Mumbai: The Indian investment banking industry is currently grappling with a reverse Keynesian philosophy, in that all is fine in the long run but it’s dead in the short, said P. Harshavardhan, a Mumbai-based partner and director of consulting firm The Boston Consulting Group Inc. (BCG).
Under question: Earlier, US investment banking firms earned 60-70% of their revenue from the advisory business, which declined to less than 25% by September, when Lehman Brothers Holdings Inc. collapsed. Tom Starkweather / Bloomberg
As it turns out, said Harshavardhan, they are getting into businesses that they would not have earlier, be it restructuring (financial), asset reconstruction or wealth management, largely to ride out the downturn.
“You do the work that is available, not the work that you want to do. The key challenge will be whether they have the right capabilities and the people,” he said.
Over the past eight months, investment banks in India have had a rough time with a drought in the primary capital markets, mergers and acquisitions (M&As) on hold, and the retail segment completely out of the equity market.
But the silver lining is that a large part of their revenue is traditional advisory income, earned from brokerage, primary capital markets and M&As, unlike their Western counterparts who started putting sizeable chunks of their own capital behind deals.
“They did this either by raising money in the wholesale debt market, or starting pretty sizeable books of their own risk capital,” said Harshavardhan.
In 1997-98, US investment banking firms earned 60-70% of their revenue from the advisory business. By the time the liquidity crisis hit in the aftermath of the September collapse of the legendary investment bank, Lehman Brothers Holdings Inc., this pool of revenue had shrunk to less than 25%.
He noted that “70-75% of revenues and 80% of profits came from putting risk capital behind deals, and that model is under question now”, adding that Indian investment banks rarely follow this model of investing their own capital
The current crisis is also a good time to fix things in-house, he pointed out, referring to a recent article by a colleague titled Renovate your house in winter. “House-keeping is something you keep postponing in boom times, because you simply don’t have the time or the mind space to do it. So stuff on tightening operations, cutting costs, realigning organization, getting your teams right and operating multiple channels in an optimal manner are getting a lot of focus,” he said.
But if the slowdown continues into late 2010, Harshavardhan anticipates that some of the overseas investment banks in India may drastically cut their team size or perhaps even shut local offices.
“I don’t know whether all the overseas guys who have opened shop in India will have the patience to stay around, or whether they’d prefer to look at India four years down the line,” he said. The reasons are that, one, their overseas franchises are under severe pressure, and two, India is a small market, with investment banking revenue only a couple of billion dollars, including brokerage.
The biggest question now, he said, referring to a recent BCG report titled The Next-Generation Investment Bank, is about the investment banking model that will emerge from this crisis.
Will it be more the European universal banking model where investment and commercial banking go together, or will it remain the US-style independent investment bank model?
“Suddenly people have discovered beauty in deposit-taking (like a commercial bank does) and so forth, and somebody might argue that in the long run, only the universal banking model will survive. Especially if you believe that for the foreseeable period, funding is going to be constrained,” he pointed out.
Personally, however, Harshvardhan said that in the long run, the US investments banks won’t stay in the commercial banking model, because returns are structurally lower in commercial banking models, and also because regulatory oversight for commercial banks is too tight.
“Investment bankers are such a different breed. For them to come under limited bonuses, disclosures, salaries being approved by the regulators—that is not the world that they are used to living in,” he said, but added the caveat that “the comeback will happen with trimmed-down business models and tighter regulatory oversight.”