Barclays: ‘Bye now, pay later?

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Expectations are growing that Barclays’ new chief executive will dismantle the group’s investment bank, but that might be exactly the wrong thing to do.

A British retail banker takes over from an American investment banker. A hostile British media, Barclays’ competitors and analysts have all felt free to float their hopes and expectations that Antony Jenkins will now dismantle the investment banking powerhouse that Bob Diamond built.

Jenkins had not revealed any plans beyond the obvious statement that he would take a close look at any business not earning a return on capital above its cost of capital. Diamond and his colleagues, including Rich Ricci, had already been doing this for over a year, cutting costs, reallocating capital and shrinking certain businesses. But the British press seized on Jenkins’s remarks as confirmation that he would take an axe to the old Barclays Capital businesses.

Certainly Jenkins will need to inspect these closely. They are not his area of expertise and yet they account for more than half of the bank’s profits and an even bigger proportion of its balance sheet. In its most recent reporting period, for the first six months of 2012, the investment bank alone contributed 53% of pre-tax profit, while retail and business banking contributed just under 40%.

Of course, Jenkins must conduct his review at a time when British politicians and regulators clearly want banks to be smaller and more focused on domestic lending. Barclays has £1.63 trillion ($2.6 trillion) of assets, making its balance sheet bigger than that of the UK economy, last measured at £1.5 trillion. Three-quarters of Barclays’ balance sheet is in the investment bank.

Some analysts think the most likely outcome is an aggressive de-leveraging of the investment bank balance sheet, amounting to an unwinding of the Lehman Brothers acquisition, arguably Diamond’s greatest achievement and the move that propelled Barclays into the investment banking big league.

But would this be the best outcome for Barclays’ customers and shareholders? True, more needs to be done in restructuring and possibly reducing the investment bank, especially as its return on equity looks to be just below the cost of equity. And investors might want a repositioning of the business, hoping Jenkins will be better able to adapt Barclays to the new normal than Diamond, who was a great builder of businesses.

But remember that Diamond and Co were already targeting market share in the less capital-intensive parts of the FICC business, as well as M&A advisory and equity capital raising. They cut costs at the investment bank by 12% in 2011, and in the first half of this year started to deliver results as revenues grew by 4% while costs came down by 3%. That’s impressive operating leverage.

Barclays’ investment bank has been delivering returns superior to those of many of its rivals amid difficult market conditions. Jenkins might need to reflect on the performance of one or two of the businesses on his own previous watch, such as retail and business banking in Europe, which is still not performing well, and in Africa, where returns are not exceeding cost of capital.

As Euromoney reports in its cover story this month, the capital markets arms of the big banks will become ever more central to the intermediation of finance, earning a return from performing a function that companies and investors really need. Barclays is one of the best at this. It should retain and nurture this expertise, not toss it away.

Jenkins is no fool. The press might have overlooked his mention of being proud to become chief executive of a strong universal bank including market-leading businesses. Many of these happen to be in investment banking.