Nearly two-thirds of equity analysts (61 per cent) who cover global capital markets institutions expect regulatory pressures on banks to intensify further through 2020, with potential new capital rules, informally known as "Basel IV," likely to have the greatest effect on their operations.
That’s according to a global survey of nearly 150 buy-side and sell-side analysts by Broadridge Financial Solutions who canvassed analysts across the US, Europe and Asia on their outlook for banks and their views on the industry's opportunities and challenges over the next five years.
The report, “Restructuring for Profitability," reveals that more than two-thirds of analysts (68 per cent) believe regulation has made the financial system safer. But, they are also concerned about "regulatory creep" and its potential impacts on the industry. Although so-called "Basel IV" rules are still under discussion, nearly three-quarters of the analysts surveyed (72 per cent) believe these rules – which are expected to standardise the risk-weighting of bank assets – will have the biggest regulatory impacts in the next five years. Among European analysts, 87 per cent held this view. US analysts surveyed are primarily concerned with the future effects of annual stress tests (cited by 77 per cent).
New regulation will have the most impact on banks' trading operations through 2020, according to the study, with more than three-quarters of analysts (78 per cent) expect regulations to disrupt equity-trading business models over the next five years. Ninety-two per cent expect FICC trading business models to be disrupted, including 28 per cent of analysts who characterize these changes as "dramatic."
While analysts predict revenue growth rates to increase across business lines, compared to the period between 2010 and 2014, trading growth is expected to recover but remain relatively muted. FICC, which experienced annualised declines of 8.5 per cent over the previous four-year period, is expected to grow at 0.2 per cent, while annual equity trading growth is estimated at 2.8 per cent, versus 1.7 per cent previously.
"Regulation has imposed tougher capital rules on banks, creating pressure on traditional models," says Broadridge Senior Vice President of Strategy Vijay Mayadas (pictured), who oversaw the study. "This means that banks will need to explore more creative ways to realign their operations and employ more transformative measures to reduce costs."
The report suggests that analysts generally favour bank responses focused on cost reduction – above efforts in balance-sheet management and top-line growth – or restructuring. More than half believe banks over the past five years were not aggressive enough at re-engineering business processes (55 per cent) and investing in new technology (54 per cent) to improve efficiencies. More than half (55 per cent) sees back-office technology as having high potential to increase efficiency and reduce costs over the next five years, with another 30 per cent citing some potential.
A key challenge facing these institutions is how to streamline the technology and operations that enable equities and fixed income trading. Commenting in the report, Brad Hintz, a top-ranked banking analyst for more than a decade and now adjunct professor at New York University's Stern School of Business who advised on the study, says, "Wall Street has cut back in each silo but done very little re-engineering across the business."
The survey spotlights major differences in how analysts across the U.S., Europe and Asia foresee the industry evolving over the next five years.
Firstly, US analysts are the most positive about the outlook for global banks and had the most upbeat predictions for revenue growth across nearly all lines of business. Similarly, they expect return-on-equity to double from 2014 levels over the next five years, essentially meeting the cost of capital. European and Asian analysts also expect banks' returns to increase substantially, but still fall short of average equity capital costs.
Secondly, European analysts advocate most strongly for restructuring and cost reduction. More than half (58 per cent) cited "significant opportunity" in rationalising and disposing business units to improve performance, compared to 38 per cent of US analysts and 40 per cent of Asia analysts. Forty-five per cent of European analysts believe cost controls will have the greatest impact on bank valuations over the next five years – above balance-sheet management or growth – compared to 39 per cent of US analysts and 28 per cent of Asia analysts.
And thirdly, Asian analysts hold the strongest views on regulatory changes. Nearly half (49 per cent) believe that new regulations since the 2008 financial crisis have not notably improved the stability of the financial system, compared with 22 per cent of U.S. analysts. They were nearly twice as likely as US analysts (75 per cent vs 39 per cent) to predict regulatory pressures on global securities firms will increase – rather than remain the same or decrease – over the next five years.
"These trans-oceanic differences reflect a three-speed industry transformation," says Mayadas. "Put simply, US banks have adapted more quickly to the post-crisis environment. Many of the most persistent cost challenges are still common across regions, but rule-making will weigh more heavily on Europe and Asia in the years to come."
