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Bank earnings: Margins shrink in flow business

Bid-ask spread spreads are narrowing in rates; ECM fees and volumes are under pressure

Although many banks continued over the summer to report strong second-quarter earnings from their investment bank and trading businesses, it doesn’t take too much digging beneath the headline numbers to catch sight of a more worrying trend.

The boom in revenues that arrived just in time to save banks in the first quarter of 2009 is already coming to an end. It had been derived largely from higher volumes and wider bid-offer spreads in flow trading of simple products such as fixed income and foreign exchange

Back in April, as wholesale banks’ high trading revenues enabled them to raise capital and seemed to nurse them through the worst of the industry downturn, Morgan Stanley and Oliver Wyman researched the changing margins derived from flow credit, rates, FX and commodities, and suggested that bid-offer spreads and margins were up by anywhere from 50% to 300%. As large competitors withdrew from these markets or substantially scaled back their capital committed to trading, customers willingly paid up to rebalance their portfolios with a smaller remaining number of high-quality bank counterparties.

Anyone optimistic enough to believe that such a benign combination of wide margins and high volumes in low-risk businesses would become a permanent feature of the global markets will soon be disabused.

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