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In this piece from 10th Man, author Jared Dillian discusses how the ETF revolution is less about ETFs and more about indexing; about how people have come to view stocks less as stocks and more as blobs of stocks.

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February 1, 2004

Trading Firms Put Capital on the Line

By Peter Chapman

Traders at bulge bracket shops are betting more of their firms' capital these days, but the practice is not leading to prosperity for all.

That's the conclusion of the Boston Consulting Group (BCG), which counts as clients some of the major investment banks. In an analysis of the equity trading departments of the ten largest banks, BCG found risk levels but not revenues rising.

From the fourth quarter of 2001 to the third quarter of last year, the banks have, collectively, increased their value-at-risk, or VaR, from $195 million to $230 million. VaR measures how much money would be lost in a single day on the banks' positions if the market turned against them. Over the same period, quarterly revenues were flat.

Goldman Sachs, Deutsche Bank and UBS are making the biggest bets. Lehman Brothers makes the most money relative to its risk. More risk means either committing more capital to customer trades, or more bets by the firm's proprietary desk.

Some firms' numbers look better than others. On the last day of the third quarter, Goldman, for instance, had about $35 million at risk. For the entire quarter, it made less than $500 million. By contrast, Lehman had only $10 million at risk, but grossed slightly more than Goldman.

According to BCG, sellside desks are taking on more risk to offset commission declines. In addition, they must commit more capital to address buyside desks' increased sophistication.

"Asset managers have developed intelligent trading desks that are better able to properly channel their orders," BCG's Svilen Ivanov said. "[The banks'] desks get predominantly difficult trades. Those require more capital."