Friday, June 01, 2007

Returns in investment banking

Investment banks' returns on equity have always been the envy of other industries. The Economist Survey on international banking (May 19- 25 ) gives us an idea of why Wall Street firms make their peers salivate. Current return on equity: 25%. Long run returns (since 1985): 16%. Goldman Sachs, the bluest of them all, had a return last year of 33%.

People have agonised over these kinds of returns. Is it lack of competition? Sheer innovation? Superior information?

One thing is clear- these firms are extremely nimble-footed. When brokerage income declined, they fell back on underwriting income and properietary trading.Then, they focused on advisory services, including mergers and acquisitions. When that field became crowded, they turned to private equity. These firms are well run, they hire some of the smartest people and their incentive systems are hard to beat.

The trouble, as the survey points out, is that it is hard for regulators and industry watchers to tell whether risks in the system are under control.

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