Rigging in the free world...
Photograph by Jin Lee—Bloomberg via Getty Images
By Bethany McLean
July 30, 2015

On Wednesday, Barclays reported solid results, with adjusted profits before tax up by 11%. “The results today represent continued good progress for the business,” chairman John McFarlane said in a press release accompanying the bank’s earnings announcement.

True. But Barclays (BCS) still has a long way to go. In early July, after Barclays abruptly and publicly fired its CEO, Antony Jenkins, McFarlane, who arrived last fall—and whose reputation as a turnaround artist has been cited as a reason for Barclays’ stronger recent stock price performance—told CNBC that “bringing forward the returns for shareholders was the absolute priority.” McFarlane focused on Barclays’ unwieldy cost structure, but he also talked about growth. He said he wants Barclays to return to “the rightful position that the bank has always enjoyed.”

The challenge is that while Barclays’ other businesses appear to be performing solidly now, its investment bank, which was once a major growth engine, was built in a different time, and for a different time. A quick review of its history raises more questions than answers about at least that business line’s “rightful position.”

Barclays’ roots are in retail banking. But after Britain deregulated its securities business in the late 1980s, Barclays, along with everyone else, tried to build an investment banking business. It failed initially, and in 1997, as losses mounted, Barclays sold most of its investment banking division to Credit Suisse, keeping a fixed income business that was helmed by an aggressive American-born banker named Bob Diamond.

Diamond wasn’t the sort to play also-ran, and in 2003 Barclays launched what was internally called the “Alpha Plan.” The goal, according to a 2013 report commissioned by the Barclays board and led by lawyer and investment banker Anthony Salz, was to close the gap with the dominant firms and more than double revenues in four years. To do this, they decided to hire the best people and pay whatever they cost. In 2004, Euromoney noted that Barclays Capital had increased its staff by 30% to 7,000 in the preceding 19 months. The Times of London called it an “unapologetic spending and lending binge.”

Diamond’s strategy worked—for a time. As Salz noted, Barclays Capital took “advantage of seemingly endless liquidity and rising asset prices. And the applicable Basel capital rules permitted it to add assets with significant leverage.”

Barclays survived the financial crisis, thanks in part to a few narrow escapes. In 2007, the bank offered about $91 billion for Dutch bank ABN Amro, but it was outbid by a consortium that included Royal Bank of Scotland. (That deal helped precipitate RBS’s bailout by the UK government.)

Next, Barclays would have bought all of Lehman Brothers, including the highly problematic Lehman London, if not for the difficult conditions insisted upon by the UK authorities. As it was, Barclays purchased Lehman’s U.S. broker dealer business, which added about 10,000 employees to Diamond’s U.S. staff. The investment bank grew to constitute over half of Barclays’ risk weighted assets and over half of its profits.

In large part due to his perceived success with the investment bank, Diamond became group chief executive in January 2011, and he didn’t hit pause. In a late 2009 Institutional Investor article entitled “Wall Street’s Would-Be King,” Diamond discussed his plans for Barclays to crack the top three in all the major investment banking league tables. Institutional Investor later called it “the last great build in investment banking.”

Diamond was derailed in 2012 when he was forced to resign over the Libor scandal, which resulted in Barclays paying $453 million in fines. There were plenty of other scandals, too, including claims that Barclays, along with other banks, rigged foreign exchange markets, which has resulted in Barclays paying over $2 billion in fines.

Salz also noted that a tax-led transaction-structuring business—short hand for trouble in today’s regulatory climate—was a “significant contributor” to profits. “There was an over-emphasis on short-term financial performance, reinforced by remuneration systems that tended to reward revenue generation rather than serving the interests of customers and clients,” Salz continued. “We believe a culture developed within Barclays, quite possibly derived originally from the investment bank, which came across to some as being ‘clever’ or what some people have termed ‘too clever by half,’ even arrogant and aggressive. Barclays was viewed by some as pushing the envelope to the limits.”

None of this works in the post-crisis regulatory environment. McFarlane wasn’t overstating things when he told Bloomberg that Antony Jenkins, a lifelong retail banker who replaced Diamond, had a “terrible role.” On top of everything else, the UK implemented new rules that force investment banks to increase their capital cushions harder and faster than anyone had expected. And the UK is tightening its rules surrounding investment banks’ use of customers’ assets to finance their activities, which Standard & Poor’s has said could force banks to lower their risk appetites even more.

So, what does that mean for a business that was built on being aggressive? Well, about a year ago, Jenkins announced that Barclays would rapidly scale back, slashing jobs and assets and transforming the bank from a fixed income powerhouse into an advisory and equities-based firm—activities that require far less capital but have historically been harder to crack, competitively speaking. Jenkins also took major steps to overhaul Barclays’ culture even before the Salz report was published. He was ousted, at least in part to “accelerate the pace of execution,” Barclays said at the time.

Today, there are some glimmers of hope. In the second quarter, the investment bank’s pretax profits were up a stunning 36%. Like most banks, Barclays doesn’t provide a ton of detail on how it achieved its results, but so-called “macro”—currencies and commodities—was up 11% due to increased volatility with the situation in Greece and the Eurozone, while overall operating expenses fell 11%. Culture is notoriously hard to change, but McFarlane told reporters on a call that the bank had “broken the back” on those issues—although he also said that there was a ways to go, because the word “customer” was “not a word that I hear very often walking around the floor here.”

But the macro results aren’t necessarily replicable. And, overall, the investment bank’s revenues were pretty much flat. Barclays says it cares far more about profitability than revenues, and there’s always more work to be done on costs. But you can only cut so much so fast, and, at some point, you do need some growth. According to a story in Bloomberg, Barclays’ fixed income market share is falling, and its equities business is struggling, in part due to a complaint by the New York Attorney General that the bank’s electronic trading business was lying to customers. (Barclays is contesting the complaint.) A league table compiled by the Financial Times for the first half of 2015 shows that, ranked by total fees across M&A, equity, bonds, and loans, Barclays is 7th, with total fees collected down 16% from a year ago. Rival Goldman Sachs (GS), by contrast, was up 15%. (League tables are notoriously contentious, and the numbers can be compiled to show a different picture.)

In the bank’s press release accompanying earnings, McFarlane said, “the challenge [for the investment bank] will be to convert this performance into sustainable economic returns through subsequent periods.”

And it will be a challenge. You can’t do Diamond in today’s environment. Focusing on niche, high profit areas that don’t require large amounts of capital is a nice idea, theoretically, but it’s one that has not proven easy for many banks to execute.

If McFarlane can figure this one out, people will stop referring to him merely as a turnaround artist, but more like a genius instead.

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