Investment banks will revert to the smaller and more conservative institutions of 20 years ago as a result of the global financial crisis, according to Larry Tabb, CEO and founder of research firm Tabb Group.
When the fall-out from the credit crunch starts to ease off, new and simpler business models from investment banks, which use their own capital to bankroll activities such as proprietary trading and underwriting, will be required to prevent a repeat of the current market disarray.
In his latest paper ‘The future of investment banking: sub-prime and its impact on the industry’, Tabb writes: “A well capitalised partnership structure [for investment banks], where partners are vested and tied to the success of the organisation, would be a more effective ownership structure for this type of institution.”
The top ten US investment banks have lost $460 billion or 54% of their value since the beginning of the year, and must now find better ways of managing risk, according to Tabb.
The report considers the possibility of a new Glass Steagall-type act, which distinguishes between banks based on the degree of risk in the services they offer.
“While the new universal banks will have both equity and fixed income businesses, they may be prohibited from proprietary trading, taking sizeable risk positions, and/or underwriting corporate securities (both equity and corporate debt), leaving the universal bank’s role in the capital market as more of a processor, custodian, and agency trading operation rather than proprietary desks using retail deposits and naive investor capital,” writes Tabb.
For investors, Tabb predicts the fall-out from the huge losses in the sub-prime and related credit markets will mean a switch to more transparent, exchange-traded and centrally-cleared instruments. “The push toward investing in transparently priced and valued products in conjunction with the banks’ desire to get risk off their balance sheets will force a restructuring of the way products are issued, underwritten, distributed, traded and cleared,” he said.
The study also noted the “distinct disadvantages” facing hedge funds because of reduced and more costly credit. Tabb estimates this will lead to less liquidity, forcing between 700 and 1,000 hedge funds – or 15% of the industry – to close in the second half of this year.
However, the report predicted the financial crisis and sparse liquidity would encourage the advance of electronic trading, as the buy-side looks to reduce costs with more efficient trading methods.