Outlook for Global Wholesale and Investment Banking - BlackRock ...

March 16, 2010Banks9) Compensation – a key lever to raise returns and align risk to rewardThe industry has taken significant steps in 2009 to movetowards aligning to the FSB’s compensation principles;however, there is further to go in transmitting the cost of riskand funding to the practitioners. In some areas, regulatorsand shareholders can do more to help the industry break thecycle of compensation inflation.Net headcount has fallen since the onset of the crisis as theindustry has gone through a relatively painful downsizingprocess, particularly in the US. As a result, headcountproductivity has improved, and absolute compensation levelshave been maintained within closer bounds. Compensationper unit of revenue dropped heavily from the historicalaverage of 45% to 31% in 2009, though if revenues areadjusted for the gains in rates that figure rises to 35%Exhibit 31Industry compensation, 2004-09Cost/revenues(ex write downs, CVAs)75%Average compOliver Wyman is conducting an update of the IIF and FSBsurveys of industry compensation practices. Early findingsreveal the industry now largely aligns to (and is uniformly atleast moving towards) the compensation principles set out bythe FSB in 2009. However, implementation is proving difficult,particularly in the area of pushing risk-adjustment ofcompensation down to the desk or individual level.We see important structural shifts still to come that arecritical to the long-term health of the industry. Theindustry has yet to fully pass on (or be forced to pass on)either the cost of additional capitalisation (proxy for risktaking)or cost of liquidity risk (proxied by funding costs) to thepractitioners. Once done, we think this will lead tocompensation levels stabilising at ~35% of revenues over thecoming three years, a necessary precondition to offsetting thelikely capital/funding drag on returns.58%50%46% 45% 45%42%31%35%25%0%2004 2005 2006 2007 2008 2009 2009 adjComp / revenues (LHS)Average comp. (RHS)e: Oliver Wyman estimates; Source: company report; Oliver Wyman analysis; Sample banks:GS, MS, BoA-ML, JPM, CS, DB, UBS, Barcap and NomuraNote: 2009 adjusted excludes extraordinary growth coming from abnormal market conditions27