Investment banks continue to lose ground in capital markets industry

09 May 2017

Investment banks continue to lose ground in the capital markets industry, new research finds. Their share of total revenues fell from 52% in 2006 to 39% last year, although the decline in revenues for the investment banking industry slowed somewhat last year. Profitability and return on equity however were up in the same period.

According to a new report from The Boston Consulting Group (BCG), capital markets began to stop the rot last year, following a number of years of lacklustre results. The report notes that value migration, by which revenues shift from investment banks to the wider industry, continued. While various support and enabling firms in the wider ecosystem enjoyed solid growth, investment banks saw declines, albeit slower than the years previous.

The value migration continues to prevail

In recent years changing market dynamics have seen the total share of industry revenues fall significantly for banks, from 52% in 2006 to 39% according to Boston Consulting Group’s analysis. In 2016, the broader capital market saw steady growth last year, climbing by 5% to $656 billion, however different segments noted considerably varied levels of growth. Investment banks saw their total market share fall by 2% to 34%, while buy-side firms saw their position strengthen further, increasing 2% to 48% by the end of the year.

Revenue declines for investment banks have eased

Sliding market share

Investment banks have seen considerable erosion of their market share over the past decades, however the study also demonstrates that the slowdown between 2015 and 2016 was not as sharp as in the four years previous. Total revenues fell 1% last year, from $228 billion to $226 billion but again, in the previous year the drop was a considerably sharper at 5%. The research attributes this stymying of the decline in revenues at investment banks to a number of different factors, including market volatility, interest rate changes, and an increase in fixed income, currencies and commodities (FICC) trading volumes following the US election result.

Investment banking profits rose in 2016

While revenues declined less steeply, the data compiled also revealed that the profitability of investment banking was on the rise in 2016. Operating income hit $76 billion, amounting to $10 billion increase, as income levels returned to levels last seen in 2013. Foreign exchange and rates were the segments to see the largest boost in 2016, while credit and prime services saw slight increases. Equity capital markets and equity derivatives saw minor decreases on the year previous however.

BCG’s study also showed that relative to the year previous, FICC sales and trading contributed significantly to the profit pool in 2016, at 60% and 46% respectively. Profitability from the segment hasn’t been as high since 2012, when it made up 70% of total profitability.

Investment bank return on equity increases

Return on Equity

Investment banks have managed to up their return on equity since 2015, buoyed particularly by the performance of North American banks. While risk-weighted assets saw a minor increase, up 3% from $3.8 trillion to $3.9 trillion between 2015 and 2016, return on equity (RoE) jumped 2% to 8% in the same period. However, return on equity in the industry is still considerably lower than the highest point over the past six years, standing at 12% in 2012, or more than 20% prior to 2008 – the fundamentals of the investment banking sector across the board remain considerably below pre-crisis levels.

Non-banks continue to enjoy growth

The authors concluded that broadly, banks have both slowed their revenue losses and increased their respective profits, while non-bank players in the industry are shown to be enjoying steady revenue growth. Exchanges, venues and clearing-houses saw profits up 6%, from $36 billion to $38 billion between 2015 and 2016 – with particularly indices and benchmarks and venue execution seeing strong growth, at 11% and 10% respectively. Post-trade services saw the steepest growth in the period, up 12%.

Information providers too saw their revenues increase, jumping from $43 billion in 2015 to $45 billion in 2016. Post-trade services saw the biggest increase, up 10%, followed by venue execution, up 8%.

“The value migration has continued along many paths,” Philippe Morel, a co-author of the report and the global leader of BCG’s capital markets segment, stated, “from smaller investment banks to large universal banks, from regulated to unregulated entities, from firms with weaker digital capabilities to those that are data and tech savvy. Although a lessening of the effects of quantitative easing, along with impending deregulation, may dampen the impact of the migration, institutions must still find ways to master it and make it work to their advantage.”


The business and operating models of digital-only banks

04 April 2019

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.