Wholesale & Investment Banking Outlook - Morgan Stanley

Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result ..... wholesale and investment banks could earn RoE in the low to mid- teens (well ...... Disruption. Mobile Users Come of Age.
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23 March 2011 MORGAN STANLEY BLUE PAPER MORGAN ST ANLEY RESEARCH

Global Banks 1 Huw van Steenis +44 (0)20 7425 9747 1

Hubert Lam

+44 (0)20 7425 3734

Betsy Graseck

2

+1 212 761 8473

Cheryl Pate

2

+1 212 761 3324

Michael Cyprys

2

+1 212 761 7619

Edward Moynihan

Wholesale & Investment Banking Outlook

+44 (0)20 7852 7555

Reshaping the Model

+44 (0)20 7852 7631

James Davis Lisa Draper +1 646 364 8673

The market underestimates the potential for banks reaching mid-teens RoEs. This cannot happen without managements acting decisively to reshape the business model. New regulations will depress industry RoEs 4-6% in our analysis. But contrary to market perceptions, we find that three-quarters of banks’ revenues are already “fit” for the new environment. This includes most of equity trading, debt and equity underwriting, advisory, foreign exchange trading, and government bond trading; other categories are being much re-engineered. In the next two years, growing equities revenues, improving asset quality, efficiency programmes, and portfolio reshaping should support 13-15% returns. The market also underestimates the knock-on impact of regulatory change on banking clients. Faced with higher capital and funding requirements, banks will respond by repricing and, failing that, shrinking credit provision in the business lines most affected by new regulation. Corporates hedging their exposures will feel the impact, as will pension funds/insurance hedging long-term liability with derivatives and users of long-dated lending (infrastructure, municipal finance). Asset managers, pension funds, and the nonbank sector should benefit from the new opportunities. Regulation is changing the basis of competitive advantage. Infrastructure, client service, scale, and efficient use of capital become critical as automation lowers margins in trading and clearing of OTC derivatives, credit, and rates, and as funding costs hit financing activities. We estimate a global investment bank today faces $4 billion of quasifixed costs. Flowmonsters will gain greater advantage, mid-size firms will need outstanding strategic focus to outperform. Banks need to take hardheaded portfolio and investment decisions today, as well as become more efficient; we think banks have to take out 6-8% of costs in the next 12-18 months alone.

Oliver Wyman is an international management consultancy firm. For more information, visit www.oliverwyman.com. Part 2 of this report solely reflects the views of Morgan Stanley Research, not Oliver Wyman. Oliver Wyman is not Authorised nor regulated by the FSA and as such is not providing investment advice. Oliver Wyman authors are not research analysts and are neither FSA nor FINRA registered. Oliver Wyman authors have only contributed their expertise on business strategy to the first part of this report. The second part of the report is the work of Morgan Stanley only and not Oliver Wyman. For disclosures specifically pertaining to Oliver Wyman please see the Disclosure Section, located at the end of this report. 1 2

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*See page 33 for all Morgan Stanley contributors to this report

Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. += Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may no