BANKING : AGAIN ON THE EDGE / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

August 14, 2011 8:17 pm

Banking: Again on the edge

By Patrick Jenkins and Megan Murphy

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Stepping down: many of the positions being eliminated in western financial centres such as London's Canary Wharf are unlikely to return, even when the industry's current troubles are over

They were never going to attract outpourings of sympathy from the general public. But the job cuts that have hit whole echelons of the world’s biggest banks in recent weeks have not only attracted little compassion, they have barely been noticed at all amid the seesawing global markets and predictions of economic gloom.


Yet the 60,000 redundancies un­veiled in a matter of weeks by eight big banks, six of them European – an average of about 5 per cent of the headcount of each institution – are likely to be just the start of a brutal reshaping of the industry that could result in the axing of hundreds of thousands of jobs worldwide.

“If you have to cut costs, you have to cut jobs,” says one European bank chief executive. “If economies aren’t going to grow, there will have to be a lot more job cuts than we have seen so far.”

More importantly, the cuts this time are set to differ from those of previous cyclical downturns. Bankers and regulators agree they may mark a profound change in employment patterns across the world’s banking industry.


The reason is simple enough. At the same time as western economies are teetering on the edge of double-dip recessions, the banking industry itself is caught in the middle of a period of deep structural change – much of it ushered in by the regulatory response to the first wave of the financial crisis three years ago.


Many of the redundancies will be in the cut-throat investment banking sector. It is there that twin regulatory offensives – first, explicit changes to pay structures to promote more de­ferred pay; second, the knock-on effect of certain more risky investment banking activities becoming prohibitively expensive under new capital rules – are leading to job losses.
On the first, it was relatively common before the crisis for bankers to take home the vast majority of their pay in the form of an annual bonus. Now, that equation has been changed, with a much bigger proportion coming in the form of a fixed salary. Bonus payments, meanwhile, are normally deferred over three to five years. Employees waiting for several tranches of prior-year bonuses to pay out therefore have reduced incentives to move to new jobs.


Bankers say this shift is a prime example of regulatory changes backfiring. As pressure was applied in the wake of 2008’s bank blow-ups to defer bonuses over longer periods, staff campaigned for higher salaries to allow them to make up for short-term shortfalls. In many cases, they won salary increases of 50-100 per cent.


As a consequence, the investment banking sector says it is now grappling with a new problem – the loss of its traditional method of shedding staff. “These days, when a banker doesn’t get a bonus, they no longer leave automatically,” says Rich Ricci, co-head of Barclays’ investment banking operation. “They’ve got their salaries to fall back on – and, really, there’s nowhere else for them to go.”


But it is not just the inflexibility of higher salary outgoings that is scuppering room for manoeuvre. “More importantly, far higher deferred bonus allocations mean that banks have much less flexibility now when it comes to cutting costs in any one year,” says Mr Ricci. With deferred pay-outs typically distributed in equal measures over three years, banks have suddenly realised that two-thirds of their total bonus outgoings – the hangovers from previous years’ allotments – have in effect turned into fixed costs.


Some of the most dramatic shifts in pay structures are under way at Switzerland’s big banks. According to research from JPMorgan Chase, fixed pay last year accounted for 35 per cent of total remuneration expenses at UBS’s investment bank and 37 per cent at Credit Suisse. By next year, more than 80 per cent of Credit Suisse’s pay bill for its investment bankers will be from fixed salaries and deferred pay, and the figure will be 63 per cent at UBS, JPMorgan analysts estimate.


Left with just a fraction of the flexibility to cut pay costs through bonuses, many banks are finding their options curtailed. “The cuts are a reaction to the downturn in profitability – and a sign of how remuneration has been restructured,” says the head of one big UK investment group. “When the banks started hiring last year, there was a big switch to fixed costs. Basic salaries doubled and variable pay halved. But there is no growth, and the only thing banks can do is cut jobs.”


A few senior bankers, jaded by booms and busts of the past, brush off the current efforts to slash costs and staff as merely a repeat of one of the industry’s biggest sins – taking on far too many people before business actually gets better, and shedding way too many when markets deteriorate.


But far more experts warn that on this occasion there is something fundamentally different – a lot of the jobs being eliminated will not be coming back. “The cuts are very deep and I think they will last a long time,” says one seasoned City of London headhunter.


One of the central reasons is that banks around the world are still adjusting to a much more regulated environment, one in which they will have to hold significantly more capital as a buffer against future losses, and in which some of their riskiest and most profitable activities have, in effect, been outlawed.


In the US, so-called “proprietary” trading – whereby banks make bets on the market with their own money – has been banned under Dodd-Frank financial reform legislation. Most institutions have disbanded or significantly scaled back such operations as a result.


In the UK, “universal” banking groups with both investment and retail operations, such as Barclays, Royal Bank of Scotland and HSBC, are preparing for the biggest overhaul of the industry in decades, with the government-appointed Independent Commission on Banking poised to recommend sweeping reforms in a September report.


It is probably no coincidence that some of the biggest cuts have been at British banks – 30,000 at HSBC, 15,000 at Lloyds and 3,000 at Barclays. New chief executives in the UK are not simply undertaking a change in corporate direction, as might be expected upon taking up such a post, but are also preparing for an altered operating environment.


Globally, the new Basel regulatory framework will reduce the profitability of one of banks’ most lucrative businesses since the financial crisis – trading in fixed-income instruments, particularly derivatives – as authorities impose higher capital buffers on riskier activities. That has prompted some banks to rethink their ambitions in an area that is dominated by a relatively small number of operators. UBS, for example, which is shedding about 5,000 employees across the group, has recently abandoned its target of earning €8bn ($11bn) a year from fixed-income trading, and is scaling back its operations.


In a deteriorating market, the fastest way to cut costs is to cut people. The revenues eaten up by costs shot up alarmingly at many banks in the second quarter; Credit Suisse’s cost-to-income ratio hit 92 per cent in its investment bank. That means that for every SFr100 the bank earned, all but SFr8 went on expenses.


Some banks, including Credit Suisse, were still adding to staff numbers in the second quarter of this year, reflecting a widespread misreading of the economic situation. “A number of firms had been rebuilding aggressively coming out of the financial crisis [and] had until now believed that weaker industry conditions would only be temporary,” says Jeremy Sigee, banks analyst at Barclays Capital. “That view has now changed and firms have very rapidly switched into cutting mode.”


So far, most of the cuts have been focused on Europe, reflecting as much as anything banks’ response to eurozone woes. But with the US economy also flailing, and the likes of Bank of America Merrill Lynch under increasing pressure, bankers and analysts agree that the modest cuts that have come from BofA and Goldman Sachs in recent weeks are just the start. More redundancies are inevitable.


“Some US banks are slowly realising they will need to fundamentally resize,” says one seasoned US investment banker. “And that can mean only one thing – big job cuts on Wall Street.”
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ASIAN GROWTH SPOTS

Where the vacancies now are: ‘We’re ramping up our expansion’Royal Bank of Canada, one of the few banks that emerged largely unscathed from the first round of the financial crisis, has been hiring steadily ever since, writes Patrick Jenkins.

In recent months it has been among only a handful of banks – alongside the likes of Jefferies, a midsized US boutique, and Spain’s BBVA – to be taking on staff in the City of London.

But even Gord Nixon, RBC’s down-to-earth chief executive, concedes there is an inevitable shift under way in the world.
“If you look at how we’ve expanded our global businesses of wealth management and capital markets, I would say the original focus was very much on the US, because it was the natural base,” Mr Nixon says. “We followed in the UK. But I would say Hong Kong and Singapore and Australia are now the natural extensions to that. We’re significantly ramping up that expansion.”

Underpinning the shift of focus to Asia is the continued growth in markets across the region. Mainstream Wall Street banks such as JPMorgan Chase and Goldman Sachs have also been building on their trading operations in Singapore and Hong Kong. Citigroup – despite the fallout it suffered in the US from the 2008 financial crisis – maintains a strong presence across Asia.
European banks with strong Asian credentials, such as HSBC, Standard Chartered and UBS, are hiring particularly aggressively.

Earlier in August, HSBC signalled – as it announced 30,000 redundancies worldwide – that it would offset the cuts by hiring as many as 15,000 in Asia and Brazil. StanChart said it expected to take on 2,000 more staff in Asia in the second half of 2011.

Both banks have seen their Asian businesses sustain group-wide profit growth as lending volumes soar.

As for UBS, despite troubles closer to home – and 5,000 group-wide job cuts – it has spent recent months hiring 1,000 staff in China, Hong Kong and Taiwan, in an effort to capitalise on the bank’s historic strength in the region.

Oswald Grübel, UBS chief executive, is pinning his hopes on Asian growth to make up for more troubled operations elsewhere in the world, particularly the US, and has posted former investment banking co-head Alex Wilmot-Sitwell to Hong Kong to lead the build-out.

Home-grown Asian banks, too, have been recruiting fast as they expand away from their domestic markets. In the past three months alone, Hong Kong’s Bank of East Asia has signalled growth plans in Singapore; Singapore’s own DBS is expanding in India; and Mega Financial of Taiwan is pushing into Vietnam, Indonesia and Thailand.
The pan-Asian success story has its own natural limits, however.

There are not enough qualified bankers to fill the job vacancies, and Asian pay deals have consequently escalated to potentially unsustainable levels.

As HSBC divulged in pay data in February, its senior bankers in Asia and other emerging markets earned almost 40 per cent more than their London-based colleagues last year.

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Copyright The Financial Times Limited 2011.