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Steering Through The Next Cycle

Reviewing the rising demand for smart mobility and transport

The 2020 edition of our annual report with Morgan Stanley offers an overview of industry trends and analysis in wholesale banking.

The COVID-19 pandemic and its economic repercussions are putting wholesale banks‚Äė resilience to the test. This year‚Äôs report sketches out three alternative scenarios for the evolution of the pandemic and its economic impacts, ranging from a rapid rebound to a deep global recession, and assesses the implications for wholesale banks over the medium term.¬†

Exhibit: Past recessions and forward-looking scenarios

The impact on bank earnings

The combination of lower revenues and elevated credit losses could drive earnings down by 100 percent in our central case to over 250 percent in our deep global recession scenario. Compared to previous cycles, we project over 10 quarters worth of earnings lost in our deep global recession scenario, compared to 14 during the global financial crisis, and 4 to 7 in prior shocks.

The industry has built extensive capital and liquidity buffers to withstand this kind of stress event, putting them in a position to play an important role as shock absorber for the economy. But profitability going into a crisis has never been lower, and the pressure on earnings could reveal structural weaknesses in the business models for some banks. Our analysis suggests that, through the cycle, some banks will deliver returns of less than 5 percent, well below the 10 percent targeted by investors. We explore the drivers of resilience across wholesale banks and the role of scale in driving profitability when costs are increasingly inflexible. 

Exhibit: Corporate and investment banking returns forecasts

What banks can do to position their business for the next cycle

The corporate franchise was the engine of growth over the last 5 to 10 years, but now the corporate business is bearing the brunt of the current economic fallout. We estimate banking book credit losses could reach $200-300 billion in our most adverse scenario. The industry as a whole has struggled to cover its cost of capital in serving the large corporate franchise over the prior cycle -- we discuss how management can rebuild and reshape this business over the coming cycle. 

Exhibit: Corporate banking business cost of capital

Meanwhile the institutional franchise will benefit from the resulting heightened volatility. This could create big market share moves in the near term, we argue, while in the longer term winners will be those best able to adapt to the structural pressures on the business. 

Cutting across the institutional and corporate franchise, we discuss the impact of the increased focus on climate change, and ESG investing more broadly. We argue that this is set to be the defining issue of the next cycle, and could drive ~3 points of Return on Equity differentiation across banks, as well as become an increasingly important factor for how banks are assessed by investors.

How the structure of the industry may change

Technology providers for the wholesale banking industry have been growing rapidly and attracting high valuations, and we do not think the pandemic changes this value story. We estimate the industry has created $50 billion in equity over the last 5 to 10 years, and could generate another $60 to 120 billion in the next 3 to 5 years. We discuss how wholesale banks should respond as part of their efforts to restructure their cost base, and participate in the equity upside.

More fundamentally we argue the time may now be right for another wave of consolidation in the sector. Europe is in focus, given increasingly positive signals from policymakers and challenging economics for many in the region. In times of economic stress, major shifts of this kind can happen quickly.

Steering Through The Next Cycle