I could not agree more with this quote from Niall Ferguson. The problem is leverage, and securitization is nothing more than leverage that is not appropriately recorded on the balance sheet. There is no amount of regulation, bank taxes or bonus taxes that will decrease the propensity for the next crisis until that simple recognition is agreed.
"I don’t think it was really the banks’ involvement in hedge funds that were nearly as much of a problem as banks involvement in securitized MBS collateralized debt obligations."
I happen to believe in the L shaped recovery theory. Recovery will be based on a stop in the reduction of growth, and will flatline there. We will not go back to the GDP $ levels of 2007 ( a return to 2007 would require a V shaped recovery). This post from Mish summarises why, quite well.
However, the clock is ticking on many things at once: Leveraged loans, boomer retirements and subsequent downsizing, Pay Option ARMs recasts, Alt-A recasts, and last but certainly not least, a jobless recovery that ensures massive credit card defaults. Such structural problems in conjunction with changing consumer attitudes towards debt all but guarantee an L-Shaped Recession. The recession will end, but don’t count on a recovery.
Managing leverage combined with sound lending practices are essential for Banks | Wachovia failed on both
The Wachovia situation is a good example to illustrate the point I have been making insufficient capital at Banks, and their extended leverage.
Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk.
They are saying in effect that the $312 bn loan portfolio has significant bad debts and that Citi will absorb up to $42 Bn. If we look at the last balance sheet here, Wachovia’s capital base was $74 Bn at the last quarter. If the $42 Bn is correct, then Wachovia’s capital would be more than cut in half. If the losses are greater, then the entire capital base could be erased.
Managing leverage and sound lending practices are essential for Banks, and Wachovia is a good example of how bad lending practices combined with high leverage is a disastrous combination.
In view of the strategic and financial benefits of Internet banking, Brazilian financial institutions have aggressively pushed their online services, making Brazil one of the most developed countries in Latin America in terms of e-banking practices. In the process, they are expanding their customer base and providing opportunities for Internet service providers (ISPs) and telecoms service companies, according to a recent report by Pyramid Research, the Economist Intelligence Unit’s Internet and telecoms consultancy.
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The new CapGemini/ Efma World Retail Banking report is out today. This is the 3rd annual.
A link to the full report, press release and infographic can be found here. Its 40 pages and worth the study for anyone in bank channel strategy and management.
Paris, New York – April 23, 2013 – Within the next six months, ten percent of retail banking customers surveyed globally will likely leave their bank and an additional 41 percent of customers say they are unsure if they will stay or go finds the tenth annual World Retail Banking Report 2013 (WRBR 2013) released today by Capgemini and Efma. To re-build the customer-bank relationship, opportunity exists for banks to become more customer-centric by leveraging vast amounts of customer data and by further developing mobile capabilities to create more personal interactions. The cornerstone of the WRBR 2013 is its extensive customer survey and Customer Experience Index (CEI) which measures perceptions of 18,000 customers in 35 markets about the factors that matter most to them across channels, transactions and products.
The report is an interesting of assessment of banks customer experience around the world, and development of potential solutions.
The is a great definition of the problem banks face in the commoditization of their products.
Banks have historically had difficulty distinguishing
their products from one another, and in recent years the
problem has only intensified. The look and feel of basic
banking products has remained largely the same, with
very little innovation forged in terms of linking products
or developing them outside their traditional silos.
Attempts to differentiate on price too have been curtailed
in recent years due to regulatory and cost pressures that
are keeping rates universally low.
As new channels have become available, the industry has
moved in lockstep to add them, creating an environment
in which most banks have at least a presence in every one.
The sole exception may be mobile, which the industry
is currently in the process of broadly adopting. The
retail delivery ideal has evolved into being able to make
any product available through any channel at any time.
However, banks often bolted on new channels instead of
fully integrating them with existing ones.
It then goes on to speak about what interests me and the various channels and how banks can improve their customer experience there, versus what many have done and merely bolted on new channels, particularly mobile and merely presenting similar offerrings.
Where the Customer Experience Index (CEI) improved the most, credit is given to improvements in mobile and telephone. (Philippines & Portugal).
Next is the positive correlation between understaning of customer needs and customer experience.
Finally the link is made between knowing the customers needs through data and using that data to support the channels appropriately.
The focus really turns to mobile and rightly so.
The correlation between age and positive experience seen
for branch and internet banking does not hold true in the
case of mobile banking. Because they are less familiar
with the full array of mobile functionality, customers of
all ages have a lower tendency of positive experience with
mobile. In addition, increasing age appears to have little
relation with more positive outcomes in mobile as in the
other channels. In North America, for example, 34% of
older customers have positive experiences with mobile,
compared to 41% of younger ones. As banks continue to
make investments in improving their mobile capabilities,
the overall number of customers with positive experiences
associated with the channel is expected to grow.
There is determined to be a direct correlation between Customer Experience and Product Channel fit.
The report assesses the digital maturity of banks based on their finding that:
The study found that a firm’s level of digital maturity
is strongly correlated to its profitability and efficiency.
Banks rank high with 35% in the upper right quadrant. Mind you that means 65% are not there.
Interestingly the challenge facing banks is quite similar to that facing FaceBook and Google. But banks have an important asset that those two do not … customer specific data.
The next frontier for mobility is to use the mobile
platform to enhance marketing and sales. Banks already
are using mobile messages to welcome customers and
inform them of new products.
Finally the report follows through to the logical conclusion
Becoming a Customer-Centric Bank by Leveraging Data
Banks have access to more customer data than ever before and this must be more effectively
utilized for relationship-building to succeed in the future.
- Banks today have tremendous amounts of customer data available to them, but are able to
successfully leverage only a small fraction of it for delivering actionable business insights.
- Extraction and cleaning of data is as important as analyzing it to gain customer insights.
- Before technology investments are made, firms need to be more successful at defining business
objectives and aligning the necessary technology to support those goals.
The remainder of the report provides a useful discussion on the nature of data that Banks’ possess and makes the case for a more rigorous and scientific data driven strategy to support customer experience in the channels, and particularly mobile and online.
New CCPA report | Several Canadian banks drew government support (in 2009) whose value exceeded the bank’s actual value
I have written here at length about Canadian banks and how the world impression that they are industry leading in strength is at best coloured by superb behind the scenes co-operation between the banks, the government and the Bank of Canada. The biggest example I could write about was the 2008 freeze on interbank and inter institutions derivatives hastily forced on the banks in 2008.
Purdy Crawford/ Pan Canadian Investments: The Canadian government did presciently freeze $35 billion in derivatives back in 2007.
But if you flip through the Canadian Banks search on this blog there is a general theme that Canada’s banks are not materially better capitalised than other banks in the world. And now we have the ammunition many of us knew existed but had no evidence.
Todays bombshell from the Canadian Centre for Policy Alternatives, authored by chief Economist David McDonald, provides clear evidence of the extent of Government assistance to the Canadian banks during the crisis. The amount of that assistance is $114bn. This is several times total Canadian Bank equity.
The report begins;
The official story of the 2008 financial crisis goes like this: American and international banks got caught placing bad bets on U.S. mortgages and had to be bailed out. But not in Canada. Through the financial crisis, Canadian banks were touted by the federal government and the banks themselves as being much more stable than other countries’ big banks. Canadian banks, we were assured, needed no such bailout.
However, in contrast to the official story Canada’s banks received $114 billion in cash and loan support between September 2008 and August 2010. They were double-dipping in not only two but three separate support programs, one of them American. They continued receiving this support for a protracted period while at the same time reaping considerable profits and providing raises to their cE Os, who were already among Canada’s highest paid. In fact, several banks drew government support whose value exceeded the bank’s actual value. Canadian banks were in hot water during the crisis and the Canadian government has remained resolutely secretive about the details.
Now some details;
CCPA Report (pdf)
The first point of interest in the report is the extent of support as a percentage of the banks’ market capitalisation. This one should be read in the context of the high leverage that banks enjoy courtesy of government support through deposit insurance and liquidity advances from the Bank of Canada on a day to day basis.
In the reports own words;
Three of Canada’s banks—ciBc, BMO, and Scotiabank—were at some point completely under water, with government support exceeding the value of the company. In March 2009, ciBc stood out for receiving support worth almost one and a half times the value of all outstanding shares. It would
have taken less money to have simply bought all the shares in CIBC instead of providing it with support.
The irony of CEO remuneration during this period is not lost on the report;
To top it off, the CEO of each of Canada’s big banks ranked among the highest paid 100 CEOs of Canada’s public companies and at the height of government support between 2008 and 2009 each CEO of each bank received raises in total compensation. For instance, Edmund Clark of TD Bank saw his overall compensation jump from $11.1 million in 2008 to $15.2 million in 2009.
The total support to Canadian banks and the surprise that CMHC was the primary conduit.
Individual bank support;
And the reports conclusion which most would support;
A healthy financial system cannot be based on massive government support for which the details remain secret. It is only through an honest and transparent examination of what occurred and how it can avoided in the future that a stronger financial system can be built, which is in everyone’s best interest.
Relevance to Bankwatch:
This is a stellar piece of work and probably the best report on the Canadian bank system of the 2008 banking crisis. Recommended reading for anyone interested in banking and how it really works. There is no magic Canadian bullet.
One of the key learning’s and outcomes of the 2008 banking crisis was the need to tighten up control over bank leverage, which in turn promotes de-leveraging and reduces rapid increases in debt. This is primarily centred in Basel 3 which curtails off-balance sheet lending, and requires debt to to be first risk adjusted and have capital held against that risk.
As with anything financial there are always unintended consequences, and those that seek to bypass the new rules. Enter JP Morgan.
JPMorgan is among several banks that have begun testing investor appetite for the trade finance equivalent of collateralised debt obligations – the derivative products blamed for compounding the financial crisis – in an attempt to boost lending capacity
Trade Finance or the financing to provide working capital for imports and exports is experiencing reduction in lending capacity as a result of Basel 3. Trade Finance accounts for trillions of dollars per annum, and will a significant revenue source for JP Morgan.
The interesting shift in this new idea is that Trade Finance would in effect be funded directly by Institutional Investors. The regulators have acknowledged the problem JP Morgan seek to solve, but are hesitant to make more than minor changes to allow banks any dispensation.
It seems to me what JP Morgan are doing is rational, and supports the idea that banks are over levered so locating additional sources of smart funding supports the target of de-risking banks. I keep going back to the idea that banks have become such broad based credit vehicles and deposit taking vehicles that some separation of high volume and high risk from regular peoples finances is a good thing.
There remains plenty of money in the world and if JP can develop new method of wholesale access to it, then that seems in keeping with the spirit of the regulation design.
Someone I know was walking through shopping malls in Washington DC last month and there were many closed stores, including a Banana Republic. That would be unheard of in Canada. The effect of the 2008 crash is still with us especially in US and parts of Europe. The target of re-building a safe banking industry is not easy and will require big adjustments.
Once in a while Martin Wolf is on fire. Economists can appear somewhat dissociated from real life. This piece is one where he strikes home. If you have any doubts about skepticism about banks then read this.
Bob Diamond’s unconvincing defence | ft.com
Did the economy at least benefit from the run-up in leverage? Hardly. We saw huge rises in banks’ exposure to one another, which worsened systemic fragility, and in the prices of – and debt secured against – property. Who thinks these provided durable benefits? Mr Haldane also noted that “The purchaser of a portfolio of global banking stocks in the early 1990s is today sitting on a real loss. So who exactly is it extracting value from these incentive distortions? The answer is twofold: short-term investors and bank management.”
He goes on to make the argument for ring-fencing (separation of retail banking from investment banking), and better capitalised banks.
Relevance to Bankwatch:
All in all, it is not that hard. When someone of Martins stature gets angry and writes a concise piece like this it all becomes clear.
Banks cannot innovate successfully using financial gymnastics. Innovation must come from customer focussed innovation, which sadly is nowhere in sight amongst the big banks who are fighting the wrong fight against government, rather than for their customers.
A new report from McKinsey paints a bleak picture for banks and supports the notion that banks need to adapt and adapt in a significant way. Their survival is at stake. The banking and economic crisis just brought banks deficiencies to the fore.
This extract from the intro page to the McKinsey study (emphasis mine) highlights that shifting consumer practices plays a role in the falling fortunes of banks. The banks who choose to not redesign themselves will be relegated to utility banking, which looks more and more, certainly in Europe as involving direct government ownership.
On its face, 2010 was a good year for the industry. Global banking revenues reached a record $3.8 trillion, and after-tax profits jumped from $400 billion in 2009 to $712 billion—above their 2008 level, if not the 2007 peak. But this rosy picture did not necessarily imply a bright future for banks in Europe and the United States: 90 percent of the profit improvement was attributable to a reduction in provisions for loan losses, and most, if not all, of the good news came from emerging markets.
As a result, investors have been reassessing the banking industry’s long-term growth prospects and rerating the sector. The major problems include the rising cost of doing business—thanks primarily to new regulation requiring banks to hold more capital and liquidity to ensure that the industry better withstands future shocks—scarcity of capital and liquidity, changing consumer behavior as a growing number of customers move to mobile and online channels, and diverging regional growth paths.
Full report pdf (registration required)
The report obviously covers many economic aspects including higher costs of capital, regulation and sluggish markets in developed countries. I will highlight some of the comments though on the changing consumer behaviours.
Finally, banks will have to contend with shifts in consumer behavior – none more significant than the rise of the digital consumer, accelerated by the mobile and tablet revolution. We expect branch density to fall, and average branch sizes to shrink.
Banks will have to deliver superior customer experience to a generation that has much greater choice and is likely to be more price-sensitive.
Some of the shifting behaviours:
- the decline of household leverage in many developed markets, and with it, increased savings rates.
- the inexorable rise of digital consumers, further accelerated by the mobile and tablet revolution. In US retailing, more than 40% of total sales are either transacted online or influenced by the online channel; “pure online” sales already exceed $170 billion annually. Similar trends are under way in online banking. In pioneering countries such as Finland, the Netherlands, and Norway, as many as 80% of customers
already use online banking – not just for transactions, but also for account opening. In major markets such as the US, UK, Germany, and Japan, the figure is approaching 50%. Moreover, there is an extremely close correlation between overall internet usage and online banking – this suggests that as internet
penetration increases worldwide, customers will migrate out of bank branches and onto electronic channels.
If this shift turns out to be a long-term structural phenomenon, it could have significant implications for the growth of many banking products, including personal loans, mortgages, and credit cards. The banking industry on average will therefore be less profitable.
- Overall, we expect branch density to fall, especially in overbranched countries; even more importantly, we expect the average size of branches to decrease as many advice related and post-sales support activities
migrate to different channels.
- These shifts will also require banks to integrate their channels seamlessly and efficiently. New marketing activity will be necessary – banks on average spend less on marketing than other consumer-facing
industries. We would expect particularly strong growth in digital marketing. Finally, banks will have to monitor innovations closely, particularly in the mobile arena, to avoid being leapfrogged by other industries. In the US, for example, financial institutions currently own only about 70 of the around 3,000 financial applications running on the iPad, iPhone, and Android devices
McKinsey propose improvements along three vectors … a word pick to highlight that bold changes, not incremental, are required.
- Vector 1 is about improved capital efficiency – a particular priority in Europe. Here, banks would focus on
making their businesses less capital intensive and moving the risks they can no longer afford elsewhere
- Vector 2 is about completely restructuring their costs. Banks would recover their profitability through
reinventing their cost base
- Vector 3 is about capturing new revenue opportunities within their existing areas of operations. Banks
would tap into new pockets of demand and revenue via smarter pricing, customer centricity, and selective new risk taking
Again I will pick one, – vector 2, which is where technology has a large part to play and banks have much room to improve. In fact in many cases improvement is the wrong word. It will require being willing to throw out old technology and rebuild, within the context of a probably smaller, leaner and more efficient bank. McKinsey estimate a 6% annual cost reduction is necessary. These are staggering changes that cannot be done incrementally.
They pick up on one of my favourites that I covered here recently.
Finally, banks could move non core operations into industry utilities – a particular opportunity in mature markets. Some countries, such as Norway and Iceland, use shared industry utilities extensively, but others very little. Although requiring potentially complex collective action, the opportunity is there to share or outsource a large part of banks’ non core operations like cash and coin handling, payments, and ATM
Relevance to Bankwatch:
In short this is no time for sentiment. Just because you are a bank does not mean you have to manage cash, or ATM’s for example.
The McKinsey report is only 50 pages and contains detailed statistics on banking markets by country and on banks.