Investment banks in the emerging world are set to withstand the turmoil that has left their counterparts in the developed nations with reduced revenues and operating losses as the global economy slumps, says a new report.
Even in the worst case, emerging Asia and Europe, the Middle East, and Latin America will probably show absolute revenue growth over the next three years, says McKinsey, a global management consulting firm.
In an earlier report, Fitch Ratings, on the other hand, estimated total market losses from subprime mortgage assets to be around the $400 billion (Dh1.46 trillion) mark.
The rating agency, however, allows that these estimates may be as high as $550bn, depending on the method of calculation used. Approximately 50 per cent of these losses, $200bn to $275bn, are held by banks, with the remainder held by financial guarantors, insurance companies, asset managers and hedge funds, Fitch added. It also estimated that, as of May 2008, disclosed losses by banks on subprime residential mortgage-backed securities or collateralised debt obligations referencing mortgage-backed securities to be $165bn, or 83 per cent of the banks' portion of the losses.
In contrast, revenues of investment banks in emerging markets will increase by 16 per cent a year from 2007 to 2010, when they will generate 28 per cent of the global total, estimates McKinsey.
Collectively, revenues of investment banks in emerging markets are expected to match those in North America, where the leading investment banks are headquartered, by 2010.
In the Middle East, investment banks will generate even better returns, predicts McKinsey. "Our research shows that this region [the Middle East] is likely to enjoy the fastest capital market expansion in the emerging world under both of our scenarios. Revenue pools will grow by 25 and 16 per cent a year under the optimistic and pessimistic ones, respectively, from 2007 to 2010," states the report.
At the same time, global investment banks are redirecting their resources – both human and capital – toward emerging markets, which they see as a new source of revenues to compensate for leaner times at home, explains the report.
Investment banks in the region are reassigning more and more bankers from London and New York to the region, despite its small capital markets (2007 revenues of $3bn), a limited but growing number of listed companies, and debt markets that remain small relative to GDP.
With huge petroleum reserves, the Middle East has been on a roll in recent years. Gulf Co-operation Council (GCC) countries are deploying their oil windfall in various sectors to diversify their economies. High oil prices have triggered an unprecedented wave of investment, including a huge pipeline of industrial and large-scale infrastructure projects, such as Saudi Arabia's new 'economic cities.' It is expected that by 2020, GCC should have invested around $3 trillion in the region.
A number of domestic companies are using these resources to expand internationally and become 'global champions' while wealthy private investors are investing around the globe. Countries across the Middle East continue to modernise their regulatory and institutional frameworks while governments and listed companies increasingly embrace Islamic structures supporting the growth of sukuk, says the report.
"Even under our pessimistic scenario, the medium-term outlook for capital markets in the Middle East remains positive. The sheer magnitude of the wealth accumulated over the past few years should help support these markets if a protracted economic recession ever chokes global demand for oil and slows the flow of capital into GCC."
McKinsey believes that emerging markets now have a rare window of opportunity to catch up with the rest of the world, not least because they don't have to mitigate the mess created by current market dislocation in the West. However, unfavourable events in the Middle East could hamper this growth. But barring a geopolitical disaster, under the benign and the pessimistic scenarios alike, emerging Asia, Latin America, emerging Europe, and the Middle East should achieve sustained growth and capture close to 30 per cent of the global investment-banking pie over the next few years, says the report.
McKinsey does not give a specific time when it expects a full recovery of capital market activity around the world but states that the Middle East is poised to show sustainable growth. On the supply side, the emerging world's capital markets will continue to develop. In part, their growth reflects intraregional competition, seen in the rush to develop financial centres in the Middle East and in government-sponsored bond issuance programmes.
"In the event of a relatively benign outcome for global capital markets — a one-year setback, with growth resuming in 2009 — we calculate that revenues from investment banking in emerging markets will increase by 16 per cent a year from 2007 to 2010, when they will generate 28 per cent of the global total. In this 'steady recovery' scenario, Asia will continue to represent the lion's share (66 per cent) of the emerging markets' revenue stream of almost $120bn," it says.
"Suppose that the industry contracts more sharply during the second half of 2008, with a much slower, even faltering recovery in 2009. Revenues from emerging markets will still rise significantly (6 per cent), according to our research, and will probably exceed $90bn by 2010. In this 'long chill' scenario, these regions will account for a bigger share of the global total (30 per cent) than they would under our more benign scenario."
What is really likely to distinguish emerging and developed markets over the next few years is the different effects of the credit crunch. Emerging markets, after all, do not have as much fallout to manage as their Western counterparts do: by the end of the first quarter of 2008, they had generated only around seven per cent of investment banks' write-downs, as opposed to more than 21 per cent of global revenues.