Big banks face break-up calls in subprime wake

ZURICH (Reuters) - Battle lines are forming in banking that pit bigger-is-better against break-up advocates, and some of the largest conglomerates -- like subprime victims UBS (UBSN.VX) and Citigroup (C.N) -- could fall prey.

Such sprawling financial groups are facing pressure from regulators and shareholders to look back to the future and simplify, sell assets and focus on what they do well.

Big banks have long held that they profit from broad strategies in two ways: one business unit often feeds another, and diversified activities lessen earnings volatility.

But new risks have come to the fore with the subprime crisis which saw, for example, a handful of traders and managers at UBS's investment bank rack up over $37 billion in losses and damage the reputation of its prestigious wealth-management division, the world's largest.

"The supposed synergies of having investment banking and private banking in one company have been grossly overstated by the previous UBS management," said analyst Peter Thorne at brokerage Helvea.

"They have persistently ignored the large conglomerate discount that held back the UBS share price because of the presence of the risky investment bank," Thorne said.

UBS on Friday suddenly saw the emergence of a major shareholder who is leading a campaign to break up the bank into its parts and possibly sell them off, reducing the Swiss bank to its core wealth-management activities.

Luqman Arnold -- who in no small irony served briefly as UBS CEO in 2001 -- controls a 0.7 percent stake in the bank and launched the campaign by sending a letter to UBS management.

"We are not convinced that the ‘one bank' integrated business model ... will survive the damage inflicted by the proprietary trading losses and write-downs," Arnold wrote.

In a parallel case, Citigroup faced criticism from a former senior executive that the $166 billion megamerger he helped mastermind in 1998 and that made it the world's largest financial company was a mistake.

Neither stockholders nor customers nor employees of the firm have benefited from the deal, said John Reed, according to a report in the Financial Times.

Citigroup is reeling from the subprime crisis and is also facing calls to simplify after being forced to raise some $30 billion of capital and slash its dividend.

The bank has shed more than 6,000 jobs this year, and more cuts are widely expected, including in the investment bank.

"If you look at UBS and Citigroup here, there are similar problems here in terms of size and complexity," Arnold said in an interview on CNBC television.

SAVIOUR, TORMENTOR

Why is yesterday's fashion today's curse?

In a word, complexity. Once the savior, complexity became the tormentor as highly engineered products collapsed.

Banks grew enamored of their ability to manage multiple risks, which grew increasingly complicated and overlapped in unforeseen ways to the point that they flew out of control, but not before a critical number of banks had gotten deeply involved.

Simplicity and transparency -- for structured products, for balance sheets and for business models -- is now what investors and regulators seek.

Investors want to know exactly what they are buying and regulators want to know exactly what they are regulating.

In addition, regulators have made it no secret that the trading activities of investment banks -- who often get cheap funding from a conglomerate's more staid divisions -- will face new fees that will make them less attractive.

Investment banks at groups such as UBS were able to get cheap capital from the wealth-management division, for example, and use it to leverage themselves 80 times or more by some estimates in risky markets for complicated mortgage products.

Regulators have signaled they will assign new, higher risk fees in terms of capital requirements to risky trading activities that will make those activities less profitable.

What happens next?

The precedent set by former Dutch banking group ABN AMRO last year is more relevant than ever:

The eight month-long battle that saw ABN AMRO taken over and broken up started with a single activist, who sent a letter in February 2007 to top management arguing there was more value in the sum of the parts than in the conglomerate as a whole.

In the end, giant groups like Citi and UBS may not be parceled up and sold off as some may have it, however.

Rather, they will simply have to pare back, selling some units and exiting some geographies, as the pendulum swings back towards simplicity.

(Editing by Quentin Bryar)