Slow death for smart staff in investment banks as 'working ants' take over

It's not easy to take cost out of an investment bank. Chirantan Barua should know. Before becoming senior analyst for UK banks at Bernstein Research in London, Barua was an associate partner focused on the banking sector at McKinsey & Co. At such, he was at the forefront of the big banking cost squeeze - or in the case of some British and European banks, the big banking cost tweak.

"Five to seven per cent of investment banking costs can easily be taken out," says Barua. "Another 10% to 15% can then be removed in addition, but that big chunk is very strategic in nature. It takes a lot of thinking to achieve. A lot of banks don't have the either the willingness or the capability to for a structural review, which is why most go for 5%-7% cuts and hope income will bounce back."

As is becoming apparent from banks' recent results, revenues may not be bouncing back after all - especially in fixed income. During yesterday's conference call, Deutsche Bank made a big deal of the fact that its fixed income sales and trading revenues had fallen a mere 10% - despite the fact that it was allocating more capital to the business. Barclays has warned that its fixed income currencies and commodities (FICC) revenues have suffered a "significant year-on-year reduction" in the first quarter. And Morgan Stanley and Oliver Wyman are predicting a further 1% reduction in FICC revenues in 2014, following on from last year's drop of around 20%.

The persistently depressed fixed income business is creating big problems for bank CEO's, says Barua. This is especially the case for Barclays, which has spent far too long engaged in wishful thinking. "In February 2013, Barclays told us it would be generating £12.5bn of investment banking income in 2015," says Barua. "Now we're debating whether it can generate £10bn. How can a bank be so wrong about its income number?"

As banks like Barclays grapple with the need to cut costs by more than 7%, Barua says they're up against the problem of fixed costs. Co-CEOs of Deutsche Bank, Anshu Jain and Juergen Fitschen, complained bitterly on yesterday's call that regulatory costs have risen for the foreseeable future. Deutsche is being forced to hire 500 additional compliance staff and it's not the only one - most banks are doing something similar.

"Regulatory and compliance costs are not going to go away," says Barua. "Nor are technology costs - banks need to invest heavily in technology now if they want to maintain their incomes in future."

He says people costs are also less elastic than they seem. Salaries and deferred bonuses count for an increasingly high proportion of the compensation bill in investment banks. And as demonstrated by Barclays' famous invocation of the "death spiral", banks that don't pay their top staff well are at risk of losing them. "Banking is still a relationship business," says Barua. "You still need that marginal MD - he's very useful if he has his relationships and can bring in clients."

Banks can't afford the brains any more

If banks can't cut compliance and regulatory costs, nor technology costs, nor the cost of relationship bankers, what can they cut? Brains, says Barua.

"There are three kinds of people working in investment banks," he says. "You have the relationship-driven people who know the CFOs and know the clients and can bring in the income. You have the really bright guys who are good at structuring products and reading the markets. And you have the 'working ants' who just turn up and work in areas like compliance, or systems maintenance."

As M&A and equity capital markets revenues pick up, this is a good time for the relationship driven people, says Barua. It's also a good time for the ants. It's less good for the brains. "The industry doesn't need and can't afford them any more," says Barua. "They will suffer the most. It will be a kind of slow death."

Investment banking CEOs are already investing in electronic trading technologies that allow them to replace intelligent expensive bankers with more run of the mill ants, says Barua. Barclays, for example, is wedded to automating as many processes as possible. Deutsche Bank has been hiring cheaper 'low touch' traders for its Birmingham office. Goldman Sachs says it now has 25% of its staff in low cost locations like Salt Lake City, Mumbai and Singapore, up from 10% six years ago.

As many banks pull back from risk taking and revert to a flow-based agency trading model, Barua says the intelligence exodus will likely increase. "You have banks paying all these very bright people to take risk, but they're not really taking risk any more."

Banking CEOs still need to be preternaturally intelligent, however. They're faced with the most difficult conundrum of any industry."Investment banking is the world's most volatile fixed cost business," says Barua. "Look at utility businesses - their cost base is now exactly the same as a banks, but their income doesn't go up and down by 25%-30% in a quarter. Banks have become a very difficult proposition for equity investors for that reason."