Ten thousand cuts to a shapelier UBS?

Sweeping staff cuts anticipated at UBS are a particularly dramatic example of the way most major universal banks will have to reconfigure their asset bases and strategies in response to new capital regulations.

If UBS does as expected and culls 10,000 of its staff, the majority of them within its investment bank, will other universal banks follow its lead?

Actually another of the big universal banks, UBS’s Swiss sibling Credit Suisse, is already going so. Both of the giant banks – which pre-crisis had a combined market capitalisation that was a multiple of Switzerland’s GDP – are shedding assets, and people, at a near-frenetic rate.

Only last week Credit Suisse unveiled the second upgrade of its cost-cutting program this year. Where it had planned to cut about $A2 billion from a cost base of about $21 billion this year it has progressively increased the planned reductions to $3 billion and now $4 billion.

UBS, it has been widely reported, is about to announce its massive jobs cuts, having already cut the headcount within its investment bank by about a third as it shrinks that business to focus on its massive wealth management division.

Like Credit Suisse, UBS is ahead of its own targets for shrinking its asset base. In July it said it had reduced risk-weighted assets by about $45 billion in the second quarter, had already surpassed its 2012 targets for reducing its risk-weighted asset base within both the investment bank and the group as a whole and was accelerating towards its 2013 targets.

The target for 2012 was about $340 billion but the bank reduced risk-weighted assets to about $305 billion. Its 2013 target is now about $270 billion and its 2016 target less than $240 billion. Pre-crisis UBS had risk-weighted assets of almost $400 billion.

The two giant Swiss banks have, prodded by their regulators (actually it was more like being beaten with a large stick), responded as aggressively as any banks during the aftermath of the crisis as they have sought to retreat closer to their traditional banking cores and away from the universal banking model that marries traditional banking with investment banking activities.

Both banks have had capital requirements imposed on them well beyond those required of their peers by the global financial regulatory authorities.

The UBS change of strategy is particularly dramatic, although that’s not really surprising given that it lost around $50 billion during the crisis and then suffered "rogue trading" losses of $2.2 billion.

It is effectively withdrawing from the more capital intensive segments of investment banking and those where it is sub-scale to focus on activities, like equity underwritings and merger and acquisitions advice, which complement its wealth management business.

Those are, of course, the core activities of UBS’ Australian business, regarded as the shining light within UBS’ investment bank. The entire UBS board recently visited Australia to try to understand how and why the local arm has been as successful as it has been, even during the crisis.

The two Swiss banks are withdrawing from activities like fixed interest, currencies and commodities trading where capital is required to support the activity or whether their market shares or profits aren’t material enough to justify the involvement.

By shrinking their risk-weighted asset base and focusing on exiting the most capital-intensive activities they will significantly improve their capital adequacy.

The exit strategy isn’t a universal one for the universal banks. Most of the Swiss banks’ peers are cutting costs and reducing headcounts, too, albeit generally not as dramatically and generally without plans to narrow their range of investment banking activities.

As Macquarie Group demonstrated last week, they are maintaining a presence in most investment banking market segments while waiting for/hoping for a pick-up in activity.

With new capital rules being progressively implemented that will require more capital to be held against trading risks, restrictions on proprietary trading and perhaps some ring-fencing of non-traditional assets, most of the major universal banks will have to reconfigure their asset bases and strategies for the new environment, not just down-size them. Capital will become increasingly expensive for the investment banking element of their businesses.

Some withdrawal of capacity from the markets as the smaller players depart would probably help produce better risk and return equations for the handful of giant banks that dominate trading activities.

The regulators’ push for greater simplicity and less risk within big bank balance sheets and their own needs to generate returns above their cost of capital on increasingly expensive capital, however, may force some of the remaining global universal banks to emulate the Swiss, particularly if market conditions and volumes remain subdued and the cost of waiting for activity to pick up continues to weigh on already weak returns.

After the post-2007 experience, that wouldn’t be a bad thing for either their investors or the global financial system.

Connect with Stephen Bartholomeusz at Google