Mega-banks should face up to the painful truth that small is beautiful

It is only 15 years since I started working in the City, but it often feels like it should be 150. Hardly any of the names that dominated the Square Mile and yes, all the main firms used to be in the Square Mile are around these days, even in name.

Barings, Warburgs, James Capel, Wood Mackenzie, Scrimgeour Kemp Gee are all gone, rolled up in successive waves of bank mergers into one of the giant bulge-bracket banks that dominate global finance. An echo of Kleinwort Benson lingers on in Dresdner Kleinwort. My first shop, a wonderfully old-fashioned stockbroker called Laing & Cruickshank, disappeared years ago, while all trace of Flemings, where I worked for three years, was obliterated when it was absorbed by JP Morgan.

The curious thing about this whole process is that while it has enriched people in the financial world beyond their wildest dreams in those 15 years, it does not seem to have made any of them particularly happy at least when it comes to their working life. Even now, attachments to the old franchises linger on. At a recent Flemings reunion, former colleagues contrasted the old esprit de corps with the internecine politics of life in a global mega-bank. Former Schroders employees look like they are sucking lemons when you ask them how they enjoy working at Citigroup.

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Even at the US banks, the cultural ties are weakening. One former top Morgan Stanley banker told me the other day he decided to quit when the finance director told him that mergers and acquisitions the traditional heart of the bank accounted for just 2% of its value.

Now it looks like this whole trend towards financial gigantism may be going into reverse. It's not disgruntled employees who are demanding the changes but shareholders. John Reed, one of the architects of the mega-merger that created Citigroup, has now decided that seminal 1998 deal was a mistake. UBS, which has emerged as one of the biggest casualties of the credit crunch, is under pressure from former boss Luqman Arnold to break itself up. Some shareholders are demanding the Swiss bank splits off its investment bank from its private bank. Deutsche Bank, which has fared better than most these past few months, is also facing calls from an activist shareholder to dump its investment bank. This follows Morgan Stanley's decision last year to spin off Discover, its credit card business.

The activists pursuing Deutsche get to the nub of the matter. They argue that since 1998, when DB's share price was e81, and factoring in dividends, the return to shareholders has been about 2%, even as bonus levels have exploded. "Investment banks do not differ substantially from football clubs. Ultimately, everything is distributed to the players and nothing is left for the club."

Deutsche would argue that this is unfair and that if you go back 15 years, the bank has delivered returns of 13% per year to shareholders. But critics of the current model of publicly-owned giant investment banks counter that the only way these banks can deliver these returns is by taking ever bigger risks, in which those risks are usually badly managed, and with the employees taking the lion's share of the rewards and none of the losses. Meanwhile, giant bank balance sheets proved too much temptation.

I suspect that over the next few months we will be hearing more of these kinds of complaints and they will start to gain some traction. If the credit crunch has revealed anything, it is that some of these financial institutions may be just too big to manage.

It has become perfectly clear that many of the top bosses on Wall Street and in the City had no idea what was going on in large parts of their empires. I know that more than one Wall Street boss did not know what a structured investment vehicle was before last summer, despite having billions of dollars of exposure to them. How is one supposed to manage risk if one does not understand the risks that are being taken?

Better risk management will clearly be the key to preventing a repeat of the current financial crisis. But how is this to be achieved? My breakingviews colleague Hugo Dixon has proposed a number of measures, ranging from one-on-one grillings of bank bosses by regulators to financial history lessons for all bank employees.

But the simplest solution may be to break banks into smaller units where people have a better understanding of what each other is doing and a greater self-interest in knowing. Of course, nothing is going to bring all those old City names back again. But if this crisis clips the wings of the mega-banks, few in the City will shed many tears.