Structural, or cyclical?

Barclays vs Deutsche is now a real choice

Investors now have a genuine choice when it comes to European investment banks. Barclays' decision to halve its once mighty investment banking unit repositions it as the fixed-income shop for the wary. The lender's arch rival, Deutsche Bank, is now unchallenged, as the stock for investors willing to bet that a cyclical upswing in fixed income, currencies and commodities (FICC) is just around the corner.

The strategic shift by Barclays' chief executive, Antony Jenkins, involves cutting more than 40 per cent of investment bank risk-weighted assets. Such a radical change stemmed from the need to take action after weak 2013 results and a PR blunder on pay. The bank's bonus pool jumped last year in spite of falling profit. The perception of a bank paying more and getting less was exacerbated by a 41 per cent year-on-year drop in first-quarter FICC revenue.

Deutsche hasn't made similar unforced errors, and so its FICC-heavy strategy remains intact. That could give it an advantage over Barclays if the FICC business recovers, as some analysts predict. After a 13 per cent fall in global FICC revenue in the year to the end of 2013, the normalised pool in future could still rise 20 percent to $121 billion, says Citi research. Barclays' relative performance will suffer if the bank cedes market share to Deutsche and the present downturn proves cyclical rather than structural.

But Barclays' shift still makes sense. Basel capital reforms mean returns at the FICC-heavy investment banks of groups like Deutsche and Barclays lagged the cost of capital in 2013. Regulatory reform has permanently destroyed up to a third of the sector's revenue pool since 2009, Bernstein Research reckons. It is a gamble as to whether the business becomes viable again.

Barclays cannot hope to generate the headline returns that Deutsche might achieve in an upturn. But if Jenkins convinces the market that Barclays is safer, he will lower its cost of capital and in turn the bar for acceptable performance. Deutsche will have to generate higher returns to justify its riskier strategy. Its shares trade at 0.55 of estimated book value, against 0.75 for Barclays. That differential suggests investors aren't putting much value on Deutsche generating higher-quality returns in a FICC revival.