Transforminginvestment banks

2 | Transforming investment banks

The halcyon days of investment banking are over, and 20%-plus returns on equity (ROE) are long gone

Investment banking is an industry in turmoil:

► Weak efficiency and productivity

► Cultural crisis

► Eroded trust

► Intensifying competition

Profitability is being destroyed:

► Commoditization and move to exchange-trading squeezing margins

► Limited scope for revenue growth, e.g., non-modelable products restricted due to capital requirements

► Structurally higher cost base due to regulatory and compliance change

► New competition eroding dominance across manyareas of business

Low ROEs highlight the significant challenge IBs face

Aggregate investment banking revenue and expense

3 | Transforming investment banks

Major investment banks can still deliver sustainable ROE of 12%–15%, but doing so will require radical reform

Investment banks have entered “protectand survive” mode:

► Tactically optimizing capital, liquidity and costs

► Shifting away from capital-intensive, fixedincome trading activities, toward fee-basedadvisory business lines

They are delivering tactical solutions founded on broken models:

► Front-office pursuit of revenues coupled with strong oversight from powerful control functions is nolonger viable

Announced changes in strategic direction for leading investment banks

4 | Transforming investment banks

To deliver 12%–15% ROE, banks must focus on four pillars of transformation

Applying the four pillars of change to deliver sustainable returns

5 | Transforming investment banks

Pillar 1: optimizeInvestment banks must better utilize balance sheets, radically reduce costs …

The industry is suffering a cost and productivity crisis, and traditional, short-term approaches to cost reduction are no longer viable

Investment banking productivity and efficiency, as measured by average profit per employee and cost-to-income FY12–14 (illustrative)

6 | Transforming investment banks

Pillar 1: optimize… and explore innovative sourcing and shoring options

Business-line and legal entities► We estimate the carrying costs

of a single legal entity at up to $US600,000.

Assets and collateral► We have found that further

savings of 15%–20% of risk-weighted assets (RWAs) canstill be made when RWA optimization programs havealready been attempted.

Costs► We believe banks can release

savings by reviewing and re-engineering key processesacross the enterprise.

Sourcing and shoring► We believe there are three key

areas where supply chainsshould be reviewed: clientsupport services; internal supportservices; and execution services.

Supply chain opportunities

7 | Transforming investment banks

Pillar 2: transform cultureWeak controls and employee behavior have proven costly to investment banks

Cost of control

8 | Transforming investment banks

Pillar 2: transform cultureInvestment banks must incentivize behavior that will deliver value for shareholders and clients and meet regulatory expectations

Banks must look more closely at whatis driving behavior …

► Most attempts to change culture have beenreactive “point” solutions

► Management teams must lead by example

► Individuals must be held accountable

► “Good” behaviors must be rewarded

… and reform hiring practices andemployee propositions

► Focusing on internal recognition programs,mobility, secondments, education andtraining, and time to develop innovative ideas

Top initiatives to strengthen risk culture

9 | Transforming investment banks

Pillar 3: become client-centricInvestment banks must put their clients at the heart of their business …

Trust in investment banks has been eroded:

► Beyond low public trust, client trust hassuffered from high-profile reports ofinvestment banks ignoring conflicts of interest.

► Traditional operating models, based onproduct innovation to drive the bottom line,are inadequate.

► Banks must better identify their core clients and their needs.

► They should improve systems to monitorclient satisfaction …

► … and enhance the client experience by considering creating a “single shop-front.”

(1) Product innovation:

► Evolving products to support revenue-making capability

► Innovation results in lack of price transparency

► Emergence of silos to support flow vs. non-flow booking requirements

(2) Business capability:

► Capabilities emerge to optimize increased support of greater product portfolios

► The need for flow optimization drives efficiency

The traditional investment banking operating model evolved from a focus on product innovation and business capability

10 | Transforming investment banks

Pillar 3: become client-centric… and ensure future operating models are client-centric

11 | Transforming investment banks

Pillar 4: be technology-ledInvestment banks must transform legacy processes and embrace innovation

Today, banks are people-led businesses — tomorrow, they will be technology-led:

► In a more commoditized, risk-averse future, cost-to-serve, speed of execution and quality of service will be the key performance differentiators.

► Currently, 50%–66% of costs are staff costs. This is unsustainable.

Transition to a technology-led business will be difficult and stretch budgets ► Banks must invest across a number of

areas — new collateral and capitalsystems, client-centric solutions,improving data, controls technology.

► But with around 75% of IT spend on systems maintenance, they must first deal withlegacy technology.

IT investment pipeline (36-month budget horizon)

12 | Transforming investment banks

The pillars of change support the path to improved and sustainable ROEAchieving a sustainable, mid-teens ROE is possible, but it will require an unrelenting focus on transformation across four pillars of change

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