Tag: Banking

From The Conversation. HSBC’s decision to end its operations in Brazil and Turkey, and lay off around 10% of its workforce worldwide shows just how far it has come from the days of touting itself as “the world’s local bank”. Its strategy used to be to offer any financial service everywhere in the world. Whether you were in Shanghai, Sydney, Springfield or Southampton, you could access services such as personal banking, foreign exchange business banking and investment banking.

This model paid off for years. The bank provided impressive returns to investors, progressively extended its footprint, and even seemed to dodge the worst effects of the financial crisis.

HSBC was not alone in doing well by doing everything, anywhere. Its competitors have built similar business models during the last 20 years.

Merger mania wasn’t for customers

In the past, different financial services were provided by different organisations. You went to one company for insurance, one for investment banking, and one for personal banking. There were co-operatives, partnerships, publicly listed companies and privately held companies. Banks in each country looked completely different. This meant there was a verdant landscape of different kinds of financial service organisation.

But during the 1980s, all this changed. Retails banks started to provide a whole range of services they had not before, such as insurance. Then retail and investment banks began to merge. Building societies demutualised. Banks began to expand across the world. The result was that the world’s financial sector was dominated by a handful of gigantic players. There was also a business model mono-culture: a universal bank which provided almost every service to everyone in the world.

Banks claimed to do this because their customers wanted it. There certainly were a number of sophisticated global clients looking for global banking services. But the real reason for adopting this model had nothing to do with customers. By merging retail and investment banks and continually growing the size of the bank’s balance sheet, these global giants were able to effectively use the money deposited in their retail banks to engage in risky – but highly profitable – trading and investment activities.

This model paid off for many years. As big banks grew, they delivered double digit returns to their shareholders. But perhaps more importantly, they created a lucrative stream of bonuses for senior managers. They also pumped out tax income for governments which hosted them. It seemed everyone was winning.

Downsizing

That was until 2007, when the financial crisis struck. When this happened these global giants with massive balance sheets became a liability. It quickly became obvious that they were too big to fail. If a bank went down, they could threaten the global economy.

And we quickly learned too that they were too big to manage. In the long aftermath of the financial crisis, we discovered that CEOs of large banks (including HSBC) had no idea what was going on in parts of their far flung empires. We also found out they were too big to trust. The ongoing stream of revelations around wrongdoing in markets like foreign currencies and LIBOR – the rate at which banks lend each other short-term money – show that bad behaviour appeared endemic in certain parts of these global giants.

Now shareholders are beginning to ask whether these giant universal banks are too big to succeed. With costs of bad behaviour mounting and many lines of business less profitable than before, shareholders are asking whether big banks should be trying to be everything for everyone. It seems that the universal banking model has failed.

The announcement by HSBC that it is cutting 25,000 jobs across the world, 8,000 in the UK, selling operations in Turkey and Brazil and shrinking its investment bank are an important part of moving away from this model. Underneath this is the recognition the bank can’t do everything for anyone. Instead, if banks like HSBC are to be trusted, profitable and sustainable they need to focus on a few markets where they have genuine expertise.

A benefit for all?

A more focused bank may look appealing to investors and regulators. But if we are to believe recent research, a smaller banking sector may actually be good for the wider economy. However, this focus is unlikely to appeal to staff who will lose their jobs. The UK government must be rightly nervous about losing HSBC, which is one of the country’s biggest tax payers and an important employer. Many of the other large banks are engaging in similar processes of shrinking their scope and balance sheets.

But the big question which remains is whether closing a few lines of business and a little restructuring will do enough to bring back diversity to the banking sector. Creating real diversity in this sector probably means not just slightly smaller global banks – it means ensuring there are a wide range of business models. The risk is that we simply end up with a small number of global giants with oversized footprints. Creating new business models to replace the universal banks is one of the biggest challenges of our time.

Author: Andre Spicer Professor of Organisational Behaviour, Cass Business School at City University London

 

Fitch Ratings 2015 Outlook: Australian Banks report has a stable sector outlook for Australian banks in 2015, reflecting what should be a relatively steady operating environment despite a likely modest decline in real GDP growth and an elevated unemployment rate. These factors should in turn result in modestly weaker asset quality and an increase in impairment charges, which are likely to be offset by strengthened balance sheets and strong profitability.

A significant slowdown in China is the biggest risk to the outlook, given it is Australia’s largest trading partner, but such a slowdown is not Fitch’s base case. A relaxation of underwriting standards to improve growth also looms as a risk, although this appears less likely following the announcement in December 2014 of regulatory reviews of potentially higher-risk lending.

Housing credit growth is likely to slow in 2015, in part because of the regulatory review but also due to high household indebtedness and slower house price growth. Fitch expects household indebtedness to stabilise in 2015, with an easing in wage rises and as unemployment remains high.

Nevertheless, competition for loans will likely remain intense, placing some pressure on net interest margins. This and an expected rise in impairment charges will likely mean lower profit growth in 2015. Offsetting this, capital positions are likely to be strengthened, in part to address potential new requirements stemming from the 2014 Financial Services Inquiry (FSI) recommendations, while the shift towards more stable funding sources will probably continue.

Although banks may act on some FSI recommendations during 2015, many of the measures requiring government action, including legislation, are unlikely to be implemented before the end of the year. Fitch expects implementation timeframes to be set such that meeting the new requirements should not be overly onerous for banks

 

The BIS published their 84th annual report 2013-14 recently. As well as discussing the merits of central banks relying on low interest rates to try and drive recovery from 2007, and the risks in this strategy with regards to laying the foundations for GFC mark II thanks to expanding credit; there is some interesting data on relative bank performance across several countries. We will focus attention on this data, recognising of course that making cross country comparisons is fraught with dangers because of differences in reporting. That said there are some interesting points to consider. We look at Profitability, Net Interest Margins, Losses and Costs. In each case, I have sorted the countries by the relevant 2013 data, to highlight where Australia appears relative to its peers. The data shows the number of major banks in each country, and they have averaged the results, giving three cuts of data, 200-2007, 2008-2012 and 2013. All the BIS metrics are calculated relative to total bank assets.

Lets first look at relative profitability.  We see that Russia, China, Brazil and India all reported profitability higher than the Australian banks. However, Australia has the most profitable banks amongst advanced western countries, and is significantly more profitable than banks in Canada, Germany and UK. It is also worth noting that in Australia, banks are still not as profitable, relative to assets as they were before the GFC. But then, that is pretty consistent across the sample countries.

So, what is driving relative profitability? Could it be net interest margins? Well, comparing margins relative to assets, Australia is somewhere in the middle, the highest margins are returned from Russia and Brazil, the lowest margins from Switzerland and Japan. Margins in Australia are however higher than Canada, Italy, UK and France. Higher margins, in my view reflect limited real competition, and we know that Australian banks have been repairing their margins by not passing on recent lower funding costs to borrowers, or savers. Small business customers are being hit quite hard. So, banks in Australia are more profitable thanks to higher margins, in a relatively benign environment competitively speaking.

Lets look at losses. Here Australian banks have some of the lowest loss rates in the sample. The UK and USA have higher rates of loss, as do the developing economies. Only Japan. Switzerland, Sweden and Canada have lower loss rates. Actually banks in Australia have reduced their provisioning and returned some of these earlier provisions to enhance profitably recently.

Finally, we look are operational costs. Here again Australian banks rank well, with some of the lowest costs as a proportion of assets of all countries. Many countries including the UK. Canada and USA have higher operating costs.

So, putting that all together, what can we conclude. Australian banks are some of the most profitable, thanks to efficient operations, low loss levels and relatively high margins. That strength should serve us well if the BIS scenario of rising interest rates comes true. However, we should not loose sight of the fact that the big four march together when in comes to pricing, products and fees. There is ample room for banks to become more competitive, and drive margins lower. Its unlikely though they will because they all enjoy the fruits of the current environment, at the expense of Australia Inc. The argument that shareholders benefit many be true, but it misses the point because that excess profitability dampens broader economic activity, thanks to higher ongoing costs.