Investment banks are taking their most aggressive approach to performance and bonuses for four years and are planning hundreds of job cuts over the coming months.
Banks will cut more staff than at any time since 2002 as part of their annual performance reviews, according to senior bankers.
At the same time, they will slash bonuses for underperforming staff to encourage them to leave, while lavishing bigger bonuses on their best performers.
Headhunters and senior bankers also said a number of big banks have drawn up contingency plans for further cuts if there is a market downturn in the second half of next year. The existing cuts will give them greater flexibility to invest in high growth areas.
Last week, Dresdner Kleinwort, HSBC and Royal Bank of Canada set the tone for the next three months by announcing more than 300 job cuts between them just before bonuses were announced. Dresdner Kleinwort last week instigated an aggressive program of cuts that could see as many as 7 percent of its staff lose their jobs.
The cuts, reported first by Financial NewsOnline, have seen dozens of managing directors lose their jobs. A source close to the bank said the changes were a reflection of a more aggressive performance review process and the "flip side" to a new bonus approach announced in July to link bonuses more closely to profits made by individuals. HSBC and Royal Bank of Canada have made deep cuts in fixed income, where trading conditions are expected to be tougher next year.
Most banks cut between 1 percent and 5 percent of their staffs each year as part of performance reviews. In the past few years, the cuts have been at the lower end of this range as banks struggled to keep up with high volumes of business.
The head of one investment bank in London said: "We are applying greater economic discipline to our costs this year than for several years. We can only afford to pay our best staff competitively if we don't waste money on those who do not deliver. For the past few years, the industry has been growing rapidly. While next year looks like it will remain strong for investment banking, there are concerns over the interest rate environment, trading profits and levels of leverage."
One big U.S. bank recently held an offsite meeting for its senior directors, where one of the sessions was called "Preparing for the Downturn".
One banker said: "We are trying to differentiate between those that have really performed and those that haven't. A greater number of people will get no bonus this year in a move that will encourage them to leave. A small number of top performers will get a big bonus."
One fixed-income headhunter said: "The job cuts could prove to be the first sign that banks are tightening their belts ahead of a downturn. We haven't seen a wave of industry-wide job cuts since 2003, but there could be one just around the corner."
The tough approach follows a record year for investment banks. This week, Goldman Sachs will kick off the U.S. banking reporting season with record results, but analysts are predicting a 6 percent fall in earnings per share at the bank next year.
Some think revenues and profits could fall across the industry in 2007 for the first time in five years. The Securities Industry Association said in a recent report that profits at Wall Street firms could fall by 22 percent to $20 billion next year due to margin compression, slower economic growth and a fall in activity in the primary and secondary markets.
Bankers are reporting healthy deal pipelines for the next six months but are unable to predict beyond that, as they fear excessive leverage on private equity deals could lead to greater defaults and a market correction. The chief executive of one European investment bank said: "We are increasingly concerned about the high levels of leverage and valuations of buyouts. We do not think these levels are sustainable."
Nearly three quarters of people at a Financial News conference on leveraged finance last week said they expected a downturn and an increase in default rates in next year.