The biggest investment banks have gone on a crash diet over the past five years and shed a lot more in assets than you might think. My latest column for Financial News
It is something approaching an article of faith that one of the failures of the barrage of regulatory reform in the five years since the collapse of Lehman Brothers is that big banks have continued to get bigger and that the system is as risky as ever.
Far from forcing banks to shrink, regulators have allowed the biggest banks to gorge themselves on free money and the largesse of taxpayers, while hoovering up business from weaker rivals and pocketing the change. Instead of solving the problem of too big to fail, policymakers made it worse. For example, before the crisis, there were just two banks with assets more than $2 trillion. Today, there are six.
While that’s a neat narrative, when it comes to investment banks – the parts of the system that regulators and politicians are fond of telling us are the riskiest of all – it has the distinct disadvantage of being completely inaccurate.
The biggest investment banks have been on a crash diet over the past five years and have shrunk by nearly one quarter in terms of total assets since before the crisis, according to my analysis. They have also cut their leverage in half.
Along the way, they pulled off a conjuring trick that is no less impressive than their ability to pay seven-figure bonuses while losing money: they’ve made trillions of dollars in assets disappear. A sample of nine of the biggest investment banks have cut a remarkable $2.4 trillion of assets off their combined balance sheets since the end of 2007. That’s roughly the equivalent of making Goldman Sachs and the investment banking division of Deutsche Bank disappear.
Too big to shrink?
In fairness, the perception that balance sheets at the biggest investment banks were growing may have been encouraged by articles such as “Investment banks: too big to shrink” or “Investment banks lead the charge in boosting their balance sheets” (both of which were written by me in the past few years).
These articles may have given the impression that, far from shrinking in the face of tougher regulation and a slowdown in activity, the balance sheets at most investment banks were expanding.
Indeed, for a few years, they were. Many investment banks had cleared the decks after the crisis only to be wrong-footed by the surge in volumes and assets prices in 2009. This encouraged some banks to pile on the pounds again in 2010 and 2011, while others tried to take advantage of the disruption across the industry or rebuilt their business. However, over the past 18 months, as it has dawned that the slowdown is more than a temporary blip, balance sheets have gone into reverse again.
In particular, it is notable that the big European investment banks in the sample (Barclays, Credit Suisse, Deutsche Bank and UBS) increased their balance sheets by nearly a quarter between 2009 and 2011 as they tried to rebuild post-crisis, only to throw in the towel since then. In contrast, their big US rivals cut back more quickly in 2009, and have been growing steadily ever since.
Crash diet
Convert everything into US dollars and make some simplistic adjustments for different accounting standards and the net result is that, as of the middle of this year, the combined balance sheets of a sample of nine big investment banks had fallen by 23% since the end of 2007 (just before the financial crisis got going). Every investment bank has shrunk over this period except the global banking and markets division at HSBC, which has instead increased its total assets by 23% to $1.9 trillion (under international accounting standards).
Of course, balance sheets only provide a snapshot of a bank’s scale at any point in time, and comparing one bank with another – particularly between different currencies and accounting standards – is fraught. But the direction of travel and quantum are clear. A raw average in local currencies and accounting standards also shows that balances have shrunk by 24%.
The Swiss banks have been on the biggest crash diet: the investment bank at UBS has slimmed down its balance sheet by 85% over the past five years when measured in local currency, although it has only shed 70% of its weight when you include the non-core assets that it still holds. Local rival Credit Suisse has halved in size since the end of 2007 when measured in Swiss francs.
In fairness, those banks that snapped up rivals during the crisis have grown: the investment banks at JP Morgan and Barclays are bigger today in terms of total assets than they were in 2007. But when you add back the assets at Bear Stearns and the US business of Lehman Brothers (*calculations in box) to their respective balance sheets to reflect the acquisitions, then they have shrunk significantly.
Some big investment banks are not included in the sample. It’s almost impossible to work out what a combined Royal Bank of Scotland/ABN Amro investment bank or Bank of America Merrill Lynch would have looked like in 2007, and the French banks don’t disclose the assets in their investment banking divisions. Neither does Nomura. (However, it’s probably safe to say all of them are smaller today than in 2007.)
For good measure, investment banks have also significantly increased the amount of equity they use to fund their business, which has reduced leverage and the “riskiness” in the system. Allocated equity has increased by a combined 46% at the seven investment banks in the sample that disclose the numbers.
Combine this with a drop in total assets of nearly a quarter, and overage leverage has halved from just over 40 times (ouch!) as the industry heading into the crisis in 2008 to just over 20 times today (although the investment banks at Barclays, Credit Suisse and Deutsche Bank are still well above this level).
It may be that the biggest investment banks are still too big and too risky. We won’t find out until the next crisis. But they aren’t bigger and riskier than they were before the crisis. The improvement may not be much of a trade-off for the carnage of the past five years, but it is progress all the same.
Note:
• International accounting standards were converted into US standards on the assumption that US GAAP translates into 60% of IFRS after netting.
• Local currencies were converted into US dollars at average prevailing annual rates.
• To reflect the acquisitions made in 2008, the numbers for Barclays and JP Morgan are presented pro forma for 2007. Barclays’ balance sheet includes 65% of the Lehman Brothers’ assets (excluding asset management), while JP Morgan includes all of Bear Stearns assets (excluding asset management).
-This article first appeared in the print edition of Financial News dated September 23, 2013
