Chop chop

BOSSES at big banks would once have cringed at releasing the kind of results they have been serving up to investors in recent days. This week, for instance, Deutsche Bank posted a loss of €6.8 billion ($7.4 billion) for 2015. In the third quarter of last year the average return on equity at the biggest banks, those with more than $1 trillion in assets, was a wan 7.9%—far below the returns of 15-20% they were earning before the financial crisis. Exclude Chinese banks from the list, and the figure drops to a miserable 5.7%. Returns have been languishing at that level for several years.

In response, the banks’ top brass are following a similar template: retreats from certain countries or business lines, along with a stiff dose of job cuts. Barclays, which earlier this month said it would eliminate 1,000 jobs at its investment bank and close its share-trading business in Asia, is typical. More radical measures, such as breaking up their firms into smaller, more focused and less heavily regulated units, do not seem to be on the cards.

In fact, in spite of investors’ frustration at dismal returns and regulators’ insistence that banks that are “too big to fail” will be cut down to size, the world’s mightiest banks have scarcely shrunk at all since Lehman Brothers collapsed. The 11 behemoths considered the most pivotal by the Financial Stability Board (FSB), a global grouping of regulators, had $22 trillion in assets at the end of 2008; they now have $20 trillion. The assets of the wider group of 30 institutions the FSB describes as “global, systemically important banks” have grown, not shrunk, in recent years.

On the face of it, this is a puzzle. To forestall future crises, regulators have piled on new rules intended explicitly to make life harder for the banks that are thought to present the greatest risks to the stability of the global financial system. All banks must meet higher capital ratios these days, funding a greater share of their activities with money put up by shareholders rather than by borrowing. This crimps returns but ensures a stouter buffer if they run into trouble. But the extra capital requirements are especially severe for the biggest banks.

Whereas a smaller bank might be required to hold capital equivalent to 7% of its risk-weighted assets, HSBC and JPMorgan Chase, the two institutions the FSB judges to be most systemic, have to hold 2.5 percentage points more. American regulators have imposed a further surcharge on JPMorgan Chase which will push its minimum ratio to 11.5% by 2019. The intention is not just to make sure that big banks are safer, given the expense of bailing them out, but to discourage banks from getting too big in the first place.

Other bits of regulation also hamper big banks in particular. America has banned “proprietary trading” (a bank making investments with its own money, rather than on behalf of clients); Britain is “ring-fencing” the retail units of big banks to protect their assets in case of disaster in other parts of the business. And whereas regulators used not to make much fuss if the subsidiary of a multinational bank in their country was not brimming with capital, as long as the bank as a whole was, most now require local units to be able to withstand shocks on their own. These rules have little impact on smaller banks, which tend not to sprawl across so many countries or to combine retail and investment banking.

By the same token, small banks have not been fined quite so heavily by prosecutors in America and elsewhere. The penalties—some $260 billion and counting for big American and European banks—have fallen mainly on commercial and investment bankers who have fiddled markets. Some banks have regulatory staff sitting in on most meetings, even at board level. “For every maker there are four checkers these days,” grumbles one investment banker.

Such changes have had some impact. Although the 11 banks that most perturb the FSB have not really shrunk, they have at least stopped growing. There has been a marked change since the pre-crisis period. In 1990 the world’s ten biggest banks had just $3.6 trillion of assets ($6.6 trillion in today’s prices)—equivalent to 16% of global GDP. By 2008 they had assets of $25 trillion (40% of global GDP). They now have assets of $26 trillion, or 35% of global GDP.

The geographical spread of the two “global” banks, HSBC and Citi, has shrunk markedly as they have left many countries. Many investment banks, particularly in Europe, have retrenched to areas of particular strength: UBS has largely abandoned the trading of bonds, currencies and commodities, for example. In general, banks are shifting away from risky and so capital-intensive activities, such as trading financial instruments, towards safer areas such as helping firms raise capital and managing the money of wealthy investors.

Some of the titans have been more radical. Once the largest bank in the world by assets, Royal Bank of Scotland (RBS) has shrunk by more than half under its new majority owner, the British government. General Electric, once a bank-within-a-firm, shed most of its financial assets over the course of the past year. Credit Suisse is mulling spinning off its domestic retail bank; Deutsche Bank is selling Postbank, a big retail-banking unit in Germany.

Yet big banks could still go much further. Many of them currently trade below book value, suggesting that they would be more valuable broken up. Richard Ramsden, an analyst at Goldman Sachs, suggested last year that JPMorgan Chase should be split into four units. MetLife, a big American insurer, is splitting itself up in part to reduce its capital requirements and thus boost profits. There is a “gravitational pull” towards being smaller, says the boss of one bank high up the FSB’s list. Competing with non-systemic banks, which have a lower capital ratio, is hard. “If you have a unit competing head-on against a bank that isn’t [systemically important]…that unit is worth more outside than inside.”

Jamie Dimon, JPMorgan Chase’s boss, claims that having all its units under one roof brings $18 billion a year in synergies. Such claims are basically unverifiable, but researchers have long struggled to find much in the way of economies of scale in finance. Costs tend to rise roughly at the same clip as revenues. Some studies posit that savings peter out above $50 billion in assets—a tiny fraction of the trillions held by really big banks. Others see benefits continuing further up the scale, though these are relatively small. But heft could also carry costs. The creaking IT systems of big banks, some of which run code adapted from the 1950s, certainly suggest that. Smaller banks, let alone “fintech” upstarts, can adapt faster.

Big banks can borrow more cheaply than smaller ones. In part, that is because they are typically more diversified than smaller banks. But investors have also lent more cheaply to big banks on the assumption that they will get bailed out in case of trouble. New rules should make it easier to force banks’ creditors, rather than taxpayers, to foot the bill if a bank fails. This has undoubtedly shrunk the subsidy—but not eliminated it. An IMF study from 2014, for instance, found that it still amounted to a discount of a quarter of a percentage point on their borrowing in quiet times, and potentially more during times of crisis.

Even so, there is no correlation between size and returns. The most profitable banks appear to be the middling ones, with assets of between $50 billion and $1 trillion. Bigger and smaller ones are markedly less profitable (see chart).

So if regulators want them to shrink and decent returns are hard to come by, what is holding the big banks together? The risks and costs of breaking up a large bank are one consideration in favour of the status quo. As the boss of another systemic bank puts it: “Breaking up would be a gamble, and we are not paid to gamble.” Byzantine behind-the-scenes plumbing would prove a nightmare to disentangle. That gives regulators pause as well as bankers.

In all industries, not just banking, few bosses enjoy the prospect of slimming the empires they have built. Banks are both very complex and highly regulated: that puts off activist shareholders. Bondholders, who put up much of the money big banks use to buy assets, may also be reluctant, having contracted a debt against a diversified set of banking businesses rather than just one fragment of it. Tax can be a factor: banks that made large losses in the downturn can still write them off against today’s profits, in a way that might be compromised by a break-up. This argument once blunted calls for Citi to be dismembered. The clearing mechanisms that exist in other markets are jammed in banking: small banks are put off making big acquisitions by capital charges.

All the same, shareholders are growing impatient. Bosses seen as too timid are being sent packing. Anshu Jain, who built up Deutsche Bank’s investment bank over 20 years, was removed as co-chief executive in June after moving too slowly to overhaul his creation. His successor, John Cryan, an avowed cost-cutter, has warned staff of the need for “a fair balance between staff and shareholder interests”. That means less for staff and more for shareholders, reversing a decades-long trend (see chart 2). The big banks may not have changed shape radically since the crisis. But that doesn’t mean life is fun.

Correction: an earlier version of this article stated that Barclays was “shutting up shop” in Asia. In fact, it is only closing its share-trading business there. Apologies.