What happens now the golden goose is dead?

Investment banking is dead, say the pundits, and British investment banking has fallen further and faster than most. Well, OK, not quite all the pundits but Stefan Lewellen seems to be in a minority on this one.

Frances explains why:

UK investment banks have been particularly badly hit by high capital requirements and the imposition of the retail ring-fence: the UK political climate is distinctly frosty towards investment banking, despite the fact that the financial crisis actually hit UK retail banking activities much harder. Forced retrenchment of the UK investment banks due to regulatory and political pressure should have left the field clear for other European banks such as Credit Suisse and Deutsche Bank : but the EU is following the UK’s lead with higher capital requirements, and most European banks are now cutting investment banking.

But European banks are not alone. In the post-Basel III era, capital-intensive activities simply are no longer affordable. Even the American giants Goldman Sachs, Citigroup and Bank of America are under pressure to cut costs and make better use of scarce and expensive capital. We have not seen the last of serious cuts to investment banking. Remuneration, particularly, will eventually face the axe, although – perhaps understandably – investment banks have so far preferred to cut jobs rather than risk losing star players.

And retail banking just won’t generate the same level of profits:

What does seem to have ended – for the moment – is banks primarily making money by doing leveraged trades with each other. Proprietary trading is dead: customer service is the latest fashion in banking. This is to be welcomed – but I wonder if the race to outdo each other in customer service, particularly in retail, carries its own risks. Retail is already a low-margin business, and competition for customers is bound to drive down both fee and interest income. Will banks really be able to generate the profits their shareholders expect? Or will the consolidation that is currently happening in investment banking be followed in due course by a similar shake-out in retail?

Is this a Bad Thing? Wasn’t it all the clever financial instruments that got us into trouble in 2008? Haven’t we all been saying that the banks should play safe from now on?

Are we killing investment banking and does it matter?” asked the Sepctator’s business editor Martin Vander Weyer. 

If all this means that the Chancellor is poorer in tax revenue in coming years, he’s less likely to have to fund bailouts in the next downturn.

[W]ill we have ‘inadvertently destroyed the one industry in which the UK was clearly a world leader’ in what boils down to a fit of pique, as one banker put it to me recently? No, my friend, the language is too colourful: we will merely have encouraged you to operate in a safer, more sustainable way, because you seem to have forgotten that but for taxpayer and central bank largesse on both sides of the Atlantic, you would already have destroyed yourselves.

In other words, it’s a good thing that investment banking has been curbed because that reduces the risk of another banking crash. If it means lower tax revenues then so be it.

Most people would probably agree but it does leave the problem of what happens if our banks are no longer as profitable as they used to be.

At its height, the financial services industry contributed over 10 percent of the UK’s Gross Value Added.

Screen Shot 2014-05-29 at 11.23.32

Screen Shot 2014-05-29 at 11.23.49

Since the recession, the tax take from financial services has fallen, even though additional temporary taxes were levied on the banks.

Screen Shot 2014-05-29 at 11.28.26

Source: ONS

Corporation taxes for the sector, especially for banking, fell sharply after the recession:

Screen Shot 2014-05-29 at 11.38.28

Of course, taxes fall during a recession and, in any case, corporation tax rates were cut. In financial services, though, the drop was greater than anywhere else. No other sector fell so far so fast.

Screen Shot 2014-05-29 at 11.42.00

Source: PwC

The trouble is, financial services was a bigger part of our economy than it was anywhere else in the G7.

Screen Shot 2014-04-28 at 14.44.25

And the bigger they are, the harder they fall. Other countries financial sectors have recovered but ours is nowhere near where it was in 2008.

Screen Shot 2014-04-28 at 14.54.54 Source: ONS

It is very unlikely that Britain’s financial services industry will contribute the same level of wealth and tax to the economy that it did before the recession. Some of the activities that generated those huge profits in the 2000s are no longer profitable, for the reasons Frances explains. Voters around the world have decided they don’t want to run the risk of another banking crash so governments have made sure that the banking world of the pre-2008 era has gone forever.

That means the economic contribution and taxes that went with it have gone too. The banks have been called the goose that laid the golden egg, delivering economic growth and tax revenues during the 2000s. But what happens when the goose is dead?

Some, such as Howard Davies, reckon this might be a Good Thing. Finance, he says, has been taking our brightest brains, while diverting resources away from investment and into illusory asset management activity. It might be good for derivatives traders, Porshe dealers and strip clubs but it doesn’t do much for productivity and innovation.

He may be right. The return of a booming banking industry may be the last thing we need and it certainly wouldn’t be popular with voters at the moment. Right now, though, with very little investment happening anywhere else, it’s difficult to see what is going to fill the hole.


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4 Responses to What happens now the golden goose is dead?

  1. sdbast says:

    Reblogged this on sdbast.

  2. rogerh says:

    Drugs and prostitution seem to be the up and coming thing.

    But an intriguing problem, how do you make lots of money with ordinary humans in a world where everyone else is trying to do the same. Offering intellectual excellence is problematic – there ain’t much of it and it is seldom monetisable. Science is problematic, a 1000 can work for years and come up with no more than a new frying pan or a better aspirin. Legal Services – too individualistic and small scale. Engineers can do the Vin Ordinaire very well – offshore – but coming up with a new truly ‘must have’ product is difficult – the Personal Jet Pack or Mass Market Helicopters or Time Machines seem far off. We make do with a few Apps and aeroengines.

    So back to the problem – make do with less money? This is in fact what we are doing. Could we improve humans? But everyone else will do that even if we found an acceptable method. Isolate everyone else? Hardly. Re-industrialise – still too rich for that, wait another 100 years.

    Financial Services were very good and ‘everyone else’ will still need their money investing, still some hope here but strong temptation to over regulate and allow the profits to slide off somewhere less fussy. The answer – be less fussy.

  3. GF says:

    What does persistent high added value tell us? It may arise because some banks are providing an essential service in a new and better way than was formerly available but if that is the case then the sector as a whole is likely to shrink its share of the economy with only the innovative firms winning. Or it may be the result of a cartel or because the banks as a group have learned how to evade regulation and rip off their customers in which case ‘value added’ can rise for the whole sector.

    If the latter reasons then high value added is not a good but the symptom of a system gone bad. Naturally it will be much desired by insiders who benefit and, if the Treasury et al cannot see beyond the end of their noses, also by a government that sees only revenues and not the damage and rent extraction.

    The uncomfortable truth is, I strongly suspect, that the UK economy is much weaker and more moth-eaten than the government either knows or cares to admit

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