LONDON (Reuters Breakingviews) - Albert Einstein defined insanity as endlessly doing the same thing while expecting a different result. By that yardstick, global investment banks are off their rockers. New year optimism about rising rates and greater volatility boosting markets revenue has been summarily dashed. Instead, trading arms will continue to disappoint.
At a conference in London on March 20, UBS boss Sergio Ermotti said he expected investment banking revenue for the three months to end-March to be down one-third compared to 2018 due to “muted” volatility and volumes, describing it as one of the worst first-quarter environments in recent history. As a result, returns on equity would fall to “mid-single digits”, below the division’s probable 10 percent cost of capital.
Just three months ago, traders could put forward a bullish case. Rates were rising in the United States. They were set to increase in the euro zone too as the European Central Bank wound down its asset-purchasing programme, draining liquidity from the market. That was supposed to lead to both wider spreads between bid and offer prices, which traders profit from, and more demand for hedging products among companies and asset managers.
Instead, the opposite has occurred. The ECB has left rates on hold and the U.S. Fed’s tightening cycle has run out of steam. After spiking at the end of 2018 the Wall Street VIX index has for the much of the year to date stayed resolutely below the 20 level that indicates elevated volatility. And clients have mostly stayed on the sidelines.
Europe should come off worst, not least due to a dearth of advisory business compared to the United States. Analysts at UBS expect European investment banks’ revenue across fixed income, equities and advisory to fall by between 12 and 19 percent year-on-year by the end of March, compared to more muted declines in the United States.
Given investment banks make most of their money in the first half, a duff first three months means traders will continue to drag on lenders’ group profitability. Since the 2008 financial crash, shareholders weary of false dawns have left European investment bank-heavy groups, in particular, trading well below book value. They now have even more cause for scepticism.
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