The banking business is likely to be heavily influenced again by macroeconomic developments and regulatory changes in the next two years. In Europe the industry would probably face a decline in revenues and profits should the European sovereign crisis continue, whereas in the US a slowdown in growth would impact profitability.
Investment banking industry revenues may decline in 2012, especially in areas heavily impacted by regulatory changes. The strategic withdrawal of several providers – mainly driven by regulatory measures that make certain activities substantially more expensive and less lucrative – should, by contrast, enable well-positioned, well-capitalized banks to win market share. Simultaneously, this may allow these banks to at least partly compensate, via economies of scale, for the generally lower earnings potential. For the investment banking industry as a whole, lower revenues and higher capital requirements are likely to permanently reduce both profitability ratios and employee compensation levels.
Asset management performance will probably once again hinge on the direction taken in the global investment markets and the risk appetite of investors. This is likely to depend first and foremost on whether and how the sovereign debt crisis in Europe can be brought closer to a solution. In a positive scenario, the growth forces in the countries under pressure would be unleashed, credible and successful efforts would be taken to reduce budget deficits and external support would be provided as appropriate. Accordingly, the major risk banks are facing is a further escalation of the debt crisis particularly in Europe, but also in the U.S.
The technical recession in the eurozone expected in winter will probably leave a negative stamp on both lending and deposit volumes in the traditional corporate and retail business in Europe. Client demand for credit is expected to decline. However, credit supply by banks will also decrease due to expected increased defaults and persistently high refinancing costs. Moreover, households’ deposits with banks might increase only slowly or possibly even decrease. The countries affected by the crisis will probably be impacted most by these developments, whereas more robust economies such as those in Germany and Scandinavia could easily see further growth. The prolonged low interest rates may cause additional difficulties for the banking industry as they bring further pressure for revenues from maturity transformation and thus for margins. This suggests that net interest income is likely to fall.
Other uncertainties for the banking sector lie in the implementation of already adopted regulations and the introduction of further legislation that is already under discussion in some cases. While the majority of the measures to increase financial stability involve sensible changes to the framework of the industry, their cumulative effect is often underestimated. The same applies to the risks which emerge from substantial variations in the scope and implementation of new regulations, from the potential for regulatory arbitrage and from market fragmentation. Some of the ideas currently being debated – for example, the unilateral introduction of a financial transaction tax only in the eurozone – would not be conductive to the objective of achieving a more robust and resilient financial system. The banks are confronted with the task of significantly reducing their risk-weighted assets, which they must manage without damaging relations with their private and corporate clients.
Overall, the banks face immense challenges over the next two years. In the end, and mostly unintended by policymakers, the disintermediation process of the pre-crisis years may resume as financing activities shift further from banks’ balance sheets towards the capital markets and other businesses migrate into the less regulated shadow banking system. Banks will have to build up larger capital buffers and adjust to a much stricter regulatory environment which, in some cases, will demand that they redefine their business models and compel them to adapt to a permanently lower profitability level. Given the external (and presumably sustained) headwinds, many banks are increasingly likely to concentrate more on their strengths in certain market segments and regions, and intensify their focus on cost discipline. These developments will be exacerbated by a prospective slowdown in GDP growth and by the sovereign debt crisis that is casting its shadow over the European banks in particular.