There have been big changes in investment banking since the credit crunch started in 2007. Many investment banks have gone bankrupt while others have expanded rapidly.
Some companies are no longer present. For example Lehman Brothers, which was one of the top investment banks of the late twentieth century, went bankrupt in a move that was seen as the height of the credit crunch, and later had its North American operations brought by the British bank Barclays Capital, with the other operations brought by the large Japanese bank Nomura Securities. Similarly the once enormous securities house of Merrill Lynch was taken over by Bank of America, while Citigroup was forced to sell its stock broker to Morgan Stanley, creating Morgan Stanley Smith Barney. Similarly Wachovia Securities had to rename itself as Wells Fargo Advisors after being sold to the massive Wells Fargo bank.
Some investment banks flourished, such as Goldman Sachs, which still continued paying enormous bonuses. Other banks such as JPMorgan Chase became more prominent while unknown banks such as the southern based BB&T Capital Markets were catapulted into the top of the banking league tables when small but well capitalized regional investment banks were asked to take over less stable rivals.
Many of the international headlines concerned British or American banks, where local banks in large markets showed some more stability. In Canada the big five banks kept to their respective strategies with RBC Capital Markets and CIBC World Markets still keeping a high international presence in London and New York, while Scotia Capital concentrated on an internal Canadian base. The other two banks concentrated their activities on the investment management side with TD Securities continuing to build an international stock broking organization and BMO Nesbitt Burns offering an award winning full service offering, but concentrating on Canada.
In Europe, the Swiss banks faced increased scrutiny due to their private banking operations, with Credit Suisse and UBS AG having to face allegations that they aided tax evasion through creative measures such as smuggling diamonds in toothpaste tubes. In France BNP Paribas CIB was named as a potential bidder in many takeover operations, while Societe Generale was one of the first institutions to almost go bankrupt when a rogue trader lost it billions. The small credit union based banks such as Calyon Credit Agricole CIB and the relatively new Natixis tended to grow, like their Dutch equivalent Rabo Securities.
In Germany the market leader Deutsche Bank CIB faced a strong challenge from the second place Commerzbank who had merged with the Dresdner Bank. German banking has been opening up recently with its largest Bavarian bank being bought by the Italian lender Unicredit. The Italian operation MPS Finance (a sub-division of the third largest Italian bank Monte dei Paschi di Siena) kept its stranglehold on the Italian bond market.
India has seen the growth of the aggressively marketed Kotak Securities, a division of the fast growing Kotak Mahindra Bank. In Japan Nomura securities, the largest Japanese brokerage has moved its headquarters to London in order to become more international, while Daiwa Securities has been bought out entirely by its parent company the Daiwa bank. In South Korea Daewoo Securities still maintains its market leading position. In Australia the news was of a bankruptcy that did not happen as Macquarie Group, a global specialist in infrastructure finance, did not go under.
Investment banks have found that the operating atmosphere has changed considerably. Before the credit crunch it was a golden period for these banks as there was a wave of takeovers and structured fundraising. Private equity was very popular, where a management team buys out a company division on the back of a large amount of debt. Many publicly traded companies were also encouraged to take out a large amount of debt as they found that the historically low interest rates were now affordable and by leveraging and buying back shares they could radically increase their profit per share. This was somewhat of a change to the usual role for investment banks which was to take private companies that wanted to broaden their ownership and funding on to a stock market, what is known as “floatation” or an Initial Public Offering (IPO).
One of the more controversial areas where investment banks were involved was the growth of the residential mortgage backed securities (RMBS) market. This market involved the pooling together of mortgages, and their segmentation into various areas that would be paid off in different orders. The tranches that would be paid off first were regarded as highly safe and often attracted the highest credit ratings, the AAA rating meaning that many investment funds could treat them as equivalent to government bonds. The market naturally led to the rapid growth of the mortgage market, with good borrowers getting low rates, first time buyers needing low deposits and bad borrowers getting offered mortgages for the first time. This led to increased perceived prosperity and rising house prices, which led to fewer defaults and a higher return on the mortgage securities. This virtuous cycle could not continue forever and instead it broke when a number of the less trustworthy borrowers stopped repaying their mortgages and a number of investment banks found themselves exposed to these funds, including Lehman Brothers and Bear Stearns.
Another area of investment bank activity has been proprietary trading, where an investment bank maintains its own traders who buy and sell securities either for the clients or for the banks. These tend to be short term traders, who aim to take advantage of differences in the prices of various securities. Although they are often seen as a source of risk, particularly the trading that is done on the firm’s own account, this is in fact a major source of profit for the investment banks.
One area of controversy was with bonuses. As investment bankers make a large amount of money for their banks, and can easily measure their results the successful ones have tended to be paid very generously. This increased with the growth of hedge funds, which like the in-house trading operations of merchant banks would trade on short term price movements. They paid multi-million bonuses to star traders. Investment banks felt that they had to match these bonuses to retain the clients.
This led to moves to restrict bonuses, or tax them at penal rates. This has been attacked by some economic commentators and bankers as being self destructive as many bankers left for lower tax jurisdictions such as Switzerland and Hong Kong. Many bonuses stopped being guaranteed and were paid in more long term ways and were held back for a number of years.
The controversy over bonuses was exaggerated due to an international government rescue of the banking system. This was a considerable burden to the taxpayer, and led many commentators to call for more regulation and higher taxation of merchant banks.