Mustier Sees Banks Heading Back to 80s on Capital Needs
UniCredit SpA (UCG)’s Jean Pierre Mustier, a 26-year veteran of European investment banking, sees lenders reworking their business models on 1980s lines as regulatory demands for higher capital levels force retrenchment.
“Capital requirements will probably keep increasing, specifically for markets,” said Mustier, who runs the corporate- and investment-banking unit of Italy’s biggest lender by assets. “This will push banks to simplify further their activities, going back to a business model from the 1980s focusing mostly on lending, transaction banking and some intermediation.”
As regulators shift their focus to leverage to prevent a repeat of the taxpayer-funded bank rescues of 2008, universal banks, which combine investment, commercial and retail banking, are likely to farm out more of their activities, Mustier said in an interview. Mustier, who joined Milan-based UniCredit in 2011 after working at Societe Generale SA (GLE), has exited most European stockbroking and is concentrating on debt markets.
An industry transformation “isn’t going to happen overnight -- it’s a five-to-10-year scenario,” the 52-year-old Mustier said.
His vision of a banking world from times past shows the challenges lenders face as they grapple with rules that keep getting tougher. Mustier, who ran the first equity derivatives trading business at Paris-based Societe Generale after he joined in 1987, sees banks abandoning activities that soak up capital, in particular derivatives that don’t clear through central counterparties.
“Banks going back to a more commercial banking model, like in the 80s, can deliver the full range of credit offerings to their clients, from loans to bonds, as credit markets are fundamentally local,” said Mustier. “You don’t have to be global in everything. It is a competitive advantage in M&A, partially in equities, but not true in European debt markets, where the investors are European.”
Some businesses in investment banking require critical mass to generate sufficient returns, said Christopher Wheeler, a London-based analyst at Mediobanca SpA who’s worked in the financial industry since 1979. Universal banks could abandon businesses such as equities trading, merger advice, servicing hedge funds and activities which require them to retain some of the risk, such as securitizations, he said.
“If you do that you could get a higher credit rating, your cost of funding goes down, your loan-to-deposit ratio falls and you can run off less equity,” said Wheeler. “Investors would be willing to pay more for your stock even if you’re smaller and the ability to get higher-margin business is gone.”
The 1980s began with U.S. Federal Reserve Chairman Paul Volcker’s crusade to stamp out inflation, with interest rates that peaked at 20 percent in 1980. After U.S. recessions that year and in 1982, economic growth rebounded, reaching 8.5 percent in the first quarter of 1984 on an inflation-adjusted basis and averaging 3.1 percent during the decade. The S&P 500 Index more than tripled over the course of the 1980s, even after dropping more than 20 percent on Oct. 19, 1987, known as Black Monday.
Mustier’s predecessor at UniCredit, Sergio Ermotti, had tried to compete with the world’s top securities firms as mergers soared and capital-markets activity flourished before the U.S. subprime crisis erupted in 2007 and spread globally. Ermotti, now chief executive officer of UBS AG (UBSN), Switzerland’s biggest bank, subsequently reversed that course, scaling back the Italian lender’s investment-banking ambitions before leaving in 2010.
UniCredit, valued at about 30.7 billion euros ($41.7 billion) has lagged behind European financial stocks in the past two years, weighed down by a $9.9 billion capital raising and its exposure to Italian government bonds as the sovereign-debt crisis deepened. The stock is down 6.3 percent in the period, compared with a 36 percent gain in the Bloomberg Europe 500 Banks and Financial Services Index and a 20 percent increase in the FTSE Italia All-Share Financials Index.
UniCredit ranks fifth among arrangers of syndicated loans in Europe, Middle East and Africa this year, and seventh among underwriters of bonds in euros and pounds with a 4.2 percent market share, data compiled by Bloomberg show.
Any bank trying to recreate the financial model of 30 years ago would be tested by the depth and breadth of the bond market that has developed since then, said Chris Whitman, who began his career at Merrill Lynch & Co. in 1989 and is now global head of risk syndicate at Deutsche Bank AG in London.
The face value of the bonds issued in Europe to tap savings in dollars outside of the U.S. increased from about $49 billion at the end of 1982 to $264 billion at the end of the 1980s, according to Bank of America Merrill Lynch’s Eurodollar Index. The face value of the bonds in the index is now $4.58 trillion.
Banks need to service clients globally to be competitive in dealing with larger investing clients, Whitman said. Investors have consolidated, creating firms such as Pacific Investment Management Co., which manages $1.97 trillion, and AllianceBernstein Holding LP, which oversees about $435 billion.
“As a bank, if you’re global and important to their business around the world, you’re well positioned to have an open line of communication with the bigger players,” said Whitman. “If you’re a smaller player, you’re forced to come up with niche value propositions.”
No matter the business model, banks are always at risk of losing money through ill-advised lending, said Rene Karsenti, the president of the International Capital Markets Association.
Just as the capital markets-focused model powered by trading in securitized bonds led to the 2008 financial crisis, the loan-driven Latin American defaults of the 1980s showed there is no foolproof system, said Karsenti, who did business with the major lenders as senior manager of the World Bank’s treasury from 1980 until 1989.
“There were excesses in the 1980s, too,” he said. “One thing that’s changed is that back then the authorities could put the heads of the big banks that had made the loans in a room and have them work together to find a solution. With the rise of the bond market, that’s not an option anymore.”