Return on equity for the top global investment banks is falling. Here’s how they’re dealing with it

Delegates from firms making their way to Geneva next week for the 2016 financial services Sibos conference will undoubtedly have a lot on their minds. Over the past few years the industry has been facing challenges on many fronts: continued and increasing structural costs, fast-changing regulatory reform, conduct issues and capital requirements, to name but a few.

And against this background investment banking revenues fell by almost 4 per cent in 2015 compared to 2014, with average return on equity (ROE) for the top 14 global investment banks falling from 7.8 per cent in 2014 to 6.3 per cent in 2015. The typical cost of equity for an investment bank would be between 10 and 12 per cent.

With so much on the industry’s plate it’s understandable that, for many players, innovation has largely taken a back seat. But the capital markets industry now finds itself at a crossroads – one where embracing innovation could well help it seize the opportunities ahead and stem the negative trend in ROE.

Alongside financial technology organisation Innovative Finance, we’ve spoken with 40 investment banks, fintech firms, regulators and venture capitalists across the globe to find out how companies could help banks improve their go to market strategy and halt declining return on equity revenues.

Released yesterday, our report Capital Markets: Innovation and the Fintech Landscape highlights how the best near-term opportunities are in areas such as Robotic Process Automation (RPA), advanced analytics, digital transformation and the outsourcing of processes and services.

Those we questioned believe that technologies such as artificial intelligence (AI), smart contracts and blockchain could be game changers in the longer term, but will also take longer to deliver returns on investment.

Encouragingly, investment banks are increasingly recognising the need to collaborate with the fintech industry, mindful of the advances the burgeoning sector has made in the retail banking industry. The benefits of fresh thinking and new technology are becoming clear, as is the realisation that much of the research and development has been funded externally.

But while there is no shortage of willingness to engage between investment banks and fintech firms, there are practical challenges of getting ideas out of the lab and into production. Fintechs are still maturing when it comes to how they deal with large, complex investment banks. For their part, investment banks need a top-down culture that supports innovation, accepting that there is no such thing as a risk-free bet. There is work to be done on both sides.

Many investment banks are collaborating with fintech innovators and partners to better explore how to improve their businesses. Back in April, EY’s annual Banking Barometer found that nearly a quarter of banks across Europe expected to see greater collaboration with fintech – while over half of the 250 senior banker respondents were looking to invest in customer-facing technology. This is encouraging, and we will see wider bank participation in fintech as the latter seek to utilise some of the new game-changing technologies that are emerging.

The cost of investing in collaboration is low relative to the risk of falling behind technology deployments coming out of the wider investment banking fintech landscape – a fact that bankers seem to be more aware of. Our research also found that streamlining processes is now a key priority for 61 per cent of banks, up from 57 per cent last year.

The report also notes that regulators are becoming increasingly supportive of fintech solutions to investment banking problems, while also becoming more globally connected themselves through regulatory bridges. We’re seeing this, for example, between the UK, Singapore and Australia.

Banks can’t change overnight, but decisions taken now will go a long way in determining the future. It is clear that partnerships between fintechs and investment banks can help to reduce structural and operational costs, enhance regulatory compliance, support the innovation of products and services, and ultimately deliver better value to shareholders.

Given the current and projected challenges facing the investment banks, game-changing innovation is no longer optional; it is imperative.