Frédéric Oudéa of Société Générale wrote in the Financial Times that Europe needs big investment banks — and softer regulation — to level the playing field with the US. His thoughts were echoed by John McFarlane, executive chairman of Barclays, who floated a combination of banks to create a European investment banking champion.
Most corporate executives, of any stripe, prefer to run big empires. If margin growth and profits are hard to come by, revenue growth, at least, is straightforward — buy or build.
This is certainly the case with investment banks. Despite a market which is more global than ever before, hosting a big investment bank is, for some, a matter of national pride. These organisations might talk the global talk, but usually have a limited number of so-called home markets, where their relationships go beyond the biggest companies into the corporate banking world, and where their regulatory and political relationships are honed to their sharpest degree.
According to Oudéa, it is a shame that those banks with home markets in European countries are not competitive, on the global stage, with banks that have home markets in the US.
On one level, this isn’t surprising. There has never been a true single market for wholesale financial services in Europe, and Banking Union and Capital Markets Union are not likely to create one any time soon. Deutsche Bank is less dominant in France than Goldman, Morgan Stanley, JP Morgan, Citi and Bank of America Merrill Lynch are across every US state.
There is also more bank lending and less capital market funding in Europe than the US. There is also a smaller private equity sector, fewer hedge funds, smaller pools of capital, and less of a culture of engagement with financial services.
Even a Europe which was totally integrated would still have a smaller investment banking market than the US even though Europe is a larger economy on aggregate with a larger population.
But more important than absolute size is what home markets do to returns.
Being top in a market doesn’t just mean heading the league table. The top institutions also take the most profitable cream of the business. The axiom that nobody ever got fired for hiring Goldman Sachs can be applied to other institutions on their home turf, meaning pricing power, and raising the returns of the business.
The big P&L country
In Europe, the largest deals are cross-border or effectively borderless — free-floating Eurobonds marketed across the continent, or pan-European groups merging with one another — and this erodes fees. The top institutions from every European jurisdiction are pitching for the business, and companies often succumb to the temptation to reward every relationship bank they have with capital markets mandates.
But the United States is the world’s largest home market. Though international investment banks have been trying to break the US for decades, fees have remained stubbornly high. One global head of M&A said European fees were, on average, 40% lower. Being big in the US doesn’t just mean size in a large market, it means more profitable investment banking business with less competition.
A bigger question is whether any of this matters. The chief executive of Société Générale clearly has good reasons to want European investment banking champions, preferably including his own institution, but the upside for everyone else is less clear.
Oudéa points to post-crisis problems with US banks withdrawing from European assets as a reason to prefer home farm financing. This is a valid concern. You could make the same criticism of Société Générale’s wobble in central and eastern Europe in 2011, but it smoothly connects the concepts of lending and capital markets activity.
The lending that matters is the lending that goes to smaller and medium sized companies. That has been a fundamental tenet of European policy makers’ and regulators’ arguments for pretty much the last eight years, and few if anyone in the market seems to disagree. They are the engines of growth.
That kind of lending is a very different thing than wholesale financing. And it isn’t likely that US banks are doing a lot of lending to European SMEs. Where they are concentrating, according to one senior executive at a major global bank, is in using fees generated in the US to take capital markets share away from European banks in Europe.
And regulations on both sides of the Atlantic have been shifting real lending away from banks to non-banks. Witness the booming growth of the marketplace lending sector in the US, for example.
European bankers have complained that their hands are tied when it comes to SME lending — that the credits they’d consider making loans to are too risky in the eyes of their national regulators.
Oudéa may then be right about one thing. We need regulation in Europe that stimulates regulated bank lending. What we don’t need — and probably will never have, given the nature of the European market — is champion investment banks.
What we can have are banks that understand Europe, and are able to lend to it.