KEN MOELIS

“The pursuit of ever-higher margins was a central cause of the financial crisis”

Ken Moelis
Founder and CEO of Moelis & Company

The changing face of investment banking

How has the investment banking model evolved over the past decade?

The evolution of the investment banking model began in the early 1990s. As information that was previously restricted to a handful of insiders became widely available, information arbitrage became impossible and this caused the margin in processing a transaction to shrink dramatically. Realising that margins were collapsing in transaction processing, commercial banks began to look to acquire the higher margin areas that are inside an investment bank's operations - research experience, judgement and, most crucially, relationships. During the 1990s a significant number of firms were purchased for their 40 years of relationships and in an extremely short space of time almost all of the transaction processors acquired relationship-based advisory firms.

How successful has this evolution been?

Some banks have faced difficulties integrating the relationship-focused firms into their existing businesses. Having successfully created the machinery which allowed them to process large amounts of low margin trading, banks attempted, in pursuit of higher margins, to put newly acquired businesses through the same machinery, with mixed results. Many firms found it extremely challenging melding two different businesses together to produce a single culture and identity.

What has been the impact of this evolution? 

It has prompted clients to shift away from the biggest banks towards independent investment banks for quality advice free of conflicts of interest. Our approach seeks to recapture the quality of relationships investment banks had with their clients before the evolution of the current model.

Do you see similarities between the way banks changed their business models in the pursuit of higher margins and the causes of the financial crisis? 

The pursuit of ever-higher margins was a central cause of the financial crisis. As a result of the credit bubble between 2003 and 2007, nine out of every ten assets a financial institution owned tended to go up in value. This encouraged a variety of organisations, from banks to private equity funds and hedge funds, to aggressively expand their balance sheet. For many, the central proposition was to own as many assets levered against as much credit as possible.

Was the regulatory response to the crisis the right one? 

Once the credit bubble began to unwind, the regulators were unable to react in the way they would have liked because imposing the regulatory changes necessary at the time of the crisis, such as an increase in capital ratios, would have rendered some financial institutions insolvent. Following the stock market crash in 1929 it took four years for the first significant piece of legislation, the Securities Act of 1933, to emerge.  We have several years to go before we know the ultimate outcome of regulation.

What are the opportunities and challenges presented by emerging markets?

Many banks are looking to emerging markets for a new source of returns, prompted by a protracted period of slow growth in Western markets, the threat of greater protectionism and the challenge of more regulation. While emerging markets have been some of the best performers globally over the past few years, the financial infrastructure remains less developed than in Western markets. Establishing a framework of oversight and regulation is a lengthy process so it may be some time before firms feel truly comfortable operating there.

What does the future hold for investment banking? 

The old model of investment banking is giving way to a new way of doing business. Competition in the banking sector will come from new entrants who are able to offer truly independent advice, have global reach and are able to service a range of clients, from mid to large caps, listed and unlisted companies. In order to survive and thrive, organisations must cultivate the right environment so that employees feel valued and therefore respond to the needs of clients in the most effective and creative ways. Successful businesses will be those that develop their own identity, build their own relationships and dare to innovate.