As European investment banks deal with strong competition from US firms, many are narrowing down their ambitions to focus on areas where they are strong, rather than offering a wide range of products to many clients.
“If you are trying to serve the same clients that everybody else serves, in a very large global market, then I think the US banks have the size, scale and are winning,” said the head of corporate and investment banking at a European bank recently. “You see that in global equity capital markets and global M&A.”
This approach can include focusing only on clients that will deliver a sufficient return on capital. Société Générale has been particularly explicit about reviewing clients. Earlier this year deputy chief executive Séverin Cabannes, in charge of the global banking and investor solutions division, said the overall profitability of client relationships would determine which would be given lower margin products such as bank loans.
“Corporate lending is not sufficiently profitable, but as a bank we want to provide it, as it is a key service,” he said. “We will be more selective and allocate corporate lending capital to clients for which we are relevant as a whole and who offer us a satisfactory level of profitability.”
However, there are risks to jettisoning clients that may not generate much return straight away. Dinesh Sharma, capital markets consulting director at Deloitte, warns that in general banks are currently too focused on short term wins.
“The investment banking market has become increasingly competitive, across both advisory and markets products,” he said. “This competition — alongside the increasing costs for operations and regulatory compliance — has increased the cost of servicing clients. The result is that banks are focusing on recovering costs as quickly as possible, which means a focus on short term profitability.”
He added that front office staff were often still incentivised to chase short term gains.
If banks look at just the historical revenue generated by a client, when valuing it and decide what services to offer, this may not favour clients with a better long term potential. Focusing on the longer term might mean identifying which companies are likely to grow rapidly and require more banking services as they mature.
Sharma’s colleague Rawad Halawi, digital transformation lead in financial advisory at Deloitte, is more optimistic on how banks are reacting. He said a number of them “are thinking more long term and moving towards managing their clients through a ‘single client view’”.
Measuring total value
The low margins from corporate lending at a time of rock bottom rates can make this endeavour more useful for banks. Commerzbank’s latest strategic plan involves more cross-selling for its corporate clients division.
“We will talk to our clients and say, ‘Look, in some cases we need more cross-sales because the loans are not making us enough money,’ and if that doesn’t materialise, then we will have to prudently close some accounts,” said Michael Reuther, head of Commerzbank's corporate clients division, recently. “The focus will be much more on leveraging existing client relationships than on a lot of acquisitions.”
Deloitte recommends that banks adopt a “client lifetime value” lens. This involves using data to calculate the whole value of a client’s potential relationship with the bank.
Halawi thinks each bank should come up with its own way of doing this, looking at its own products and services.
“Factors typically include using the likelihood that a client will take out a product or a basket of products; the margin and average expected fees from the products; a specified time horizon; the churn rate for the products; and a discount rate to account for the time value of money,” he said.
This measurement would help firms work out how to manage each client.
Banks hope that clients they lend to will end up giving mandates for the most prestigious investment banking activities like M&A and IPOs. But it is not just about these products, according to Sharma.
“Not all small businesses or start-ups will go public,” he said. “Even if the client does not IPO, it will still have lending, financing and liquidity requirements as the business grows.”
Let’s work together
“If you were to ask each product line if the client is profitable, they would say yes. But overall, across all products, the answer may be different,” said Sharma. “To understand if a client is profitable, we’ve seen a number of banks trying to implement a more client-centric view. However, to fully implement these, challenges around information and data sharing need to be addressed.”
Sharma believes it is important to break down internal silos and incentivise front office staff to collaborate.
“It’s also helpful to appoint someone to be responsible for client service across all products,” he said. “This person should have the remit to understand the client, their nature of business, expected activities, strategy and growth plans, and company financial fundamentals.”