Banks: Beyond the Citi Carnage

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Filling the Void

At this point in the downturn, it's clear what the financial sector is losing: jobs, revenue, and profits. What's less clear is what opportunities might exist when lending revives and the economy recovers.

Iati says someone must step forward to fill the risk-taking roles on Wall Street that Morgan Stanley or Goldman seem to be forfeiting. To fill those riskier niches, Wall Street may return to old practices—such as privately owned investment banks—or rely on hedge funds or other innovations.

For example, after the credit crisis, investors are understandably scared of complex derivative products like credit-default swaps. But sophisticated investors will want and need new derivative products in the future—although these new products will have to make risk management easier than in the past, Iati says.

"There are opportunities in redesigning businesses around the new realities," says Bart Narter of Celent.

Canny Survivors

To prosper in a new era, banks and other financial firms need to make it through the current crisis. Robert A. Howell, finance professor at Dartmouth College's Tuck School of Business, foresees the "survival of the fittest" in the financial arena.

Many of the strongest players are regional banks that avoided subprime trouble through careful lending and less risky investing. Howell cites Wells Fargo (WFC) and US Bancorp (USB) as banks likely to prosper from their rivals' foibles.

Two other categories of firms may have advantages, Narter says. The crisis has meant regulators have allowed banks to merge and get very large. JPMorgan Chase (JPM), Wells Fargo, and Bank of America (BAC) all have ballooned, giving the companies competitive advantages from huge branch networks.

Another advantage may fall on smaller banks, those with assets of between $1 billion and $10 billion. Big enough to be "very efficient," Narter says, these banks are also "small enough that they actually know the people they lend to."

In a more conservative, less risky era, smart lending standards will be crucial. Dan Crimmins, founder and CEO of DPC Wealth Management, says one "bright spot" in the financial industry is a return "to traditional, straightforward banking services."

It's not clear how much the financial industry will cut before it starts to grow again. Gambera warns the sector may shrink too much before it revives. "But, if the U.S. wants to remain an economic superpower, it has to get a more efficient and better-supervised financial sector," he says.

Getting to that point may require a lot more pain for people who work for—and invest in—companies in the battered industry.

Steverman is a reporter for BusinessWeek's Investing channel.