Some are offering ultra-low prices across a range of their most prominent activities such as equity and debt sales, advice on mergers and acquisition (M&A), and more arcane - but widely used - derivative instruments.

Rivals are left with the choice of following suit and losing money, or sticking to their guns and hoping that the cut-price banks will eventually be forced out of the market.

"The industry doesn't know which way is up from a point of view of competitive prices," said one consultant at a large international accountancy firm.

"It's not hard to figure out what the true cost of pricing is, but to ... unpick what different banks do, with different cost structures and different strategies to win market share or to reposition, is tough," the consultant said.

The conundrum is a sign of how banks are grappling with changes imposed by regulators across the world on a scale not seen since after the Great Depression, which will take the industry many more years to adapt to.

The 2008 crisis has already seen the demise of some of Wall Street's best-known firms, caused hundreds of thousands of jobs to be lost, and sparked the Occupy protest movement, a PR headache bankers are unlikely to shrug off any time soon.

And banks' profits will take another hit when most of the new rules drawn up after the crisis come into effect.

Politicians have put a halt to some of their most lucrative activities, such as betting in capital markets with their own money and designing the complex debt instruments that turned toxic when the sub-prime crisis struck.

They have also told them to set aside more capital for every dollar they lend, and to fund themselves in less risky ways, which will make banking a more expensive business - a cost the industry will inevitably pass on to clients.

But so far, all it has done is cut bank profits to levels seen in staid and safe sectors such as basic resources and utilities, and that do not warrant the high risks in banking. If that doesn't change, investors will lose interest.

Next year, investment banks are expected to show a paltry 6.8 percent return on equity (ROE), an often-used gauge to measure how lucrative an investment is, according to a J.P. Morgan research note issued last week.

They will need to get that number back up to 13 percent, J.P. Morgan said. The long-term average in basic resources and utilities is around 8 percent and 12 percent respectively, according to a recent Citigroup note.

PRICES DROP

Almost five years after the start of the crisis, the banking industry is still bloated from its heady days before 2007, and banks are crowding each other out in capital markets, from where only a few have made a full-scale retreat.

It means professional clients can pick and choose the cheapest banks, and prices are going down - not up as they should if banks want to generate the higher profits needed to cope with the tougher new regulatory regimes.

"There is overcapacity and people are competing on price to stay in business," said one senior investment banker at a large institution, who declined to be identified so as not to disclose sensitive information to competitors.

The banker described how his bank came out last in an auction among eight investment banks to sell a high-yield bond for a client who had earlier sold $1 billion worth of debt for a fee of 1.75 percent, or 175 basis points.

The client planned to sell more debt worth $3 billion, and sought a lower fee because the issue was bigger.

"Only two months later, they priced it and it was going from 175 to 50 bps (basis points), which is dramatic. We came (down) by at least 25 bps and we were told you're eight out of eight."

The fee would almost certainly have been less than the cost of funding for the bank that won the mandate, making it probable that it was entering a loss-making deal.

Banks' funding costs, which can be estimated by looking at the cost of insuring their debt against default, range from some 110 basis points for the safest European banks, to far higher levels for those deemed weaker.

One area where banks have stopped undercharging is lending to corporates. German companies, for instance, are borrowing through credit lines at 40 bps.

That is still well below banks' own funding costs, but the lenders say they make up the gap by winning other more profitable business from customers, a practice that has long been the norm in the loans market.

But other areas lag.

"The banks at this point effectively are feeding a lot of uneconomic activity and they do need to stop it. But it's quite a big change," said a chief risk officer at a large international investment bank.

The picture is further complicated by the fact that the European Central Bank has inundated banks with virtually unlimited funds, through two tenders of three-year money worth a total of 1 trillion euros ($1.32 trillion).

The measures, taken at the height of the euro zone debt crisis when markets priced in the chance a European bank might go under, enable banks to postpone painful decisions about which business lines they need to scrap.

"All the ECB manages to do, is to calm down liquidity fears, rather than (triggering) the banks to push the cash back into the market," the chief risk officer said.

Britain's RBS (RBS.L) is one of the few banks to have announced a full-scale retreat from much of its investment banking activities, and Switzerland's UBS (UBSN.VX) - plagued by a series of mishaps - is another.

In its recent note, J.P. Morgan said there was only room for a handful of top-tier players in investment banking across the world, and that the other companies would be smaller specialists in a niche or a region.

With at least 10 investment banks vying for one of the top spots, that scenario means a shake-out is inevitable.

($1 = 0.7582 euros)

(Additional reporting by Helene Durand at IFR and Tessa Walsh at LPC, Editing by Elizabeth Piper)

• A Permanent Economic Emergency