Christmas Cuts

Barclays Has an Ultimatum

Banks need some clients more than their clients need them.

It's a Christmas fairy tale. After a 30-year sleep, during which costs have run out of control, investment banks have suddenly woken up to the fact that thousands of their customers don’t make them money.

Cursing the ogres of Basel, they find a magic marker pen and cross the freeloaders off their client lists. It all ends happily ever after, with increased revenue from customers and reduced costs for the lenders.

Barclays Plc wants us to believe its own spin on this tale. The British bank has a new "Flight Deck" system that ranks trading customers by return on capital. The top 500 will be ranked gold, platinum and diamond, according to Bloomberg News. The aim is to "off-board" -- a polite term for throwing a passenger out of the cabin mid-flight -- the stingiest clients.

A Year to Forget

Barclays shares have only just erased their losses for the past year

Source: Bloomberg

It's not an original idea. Deutsche Bank AG has tried a variation in its markets business, while Morgan Stanley has separated its fixed-income customers into "supercore", "core" and -- prepare for the humiliation -- "base."

Things don't work out so well in the real world, though.

Returns Drag

Return on tangible equity (ROTE) for global investment banks has fallen since 2011

Source: Bloomberg Intelligence

It's laudable banks are putting shareholders returns first rather chasing revenue. But they don't have a good track record here: return on tangible equity is at almost half the level it was in 2011 while total operating expenses still hover at about 60 percent of revenue, according to Bloomberg Intelligence.

Cost Problem

Total operating expenses as a proportion of net revenue for top global investment banks

Source: Bloomberg Intelligence

Simply cutting clients may not help reverse this. Convincing the most lucrative customers to pay more while your peers are all chasing the same dwindling revenue pool will require a big effort.

The illusion here is that lenders hold all of the negotiating cards. That may be true for clients banks are happy to lose -- those that don't fit strategically or those that can be dropped with limited impact on revenue.

But the closer you get to the top 100 clients, the less obvious banks' power becomes. Big asset managers, themselves under pressure to cut costs and adapt to new rules designed to improve transparency, have trimmed their own lists of trading counter-parties.

The biggest investment houses also want the most global full-service bank offering, making it harder for bankers to trim at the edges. That suggests pricing will be squeezed -- while banks will be forced to keep costly parts of their operations.

The other illusion is that banks can cut client lists in a vacuum. Plenty of banks have talked up their desire to focus on top-paying customers, making for a more competitive environment. Citigroup Inc. has an elite hedge-fund customer group known as the "Focus Five" -- and one can imagine the list of firms competing for this business is probably longer than just five.

With every bank whittling their prized customers down to a Top 100 list, there's likely to be a lot of overlap among those preferred clients, according to Coalition's Amrit Shahani. The problem of competition gets worse the more clients you cut.

It's possible Barclays is hoping this fairy tale will distract enough people's attention until rates start normalizing in the U.S. and fixed income markets rebound. It will certainly take more than a marker pen and reduced client lists to draw a line under this problem.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Lionel Laurent in London at

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