECB operations and new issues ofgovernment debt all denominated in euros

Wholesale financial activity expected tomove rapidly to euro denomination

National banknotes andcoins remain legal tender

No compulsion orprohibition in use of euro

Latest date for

introduction of eurobanknotes and coins

Dual legaltenderperiod

Latestdate forwithdrawal of

legal tender statusfrom national

banknotes andcoins

1997 1998 1999 2000 2001 2002

Launch date: January 1, 1999

Changeover periodSource: Bank of England

Exhibit 2

Comparison of European and US markets, 1996

Real GDP1990, $ billion

Corporate bond market $ billion, nominal value outstanding

Equity market capitalization$ billion

Total personal financial

assets1997, $ billion

PopulationMillion

Central government bondmarket$ billion, nominal value outstanding

EU countrie s Unite d State s

7,304 372.8 3,655

370 4,327 17,921

6,485 265.8 2,682

1,910 8,059 24,406

Source: Standard and Poors, DRI World Economic Outlook, 1997; Salomon Brothers, How big is the world bond market?,September 1997; FIBV, Annual Report and Statistics, 1996; McKinsey analysis

7/29/2019 ugim98

4/16

But the best opportunities in this new, vibrantmarket will probably fall to no more than ahandful of banks. Revenue growth in whole-sale banking will be concentrated in the in-vestment banking businesses of equities,bonds, and mergers and acquisitions areasin which most banks will be hard pressedto match the skills and global reach of theUS investment banks already operating inEurope. Today, business in these three areasis worth $14 billion. In less than a decade itcould be worth $29 billion (Exhibit 3).

Overall, EMU is likely to create more losersthan winners in wholesale banking. Banksthat wish to survive in this harsh new envi-ronment should wake up to the stark reality,and rethink their strategies.

Threats

Certain competitive gaps could open up be-tween those European banks whose national governments participate inEMU, and the remaining European banks.* But even more worrying is theimpact EMU will have on the industry as a whole. The three traditional areasof wholesale business are under threat.

Foreign exchange

The European foreign exchange market currently sees daily turnover of $798billion (including non-European currencies), from which European banksearn $6 to $8 billion a year in total net revenues. The lions share of this busi-ness is taken by the largest commercial banks, which dominate foreignexchange trade in their domestic currencies. Huge trading flows help keepthe cost of serving clients relatively low and give the banks the marketinformation and clout to help them profit from their own position-taking.

Following EMU, however, most European banks can expect a massive declinein foreign exchange revenues and profits (Exhibit 4). Intra-European currencytrading, worth about $3 billion in revenues a year, will simply disappear. Atthe moment, this trade accounts for 35 to 40 percent of an average European



Exhibit 3

Impact on Europes wholesale banking revenue pool

$ billion

M&AEquitiesBonds*FX

Payments

Deposits

Lending

2.58.53.06.0

14.0

21.0

55.0

41.0

10.0

18.5

5.0

8.0

17.5

3.0

Today

110

2006

103

*Government bond trading revenues onlytoday; in 2006, will include $3.3bn revenuesfrom municipal bonds, $2.2bn revenues fromcorporate bonds, and $2.5bn revenues fromgovernment bond trading

Estimated

Banks outside EMU will be relatively weak players in the euro securities market, denied theliquidity that would otherwise be derived from their domestic franchises. In addition, theEuropean Central Bank may decide that banks from non-member states should not have accessto TARGET, the real-time gross settlement system for the euro that will substantially reduce

the cost of clearing and settlement. However, banks within EMU may be required to hold low-yielding or non-interest-bearing deposits with the ECB.

7/29/2019 ugim98

5/16

banks foreign exchangerevenue, although for somebanks that mainly trade theirdomestic currencies againstother European currencies particularly those in southernEurope it represents a gooddeal more.

The average bank will alsosee a further fall in revenuesof 30 to 37 percent, because

even if it currently enjoys significant market share in trading domesticcurrency, it may turn out to be a relatively small player in the euro market. Itwill therefore lose the scale advantages that helped it win the business oflarge corporate and institutional customers and profit from position-taking.

In total, the typical European bank in terms of asset size looks set to loseabout 70 percent of foreign exchange trading revenues when national cur-rencies are abolished, leading inevitably to a rapid shakeout in the industry.Banks that succeed in becoming large-volume euro dealers will then beable to prise more and more business away from smaller institutions, leav-ing a market in which business is eventually consolidated among a few

key competitors whose scaleadvantages ofset the down-ward pressure on margins.In efect, it will resemble theUS market, in which only sixbanks have foreign exchangerevenues exceeding $100 mil-lion. In Europe, more than13 banks currently occupythis bracket.

Corporate banking

Corporate banking whichincludes the lending, depos-its, and payments business was worth about $90 billionin Europe in 1996. Some $76billion of this was accountedfor by lending and deposits

alone. Without EMU, these two businesses could grow by another 20 percent

over the next 10 years. With EMU, revenues will shrink to as little as $50billion (Exhibit 5).



Exhibit 4

Impact on foreign exchange revenues

Example: Average European bankIndex: 1997 = 100

*EstimatedSource: BIS; McKinsey analysis

Status quo

Loss of intra-EMU customer turnover

Loss of business with large companies

Loss of revenue from market share and information advantage (one-third of total revenues)

Average European bank post-EMU*

100

3540

2025

1012

2335

Exhibit 5

Impact on corporate lending and deposit revenues

$ billion, estimated

*Proportionate to GDP at 2% per annum in real termsProjection forward of historical margins decrease 198696 (0.5%)10% per annum

Current revenues

Growth, 19962006*

Preliminary projected revenues, 2006

Effect of lending disintermediation

Decreasing lending margin

Disappearance of deposits fromtraders funding in foreign currency

Fall in deposit volume connected toforeign currency payments

Decreasing deposit margin

Adjusted projected revenues, 2006

93

76

17

51

24

2

3

5

8

12

21

1041

55

5

2667

Lending Deposits

7/29/2019 ugim98

6/16

Corporate lending. Lending overcapacity and intense competition haveprompted European banks to ofer corporations extremely cheap loans. Bankloans are consequently a leading source of finance for European corporations.(In the United States, 7 percent of non-financial companies liabilities are inthe form of bank loans; in Europe, the figure is 11 percent.)

All this is about to change, and not just because of EMU. Banks are focusingmore on shareholders, and beginning to use excess capital to buy back sharesrather than lend at barely profitable rates. Governments are keen to improvecompetitiveness by eliminating state subsidies to banks (common in suchcountries as Austria) and preventing themfrom ofering preferential rates to companiesin which they hold stakes.

As for the pressures exerted by monetaryunion, thenewEuropeanCentral Bank(ECB)looks set to impose reserve requirements oncommercial banks within EMU, the cost of which will probably be passedon to customers in the form of higher lending rates. Add to this the creationof a single, more liquid European corporate bond market, and it seems likelythat most large corporations will find it cheaper to raise debt through bondissues. The disintermediation of this corporate business could reducepotential lending revenues from $67 billion to about $43 billion.

Competition for what corporate lending business remains will be fierce. Thelargest, best-capitalized commercial banks that can themselves raise moneyat low cost will be the most favorably placed to ofer competitive rates to thesmall and medium-sized businesses that still need bank loans. The reductionof lending margins because of competition could shave a further $2 to $3billion from corporate lending revenues, bringing the final figure down toabout $41 billion.

Deposit and money market business. This business today is worth about$21 billion, and without EMU might grow to $26 billion over the next 10years. With EMU, volumes will fall because corporate customers will nolonger need to hold deposit accounts for each European currency in whichthey trade, and traders will no longer use the money market to take advantageof interest rate diferentials between the currencies of EMU member coun-tries. As a result, deposit revenues will fall by about $8 billion.

Margins will also shrink because of stif competition for the remainingbusiness. As in the foreign exchange markets, the advantage held (and theprofits enjoyed) by the typical European commercial bank in its domestic

money market will disappear. Such banks will then have to vie with manyother players in a huge euro money market. The winners will be large banks



The typical European banklooks set to lose about70 percent of foreign

exchange trading revenues

7/29/2019 ugim98

7/16

with cost-eficient centralized trading, economies of scale, and superiormarket information. Margin compression and loss of revenues from position-taking will probably reduce revenue earned in the money market by a further$8 billion. Business will be consolidated among a few large institutions.

Payments. The European payments business is today worth $14 billion.Much of this comes from correspondent banking business, whereby bankshold accounts with other banks in order to make and receive payments inforeign currencies. EMU will eliminate intra-European currency payments,while the introduction of TARGET, a clearing system that enables EMUmember banks to make payments directly to one another in real time, willfurther reduce the need for traditional correspondent banking services. Nonethe less, overall cross-border payments will rise as cross-border trade con-tinues to grow, so that revenues could reach $18.5 billion by 2006.

In this market too, larger institutions with economies of scale will win sharefrom smaller, less eficient banks. Again, there will be a few big winners andmany losers.

Government bond trading

Banks operating in Europe currently generate revenues of $2 to $3 billiona year by trading government bonds on customers behalf. But the banksown investments in government bonds have also been an important sourceof revenue and profits, particularly in the run-up to EMU. One leadingPortuguese commercial bank holds a quarter of its assets in governmentbonds that yield an estimated 12 percent. Over the past three years, the costof funding this portfolio has fallen by about 6 percentage points as interestrates have converged in the countdown to EMU. The result has been a sharpincrease in net revenues from the portfolio. Indeed, it has probably been themain driver of the banks recent profit growth.

Take away these one-of gains, however, and the post-EMU outlook is bleakfor many banks in the government bond market. EU government debt stoodat $6.3 trillion at the end of 1997. Reducing each participating governmentsdebt to 60 percent of GDP (as stipulated in the Maastricht treaty) implies areduction in outstanding debt of $1.1 trillion, or 18 percent (assuming nofurther debt issuance). This will not happen by January 1999, but the figuresindicate the trend toward fewer debt issues, more competition for selling andtrading that debt, and slimmer margins. Todays $2 to $3 billion of revenuewill have to be shared between only a handful of large-volume institutions.

In addition, domestic banks will no longer win business on the basis of spe-cialist knowledge of their national currencies and interest rates. Historically,

most investors have traded European government bonds according to cur-rency movements. But once the foreign exchange risk is removed, the focus



7/29/2019 ugim98

8/16

will be entirely on credit (that is, one countrys credit risk versus anothers).The winning banks will thus be those that can efectively sell credit storiesrather than foreign exchange stories. Europes market will in essenceresemble the US market. It will be dominated by investment banks whosesize enables them to profit on slim margins, and which have a reputation forcredit analysis and sales capabilities born of experience in the huge UScorporate bond market.

Opportunities

Although there are threats aplenty, EMU will also create growth opportu-nities in European wholesale banking. A single currency will produce aEuropean capital market far more liquid than any existing national Europeanmarket, stimulating the municipal and corporate bond markets as well as theequity market. It will also prompt the cross-border consolidation of manyindustries, generating M&A business. Investment banking and securitiesproducts and services will therefore be in great demand.

Municipal and corporate bonds

Although the Maastricht treaty will constrain the issuance of governmentbonds, EMU should promote a European corporate and municipal bondmarket. The former is almost non-existent, but the latter is already beginningto show signs of growth. In Italy, for example, several cities and regions haveissued bonds to fund local infrastructure projects.

Privatization of government debt. In an era of monetary restraint, thefunding of large public infrastructure projects such as hospitals and roadswill increasingly be transferred to the private sector. Some of this fundingwill be raised by privatizing assets currentlyowned by governments (that is, by equityfinancing), but a substantial proportionis l ikely to originate in the bond market,because the stable revenues and capitalvalue of many infrastructure projects makethem low credit risks that can be sold toinvestors without recourse to governmentbacking. The debt issuer might be a privatized company or a single-purposefunding vehicle. Either way, these debt issues represent a massive oppor-tunity for investment banks bond businesses.

Another possibility is the development of a US-style municipal bond marketto replace government borrowing. Municipal bonds enable local authoritiesto issue debt without central government guarantees; to stimulate demand,

the authorities ofer investors tax incentives. The market currently accountsfor 40 percent of total new debt issues in the United States each year, which



Domestic banks will nolonger win business on the

basis of specialist knowledgeof their national currencies

and interest rates

7/29/2019 ugim98

9/16

suggests what the potential of this form of government debt privatizationmight be. If the European market were to reach a similar level of maturity, itcould generate $3.3 billion in revenues for banks in the form of originationfees and trading income.

Judging by US experience, municipal bonds could also be one of the fewareas in which European banks even small ones succeed in competingwith leading investment banks. Although large banks operate in the USmunicipal bond market, many smaller regional banks are also leadingparticipants, having capitalized on their local presence to forge links withlocal government authorities. Ater EMU, European banks will have similaradvantages in a continental municipal bond market.

Corporate bonds. To date, corporate bonds have been an insignificant sourceof capital for companies in most European countries (Exhibit 6). But a single,more liquid European corporate bond market with a bigger pool of potentialinvestors will reduce the cost of entering the market and possibly the costof borrowing and thereby encourage a move away from bank loans as ameans of financing. If European corporations were to use bonds to financetheir debt to the same extent as US corporations (where bonds account for19 percent of total liabilities), the European corporate debt market wouldgenerate additional revenues of $2.2 billion a year in origination fees andtrading income. This revenue would accrue to institutions such as USinvestment banks that have strong corporate bond origination and structuring

and pricing capabilities, and to institutions that have good relationships withcorporate issuers.



Exhibit 6

Liabilities of non-financial enterprises

United States

(1994)

Europe weighted

average*

United Kingdom

(1990)

France Spain

100% = $8,064bn 100% = $3,701bn 100% = $1,279bn 100% = $796bn 100% = $173bn

Finland Netherlands Italy Belgium

100% = $97bn 100% = $410bn 100% = $562bn 100% = $384bn

% % % % %

% % % %

48 38

46

133

3823

183

5643

15

40

2

44

4248

4 6

195

3249

10 3

39 43

1111

35

117

43

719

26

Equity Bank loans Bonds Other1995, percent

* Of the countries shown Only short-term bank

loans Only long-term loans

Source: OECD FinancialStatistics, Part III;McKinsey analysis

7/29/2019 ugim98

10/16

It has been argued that a European corporate bond market will never thrivebecause issues need to be large perhaps as big as $100 million to attractadequate attention from investors, and few European companies can raisethis kind of finance. But an analysis of the US corporate bond market showsthat 69 percent of all issues (31 percent of total market value) are smallerthan $100 million. Indeed, 46 percent of issues are under $50 million. It wouldtherefore seem that there is little to hinder the development of a healthycorporate bond market in Europe.

As that market evolves, so will the market for higher-yielding corporate paper.A single currency and strict monetary discipline will mean Europes govern-ment bond market will ofer few opportunities to investors seeking higherrisks and higher returns. This is likely to prompt demand for debt issued bycompanies with greater credit risk a high-margin and therefore attractivemarket segment for banks that have strong credit analysis, structuring, andmonitoring skills. The US high-yield corporate bond market is alreadythriving, giving US investment banks the chance to acquire experience inthis area.

Equities

Equity markets in the United Kingdom, Switzerland, Sweden, and theNetherlands are relatively mature, with market capitalization to GDP ratiosin line with those of the United States (Exhibit 7). Elsewhere in Europe, they

are less well developed. There are two reasons. First, supply has been limitedby high corporate tax rates in some countries (encouraging companies toremain private in order to shelter income in of-shore accounts), by the

availability of cheap bank loans, and by the fact that many large companiesare state-owned. Second, investor demand for equities has been constrained



Exhibit 7

Size of European stock markets, 1996

Market capitalization$ billion

Market capitalization/GDPPercent

United Kingdom

Germany

France

Switzerland

Netherlands

Italy

Sweden

Spain

Belgium

Denmark

Finland

Norway

Austria

Luxembourg

Europe total

1,643

664

587

400

375

257

240

192

119

71

61

57

34

32

4,732

143

28

38

137

95

24

96

33

45

38

49

36

15

54

191

Source: FIBV; LSE; McKinsey analysis

7/29/2019 ugim98

11/16

by a lack of large institutional pension funds, and by the availability of high-yielding government bonds.

Nevertheless, a single European equity market is poised for tremendousgrowth. The overwhelming burden that state-funded pension schemes placeon government budgets, combined with EMUs constraints on governmentborrowing, will accelerate pension reform and the birth of private pensionschemes. These schemes will flood equity markets with funds looking forrelatively high long-term returns.

EMU will also increase the supply of equities. Again, by constraininggovernment debt issuance, EMU will encourage the privatization of state-owned industry (privatizations worth $125 billion are expected to cometo market over the next five years). In addition, medium-sized Europeancorporations are expected to start making public oferings. Growth may provecritical to the survival of many of them when a single currency finallyeliminates entry barriers, and equity could be a ready source of capital. Thereare about 20,000 private European companies with turnover of $50 to $250million, all potential IPO candidates.

Which banks benefit from this growth in supply will depend on the size ofthe issue. In the case of large privatizations, the winners are likely to beintegrated, top-tier investment banks that can originate and distributeissues globally. In the middle-market segment, there may be opportunitiesfor reasonably sophisticated local banks that can leverage strong corporaterelationships.

One of EMUs most immediate efects will be to shit the asset allocation ofmany investors froma nationaldomestic focus toa pan-European sector focus.A French institutional investor, say, might currentlyhold asmuch as90 percentof its equities portfolio in French stocks. To reflect the French marketscapitalization in a pan-European market, thatshare would have tobe reduced

to 15 percent. This rebalanc-ing will generate enormousbusiness for brokers. Thosebest placed to capture it willbe the large, pan-Europeanbrokers with sector-focusedresearch departments able tomeet the needs of investorswho, with the removal of na-tional financial boundaries,increasingly want to assess

and compare European equi-ties on a sector basis.



Revenue potential in European equityExhibit 8

1996

Growth in issuance

Growth in equities turnover

Fall in origination fees*

Fall in equity commissions (20%)

2006

Excluding proprietary trading; $ billion, estimated

8.0

9.0

8.5

17.5

4.0

4.0

5.5

9.5 8.0

3.0

Origination Trading

*International fees (currently 3.5%) are likely to come down to the level of domesticfees (2%)

7/29/2019 ugim98

12/16

However, growth in business volumes will be ofset by sustained pressure onorigination fees and selling commissions (Exhibit 8).* This may deterinstitutions that have not already got strong equity capabilities and a top-notch research function from competing in the market, given the high cost ofbuilding the necessary skills (Exhibit 9).

Advisory/M&A

EMU is likely to create a notable increase in demand for advisory and M&Aservices. Although a single European market in terms of free trade has existedsince 1992, the expected cross-border consolidation has not materialized.The introduction of a single European currency will, however, be an im-portant catalyst. With investors using the best corporate performers on theContinent as their benchmark, many of Europes industries will have torestructure to close productivity gaps. Companies with limited domesticgrowth opportunities will also be more eager to venture into other Europeanmarkets when currency risk is eliminated, especially in industries where thereare economies of scale to exploit.

The banks best positioned to take advantage of this increase in demand forM&A/advisory services will be multiproduct institutions with strong strategicrelationships with CEOs, M&A expertise, sector expertise, and, above all,cross-border networks. Revenues could reach $3 billion by 2006.

Post-EMU strategies

European banks can be segmented according to the scope of their wholesalebusinesses and their geographic reach. They fall into three categories: global



This pressure will derive from, among other factors, increased competition, more powerfulinstitutional investors who are squeezing commissions, the introduction of the order-driven

market in the United Kingdom, and electronic trading that is causing the disintermediation of thetraditional broker.

Cost structure of equities tradingExhibit 9

Sales

Trading

Research*

Settlement and clearing

Office space, telecoms, etc

Risk capital

SBC Warburg

Merrill Lynch

James Capel

CSFB

NatWest

DMG

Goldman

SalomonMorgan Stanley

100

5

20

1015

2530

1015

2025 263

262

221

199

153

131

128

115

108

*75% of all research costs; 25% are allocated to corporatefinanceSource: Nelsons Directory of Investment Managers;McKinsey analysis

Typical cost structure of a first-tier playerPercent Number of equity researchers, 1995

7/29/2019 ugim98

13/16

aspirants, multilocal players (those that have ventured outside their domesticmarket on the basis of a specific expertise, such as Spanish banks using theircultural connections to expand in Latin America), and local players. Theirstarting positions largely determine the strategic possibilities open to themwithin a monetary union.

Global aspirants

The global aspirants are the top tier of European wholesale banks. Theirwholesale businesses, covering a broad array of markets and geographicregions, account for up to 80 percent of revenues. They have investedheavily to build abilities in many key investment banking markets and toforge relationships with corporate issuers of securities and institutionalinvestors.

Yet half of the six or so European banks that aspire to leading positions inthe European market are likely to be disappointed. As already stated, bigbanks will have the greatest advantages within EMU. But size alone will notsufice. The ultimate winners must be able to assume leadership in several

diferent wholesale markets and meet theneeds of corporate issuers and institutionalinvestors in diferent products, currencies,and geographies.

In this respect, the leading US investmentbanks already enjoy advantages over Euro-

pean banks in the race for leadership in Europe. To begin with, their homemarket is huge and highly profitable, giving them substantial resources forexpansion. In addition, their access to investors in the North Americanmarket appeals to large European corporate issuers. (Even now, throughalliances and mergers, they are investing to correct an apparent weakness:their lack of retail distribution capabilities.) Most important, their integratedculture, sustained through organic growth, has enabled them to provideefective service to clients across currencies, regions, and product markets.

By contrast, European aspirants are plagued with problems. Although theymay be strong in traditional wholesale banking, their expertise in key invest-ment banking products such as equity origination and advisory services ispatchy. The lack of a credible US securities business is also seen by manyas a fundamental weakness, given that US investors represent about60 percent of the global investor pool for securities. European aspirantstherefore need to make massive investments in their equity and advisorybusinesses, and then be prepared for returns to materialize only slowly, sinceprofitability is likely to be low or non-existent until a bank reaches a position

of leadership. Finally, because European aspirants have built their investment



The leading US investmentbanks already enjoy advantagesover European banks in the race

for leadership in Europe

7/29/2019 ugim98

14/16

businesses by hiring from other banks and making acquisitions, they facechallenges in integrating disparate cultures.

So what are the options for these banks, assuming that there will be onlyseven or eight leading investment banks operating in Europe, and that fouror five US institutions already command an almost unassailable lead?The main strategic question they must ask is whether they should invest inbuilding a position in US securities, a vital component of leadership ininvestment banking. This could be achieved by buying a whole bank, byentering some form of joint venture with a US bank, or by acquiring a seriesof components. All of these options would be expensive, but precedentsindicate that an organic build-up in the United States is unlikely to work.Bank shareholders will therefore have todecide whether they wish to gamble stillmore on eforts to build an integrated invest-ment bank.

It may be, however, that leadership of someof the traditional wholesale businesses ismore profitable and more nearly within thereach of Europes global aspirants thanleadership in the hotly contested investment banking businesses. In theinterests of shareholders, banks should thus ask themselves whether it wouldbe wiser to build on existing strengths and competitive advantages suchas a strong balance sheet, good corporate relationships, treasury marketcapabilities (in foreign exchange and money markets), or experience in fixedincome, payments, and lending in order to become a leader in one or moreof these fields.

Multilocal players

Like global aspirants, multilocal players are wholesale-driven rather thanretail-focused, deriving 60 to 70 percent of their revenues from wholesaleactivities. However, their international operations are limited and their equityand advisory businesses even weaker than those of global aspirants. AterEMU, these banks will no longer be able to rely on the profits from tradingtheir own investment portfolios to drive their businesses. Competition in alltheir traditional markets will intensify, volumes will fall, and they will suferfrom a competitive disadvantage because of their lack of scale.

One option for a bank in this position would be to sell all or part of its whole-sale investment business to a player willing to pay for its capabilities andmarket position. However, the pace of consolidation in the industry and theoverlap among players means it might not be easy to find buyers for such a

business, nor indeed jobs for its employees. Consider BZW, which its owner



European aspirants needto make massive investmentsin their equity and advisory

businesses, and then beprepared for returns tomaterialize only slowly

7/29/2019 ugim98

15/16

Barclays Bank had to carve up in order to find buyers. The UK and Europeanbusiness was eventually sold for a rock-bottom price, while the Japaneseoperation was closed down at a substantial loss.

Two further options would be to try to build a purely pan-European position,or to adopt a niche position. The former would be dificult in view of theinvestment needed, the intensity of competition from US banks and globalaspirants, and the questionable viability of such a strategy in the absence ofan accompanying US presence. The latter option is more feasible. But banksadopting it would have to identify their niches as early as possible to fill thegap let by the decline of their traditional wholesale businesses.

Multilocal banks need to examine their current customer franchise to identifyareas in which they have advantages. Some may be well positioned to servethe middle-market corporations that top-tier investment banks cannot serveeconomically. Others might be useful to an industry sector with specialized

needs. German banks, for example, could bewell placed to be chemical sector specialists,since the industry is dominated by German-based corporations.

Product markets should be examined in thesame light. Could a bank, for example, build aspecialist position in the high-yielding seg-

ment of the corporate bond market? And what about a geographic focus?Could a bank perhaps exploit corporate and institutional client businessspanning European and emerging markets? Some German and Austrianbanks already have strong commercial banking operations in Eastern Europeon which they might be able to build investment banking business.

Local players

Local players are retail banks first and foremost. Traditional wholesale bank-ing generates 30 to 40 percent of their revenues, and their investment bankingcapabilities are relatively insignificant.

These banks should consider withdrawing altogether from wholesale bankinginto retail banking; the drawback of this strategy is that in an era of pensionreform, even retail clients will want mutual fund products and equity broker-age services from their banks. Local players might, therefore, have to formstrategic alliances in order to provide products and services.

The only other option for these institutions is to focus on a specific niche(such as middle-market corporate lending and deposits). The choice will be

limited, as in most cases these banks advantages will amount only to a fewtechnical skills, a strong but deteriorating corporate franchise, and some local



Banks must recognize the speedand magnitude of the changes

they face and launch boldprograms to address both thethreats and the opportunities

7/29/2019 ugim98

16/16

market knowhow. Moreover, the niches in which they possess advantagesmay not be very large, which would mean scaling down considerably.

All banks face toughdecisions. Those most likely tobe successfulwithin EMUare those that recognize the speed and magnitude of the changes they face andlaunch bold programs to address both the threats and the opportunities.

For some, this will mean aggressive retrenchment, disposal of businesses,and a renewed focus on retail banking. For others, it will entail substantialinvestment in the development and implementation of strategies to becomemarket leaders. Banks that follow neither course will succeed only indestroying value for shareholders.



Date post:	04-Apr-2018
Category:	Documents
Upload:	quadranterd
View:	214 times
Download:	0 times

ugim98

Documents