This week, European Central Bank president Mario Draghi announced that the ECB would be cutting rates once again, pushing deposit rates deeper into negative territory. More notably, he expanded the size and scope of quantitative easing in the region. Monthly bond purchases will increase to €80 billion and the list of assets eligible for monetization will now include investment-grade corporate debt. How this silver age of the central banker ultimately plays out is unpredictable, but the policies will only force banks to directly compete with and invest in fintech as a source of future growth.
The public market reaction underscores the unpredictability of what unprecedented central bank policy means for investors. Much like how the yen has recently been strengthening against the dollar in spite of an abundance of Abe’s arrows from the BOJ quiver, the deflationary forces of global declining real output have begun to blunt these policies' impact on exchange rates.
So what does this mean for investment banks and PE? Banks buying and holding on to the commercial paper from buyout deals is a winning strategy right now—under normal circumstances this would be the domain of credit funds. However, introducing a whale into the corporate debt market will only increase the incentive for banks to syndicate LBO debt packages.
Even though we are beginning to see banks issuing zero-coupon iou’s, the mandatory exposure to government bonds is a drag on earnings. Out of necessity, banks must implement operational fintech and technology investments to realize cost-slashing efficiencies. In Japan, the government will soon lift regulations on bank investments in fintech startups. The policy change has been in part driven by a need for the financial sector to catch up with the U.S. and Europe, and to diversify revenue streams in the current environment.
With declining net interest margins from ZIRP and the implementation of regulations introduced by Basel III and the Liikanen Report, banks in Europe will need to further ramp investments in fintech on top of facilitating well-vetted LBO debt. Clearly there are multiple paths to bank profitability, but the sell side can no longer fall back on speculative activities.