The two biggest Swiss banks, Credit Suisse Group AG and UBS AG, have had some bad news for investors recently. Both released disappointing quarterly results; Credit Suisse is entangled in a struggle with U.S. authorities over its offshore private-client business; and UBS had a major rogue-trading incident.
Both lenders reacted in a similar way by announcing further cuts in costs, staff and risk-weighted assets in the fixed-income area. Both were also adamant that they would continue with their integrated-bank model. This is the wrong approach for them to regain trust and confidence.
The integrated, or one-bank, model is a modern-day phenomenon. It means that investment banking and consumer banking are pursued under one roof, but it extends beyond this: Management, systems, funding and client services are, within regulatory limits, integrated with a view to gaining cost efficiency and the best use of funds.
This has its advantages. The retail business provides cheap funding that can be used in the investment bank, particularly in the capital-intensive fixed-income businesses; and the excess cash-flows generated by the highly profitable wealth-management unit can be allocated to underpin the growing capital requirements of an expanding investment bank.
Benefits and Drawbacks
There are also cost benefits in systems and operations. In some parts of the world, particularly in Asia, retail- and investment-banking services can be marketed and sold together. Trading and corporate-finance advice for certain client segments, such as high-net-worth individuals and some institutions, can be delivered through the same channels.
There are, however, some drawbacks, partly because the deposits of retail and wealth-management clients are used to finance activities of the investment bank, including some proprietary trading (which Credit Suisse and UBS have reduced considerably).
In more general terms, this means the highly volatile and accident-prone investment-banking business imports risks into the retail and wealth-management units, where clients are more conservative with their money. The easy access to cross-funding, and capital fueled by the private bank’s profits, furthers the risk appetite of the investment bank, sometimes on a foolish scale. It increases management complexity, reduces transparency and allows cross-subsidies -- all of which are hallmarks of bad governance.
In the many boom years, when businesses expanded globally and wealth was created hand-in-hand, this was a good model, and the balance of advantages and disadvantages tipped in favor of the one single bank. When the system collapsed, and investment banking went into intensive care, the hidden strings attached became visible.
Clients, regulators, the wider public, and employees of the retail arm of the bank became concerned about how much risk was transferred from the wholesale business to the more-stable retail bank. In this situation, the only way to regain trust on a sustainable basis, is to separate the investment bank from the retail and private-banking units.
The integrated model may, from an intellectual point of view, still be the superior one, and this may explain why the present managements defend it stubbornly. But it is outdated in terms of what can be sold to customers and the public. Walking away from the integrated model has become a matter of trust now.
This doesn’t mean Switzerland’s two big lenders should sell their investment banks. These global wealth-management institutions need their own investment banks to serve their client base. Without such a capacity, they would quickly lose some of their private-banking prowess. But Credit Suisse and UBS should spin off their investment banks into separate divisions that are independently governed, funded and capitalized.
Back to Roots
Compensation for management and staff in these investment banks should only lead to bonuses if they create economic value for shareholders. So designed, these investment banks would quickly go back to simplicity and the roots of the business. Balance sheets would become much slimmer; trading positions would be largely collateralized or hedged; and products would be simplified to reduce operational risk. By and large -- as investment banking intended -- the activities would be limited to advising clients, trading for customers, and underwriting in the capital markets.
There is another strong argument to support this move. Credit Suisse and UBS are present not only in Switzerland but also in the major financial markets of the world, most notably the U.S. and London. The U.K. Independent Commission on Banking requires the separation of bank consumer operations from investment banking and other riskier businesses; in the U.S., the so-called Volcker Rule prohibits banks that accept deposits from engaging in proprietary trading, or from holding private-equity and hedge-fund assets.
The Swiss regulator will ask for less, and demand only that the banks draw up a resolution plan allowing, in times of crisis, the splitting of “systemically relevant” parts of the bank. This is an approach that will prove to be unworkable or at least falls short of the more effective requirements of the U.K. proposals or the U.S. regulations. One day, Credit Suisse and UBS will realize that between the Volcker Rule, the proposal of the U.K.’s Independent Commission on Banking, and the Swiss ideas, which will tighten over time, there is no other option but to do the split.
This is a good time to proceed with the separation. Bank shares are trading around book value, and investors are no longer paying premiums above it since all the hype in the market has gone. There are few who believe in a great future for investment banks; hardly anyone thinks that Swiss universal banks are good at running integrated investment banks. Whichever bank announces such a split is more likely to be rewarded by the markets, rather than punished.
(Peter Kurer was chairman of UBS AG from 2008 to 2009 and is now an independent strategy adviser. He owns UBS stock. The opinions expressed are his own.)
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