Investment banking losses

Banks and investment banks are unlikely to go under in the present market crisis but their earnings are bound to take a hit.

Deutsche Bank and Merrill Lynch are the latest additions to a growing list of investment banks hit by losses in fallout of the sub-prime crisis. Earlier, Citigroup, UBS and Credit Suisse all had issued profit warnings. Lehman is among the few banks to have weathered the storm better than expected. The losses are in billions of dollars and heads are rolling merrily.

The sources of loss in banking are the following:

• Direct losses from exposure to sub-prime securities
• Loans for takeovers that have ended up on the books of banks- this will require higher allocation of capital and the terms on which these were negotiated are unfavourable in the changed context in which interest rates have shot up
• Fee income from structured products will decline
• Private equity income will be hit
• Interbank financing costs are higher, this will impact margins

How to ride out the storm? Having a large retail base helps. Also, equities have risen and this may compensate for weaker fixed income markets. Banks will also look to boost income from emerging markets- this may well explain the surge in flows into markets such as India and the boom in the Sensex in recent weeks.