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Investment banks to shrink by 10-15% more as regulation bites: study

[LONDON] Investment banks are likely to shrink by another 10 to 15 per cent in the next two years as they cut back their trading desks due to the impact of tougher regulations, a study said.

That will reduce market liquidity and could raise trading costs for asset managers, forcing them to invest more in trading capabilities, according to the study by Morgan Stanley and consultancy Oliver Wyman.

New rules introduced since the 2007/09 financial crisis require banks to hold more capital for trading activities, making these areas less profitable and prompting cuts to trading desks.

Investment banks' balance sheets supporting trading markets have decreased by 20 per cent since 2010, and by 40 per cent in risk-weighted asset terms, the report said.

European investment banks will shrink by another 14 per cent on aggregate in the next two years, Morgan Stanley analyst Huw van Steenis estimated in the report.

That would include a 43 per cent reduction at Royal Bank of Scotland, 25 per cent at Credit Suisse, 19 per cent at UBS, 18 per cent at Barclays and 10 per cent at Deutsche Bank. "For banks, the diminishing returns on capital from market-making call for more and faster structural change," the report said, estimating that for banks to improve their return on equity (RoE) to above 10 per cent they need to deliver 2 to 3 percentage points of RoE improvement from restructuring. "More strategic selection is required, particularly in FICC (fixed income, currencies and commodities) and overseas markets," it said, adding they also needed to shift to a more technology-driven model.

The report said asset managers were increasingly concerned about the reduction in market liquidity and estimated the need for them to invest in trading and execution, collateral management and risk management could add between 1 and 5 percentage points to their costs.