Are banks experiencing a cyclical blip or an industry shift?

Goldman Sachs continued a rather dismal bank reporting season when it announced a third-quarter loss of $428m. While other Wall Street firms made a profit, their headline numbers were flattered by arcane accounting rules.

These saw Citigroup’s $3.8bn net income bolstered by a $1.9bn gain based on the bank’s widening credit spreads, and JPMorgan’s results boosted by $1.9bn. Without the same valuation adjustment, Morgan Stanley’s institutional securities division would have reported third-quarter net revenues of $3bn instead of $6.5bn.

Beneath the accounting smoke screens, Citi’s equity revenue plunged by 73% and its fixed-income revenue by 33%; Morgan Stanley’s underwriting earnings dropped 29%; and JPMorgan’s investment banking fees fell by 31%.

The question for banks and their investors is whether this is a blip or a secular shift. Goldman says this was a temporary problem driven by events in Europe and elsewhere, which led to $2.9bn in paper losses on the bank’s investing and lending business. But even given that eurozone gloom has been a major factor in investment banks’ depressed (and depressing) earnings, it looks harder and harder for them to return to pre-crisis earnings on a sustained basis.

Against the backdrop of tougher capital rules – which will, anyway, force many banks to shrink their balance sheets as well as more carefully allocate what capital they have – the business model for the entire industry is being challenged. From the Volcker Rule banning proprietary trading (which will be introduced next year) to ever greater constraints on derivatives trading, the business environment is getting more restrictive.

In late October, the Commodities and Futures Trading Commission added another limit to the mix when it approved caps on the size of positions in futures and swaps markets, which will curb banks’ and investment funds’ ability to trade commodities.

In September, McKinsey & Company published a report saying that regulatory reform will reduce return on equity for capital markets businesses to about 7%. Even taking mitigating actions into account, McKinsey estimates this will force many firms to tweak or change their business models.

Nomura’s senior executives believe that the opportunities to grab market share that the bank perceived in 2008 when it purchased the non-US operations of Lehman Brothers are about to happen. This hope was squashed as bailed out banks roared back to life. Now, Nomura thinks the new environment will force some banks to deleverage and retrench. Maybe Nomura’s senior executives are right. It certainly looks like a shake-up may be coming.