View from the Top: crimes of convergence
The author is a senior banker based in Singapore, with three decades in commercial and investment banking at major international firms.
Original sins
For many years before the global financial crisis, marketing gurus and strategists from the likes of McKinsey, Boston Consulting Group etc were engaged by major banks to assist them in strategic innovations for the future.
Almost all these highly-paid consultants started preaching that to create higher shareholder value, banks needed to adopt the following common practices:
1. Aspire to become a global investment bank for top corporations, benchmarking against Goldman Sachs, Morgan Stanley etc. A high percentage of revenue should come from fee income, with minimum assets-on-balance-sheet and exceptional returns on core capital.
2. Be a top-tier arranger/structurer of financial-market products, but always be able to sell down most of the risk to other banks or to SIVs (keeping the fees) - i.e. CDOs, asset securitisation etc.
3. Take on substantial amounts of credit risk at relatively good margins, but make sure it is always kept off balance sheet - i.e. writing CDSs.
4. Focus on selected target-market segmentation to the nth degree, for example mass market, priority and high-net-worth for consumer-banking clients; emerging, enterprise, mid caps and large caps (and even further segmentation into globals, regionals and locals etc) for corporates. Further divide into industry sectors like telecoms, power, energy etc.
5. Wallet size customers. Roll out expansive training programmes for cross-selling banking products and services to ensure that banks gravitate up the value food chain - i.e. high return on low capital usage.
6. Institutionalise product management.
The gospel of convergence
In essence, almost every bank in the world started CONVERGING – using the same strategies, targeting the same customer segments, and offering the same suites of products and services. They also started competing for the same type of skill sets, and paying huge guaranteed bonuses to keep rivals away from their talent.
The banks then encouraged a massive culture of risk taking, with ever-loosening credit terms and lower pricing. They essentially created a buyers’ market in their quest for greater market share.
Retail and commercial banks copied the investment-bank strategy of taking upfront fees while selling down risky assets and repackaging them in special asset vehicles, or booking them off-balance-sheet via CDSs to achieve a very high return on core capital.
As this orgy of convergence continued, major banks started buying each other to eliminate competition and gain more specific market share, customers and quality employees. And of course huge acquisition goodwill premiums were paid.
Judgement day: divergence
Roll forward into 2009 and the world of banking has now completely changed because of the global financial, credit and confidence crisis. Now every bank wants to return to focusing on its historical markets, roots and core strengths. The current market has the following characteristics:
1. The Goldman Sachs and Morgan Stanleys of this world now want to become commercial banks because their pure investment-bank strategy is no longer viable and sustainable. In the past, these banks would have never in their lofty minds contemplated descending so low. It was unthinkable for an i-bank to be sold to a commercial bank.
2. Almost all the super-banks are now government owned or supported and have started to scale down assets and businesses. They are all shying away from risk. Structuring has become a dirty word.
3. Many firms have taken back on their balance sheet all the bad assets that they sold off to special investment/asset vehicles.
4. Many super-regional or global banks have retreated to home markets.
5. Local banks are going back to their core SME and local corporates, with support offered by local governments’ stimulus packages.
6. Banks have walked away from guaranteed bonuses and slashed existing bonuses. Stakeholders have very little patience for employees who are not prepared to make sacrifices.
7. Highly paid arrangers and product-structuring professionals have quietly retired. Many of them are currently rich but unemployed.
8. Although not admitted publicly, many banks have very limited appetite for any risk today.
Future revelations
To be perfectly honest, no one really knows what will happen next in the world of banking. The only thing that appears certain is that the industry will have fewer players and those firms that remain will employ fewer workers. Profitability and returns will be much lower than before, especially because of the higher level of core capital required.
There will be fewer specialised banking employees and these professionals will be paid much less than before. Inevitably, all banks will face increased scrutiny and monitoring, as well as regulations which will limit their risk-taking abilities and prevent systematic risk.
We will know what banking will evolve into sometime in the near future. But right now, banks are still in a state of flux – in other words, purgatory.
Original sins
For many years before the global financial crisis, marketing gurus and strategists from the likes of McKinsey, Boston Consulting Group etc were engaged by major banks to assist them in strategic innovations for the future.
Almost all these highly-paid consultants started preaching that to create higher shareholder value, banks needed to adopt the following common practices:
1. Aspire to become a global investment bank for top corporations, benchmarking against Goldman Sachs, Morgan Stanley etc. A high percentage of revenue should come from fee income, with minimum assets-on-balance-sheet and exceptional returns on core capital.
2. Be a top-tier arranger/structurer of financial-market products, but always be able to sell down most of the risk to other banks or to SIVs (keeping the fees) - i.e. CDOs, asset securitisation etc.
3. Take on substantial amounts of credit risk at relatively good margins, but make sure it is always kept off balance sheet - i.e. writing CDSs.
4. Focus on selected target-market segmentation to the nth degree, for example mass market, priority and high-net-worth for consumer-banking clients; emerging, enterprise, mid caps and large caps (and even further segmentation into globals, regionals and locals etc) for corporates. Further divide into industry sectors like telecoms, power, energy etc.
5. Wallet size customers. Roll out expansive training programmes for cross-selling banking products and services to ensure that banks gravitate up the value food chain - i.e. high return on low capital usage.
6. Institutionalise product management.
The gospel of convergence
In essence, almost every bank in the world started CONVERGING – using the same strategies, targeting the same customer segments, and offering the same suites of products and services. They also started competing for the same type of skill sets, and paying huge guaranteed bonuses to keep rivals away from their talent.
The banks then encouraged a massive culture of risk taking, with ever-loosening credit terms and lower pricing. They essentially created a buyers’ market in their quest for greater market share.
Retail and commercial banks copied the investment-bank strategy of taking upfront fees while selling down risky assets and repackaging them in special asset vehicles, or booking them off-balance-sheet via CDSs to achieve a very high return on core capital.
As this orgy of convergence continued, major banks started buying each other to eliminate competition and gain more specific market share, customers and quality employees. And of course huge acquisition goodwill premiums were paid.
Judgement day: divergence
Roll forward into 2009 and the world of banking has now completely changed because of the global financial, credit and confidence crisis. Now every bank wants to return to focusing on its historical markets, roots and core strengths. The current market has the following characteristics:
1. The Goldman Sachs and Morgan Stanleys of this world now want to become commercial banks because their pure investment-bank strategy is no longer viable and sustainable. In the past, these banks would have never in their lofty minds contemplated descending so low. It was unthinkable for an i-bank to be sold to a commercial bank.
2. Almost all the super-banks are now government owned or supported and have started to scale down assets and businesses. They are all shying away from risk. Structuring has become a dirty word.
3. Many firms have taken back on their balance sheet all the bad assets that they sold off to special investment/asset vehicles.
4. Many super-regional or global banks have retreated to home markets.
5. Local banks are going back to their core SME and local corporates, with support offered by local governments’ stimulus packages.
6. Banks have walked away from guaranteed bonuses and slashed existing bonuses. Stakeholders have very little patience for employees who are not prepared to make sacrifices.
7. Highly paid arrangers and product-structuring professionals have quietly retired. Many of them are currently rich but unemployed.
8. Although not admitted publicly, many banks have very limited appetite for any risk today.
Future revelations
To be perfectly honest, no one really knows what will happen next in the world of banking. The only thing that appears certain is that the industry will have fewer players and those firms that remain will employ fewer workers. Profitability and returns will be much lower than before, especially because of the higher level of core capital required.
There will be fewer specialised banking employees and these professionals will be paid much less than before. Inevitably, all banks will face increased scrutiny and monitoring, as well as regulations which will limit their risk-taking abilities and prevent systematic risk.
We will know what banking will evolve into sometime in the near future. But right now, banks are still in a state of flux – in other words, purgatory.
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