This insight was originally published as an opinion piece in the July edition of the IBS Intelligence Fintech Journal. Click here to access their website.
A historic surge in bankers’ pay was the headline story from Wall Street’s 2021 full-year earnings season. Aggregate employee remuneration paid by JP Morgan, Citigroup, Goldman Sachs, Morgan Stanley and Bank of America jumped by $18 billion year-on-year to reach $142 billion in 2021. Rampant wage inflation has affected the late- and post-pandemic labour market in many sectors, but bulge-bracket banks in the US felt this more keenly than any other.
In investment banking divisions, a rising cost base was offset by record revenues. At the outset of Covid-19, market volatility drove increased trading volumes. Last year, the global dealmaking boom, which witnessed a record-breaking $5.9 trillion in M&A activity, according to Refinitiv, fuelled an increase in advisory mandates and underwriting debt and equity issuances.
As a result, Goldman Sachs and Morgan Stanley, two banks with concentrated investment banking exposure, recorded increases in turnover of 62% and 44% respectively from 2019 to 2021.
A historic surge in bankers’ pay was the headline story from Wall Street’s 2021 full-year earnings season. It is a different story for banks with proportionately larger commercial and retail banking operations. These businesses did not benefit from the same tailwinds.
It is a different story for banks with proportionately larger commercial and retail banking operations. These businesses did not benefit from the same tailwinds. This poses an intriguing strategic question, to both camps: to what extent and where should they invest in technology?
Pure-play investment banks have an opportunity to capitalise on their Covid windfall by further automating their trading, ECM/DCM underwriting and M&A advisory practices. This up-front capex spend would serve to reduce future opex on bankers’ pay.
However, there are multiple disincentives for doing so. Firstly, investment banking remuneration is, by nature, bonus-driven and therefore prone to fluctuating. This should insulate banks from margin compression as markets cool, and revenues drop.
Pure-play investment banks have an opportunity to capitalise on their Covid windfall by further automating their trading… Nonetheless, investment banks should focus on the existential risk that FinTechs pose to them, if they become complacent and stand still in their technology investment programmes.
Secondly, while there is still significant scope for post-trade automation that cuts costs, there remains very little low-hanging fruit in the automation of revenue-generating, front-office, pre-trade activities. M&A advisory is an area that remains overwhelmingly paper-based and human-led, but the scope for automating these workflows is highly disputed.
Nonetheless, investment banks should focus on the existential risk that FinTechs pose to them, if they become complacent and stand still in their technology investment programmes. In January, Citadel Securities sold a $1.2 billion stake to VC firms Sequoia and Paradigm. That transaction epitomised how a heavily automated, technologically sophisticated market-maker that serves retail and institutional clients could attract a premium valuation and therefore access cheap capital that will fund further automation of its processes.
Meanwhile, commercial and retail-led banks that have not enjoyed the same banner 2 years face a dilemma of their own. Do they invest their more limited cash reserves in technology, or do they rely on a tightening monetary policy environment to drive profitability in the coming years?
Setting aside fluctuations in interest rates or dealmaking activity, it is those banks willing and able to keep investing in ambitious automation programmes that will grow their market share and future-proof their business models.
JP Morgan, even with its own top-tier investment banking franchise, saw margins compress and has decisively opted for the first option. At the beginning of the year, CEO Jamie Dimon announced a $12 billion spend on technology upgrades in 2022, aiming to fuel gains in market share across almost every business line.
It is in the area of retail banking, however, where the big banks most conspicuously lag the FinTechs. As such, JP Morgan’s spend is targeted at areas such as card operations, where the shift to the cloud is intended to realise $30-$40 million a year in cost savings, improve the targeting of offers to prospective customers and combat fraud.
Setting aside fluctuations in interest rates or dealmaking activity, it is those banks willing and able to keep investing in ambitious automation programmes that will grow their market share and future-proof their business models.