Société Générale recently announced a restructuring plan with the aim of cutting costs in its corporate and investment bank. Kat Van Hoof sits down with chairman Lorenzo Bini Smaghi to discuss this and other matters affecting the bank.

Lorenzo Bini Smaghi

Lorenzo Bini Smaghi

Ever since the financial crisis, investment banks have grappled with a generally downward trend in revenues every year. A protracted period of low interest rates is taking its toll, particularly on European investment banks, which tend to be smaller in size than their US-based counterparts.

France’s third largest bank by total assets has felt the bite, posting a weak performance in 2018. In response, Société Générale (SocGen) laid out a restructuring plan early in 2019 to cut costs and shift focus away from less lucrative operations. The scalebacks will mainly affect its markets and trading desks. “In the current environment, we are dedicating our attention to the areas where we are first in class,” says Lorenzo Bini Smaghi, chairman of SocGen.

There are signs the plan is starting to bear fruit: the bank’s common equity Tier 1 (CET1) ratio rose to 11.7% in the first quarter of 2019, up from 11.2% at the end of 2018. Mr Bini Smaghi is confident that SocGen’s restructuring plan has set it on the right course to deal with a new kind of volatility, characterised by sudden sharp market shocks.

Stabs of volatility

Mr Bini Smaghi was born in Florence, fittingly one of the birthplaces of the banking industry, and spent years in public sector finance through several stints at the European Central Bank and the Italian Treasury. He took up the mantle of chairman at SocGen in 2015, where his mandate includes defining the bank’s risk appetite, setting the budget and liaising with the management team and CEO, Frédéric Oudéa.

He sees the roles of the chairman and the CEO as complementary, with collaboration being the key. “At times the dialogue can be, and needs to be, challenging, but it is important to maintain a good balance and have mutual confidence,” says Mr Bini Smaghi. The role of the board has changed a great deal over the past 10 years in the aftermath of the financial crisis, with increased regulatory pressure adding significantly to its responsibilities.

Career history: Lorenzo Bini Smaghi  

  • 2015 Chairman, Société Générale
  • 2012 Teaching position, Harvard University’s Center for International Affairs
  • 2005 Member of the executive board, European Central Bank
  • 1998 Director-general for international affairs, Italian Treasury
  • 1994 Head of the policy division, European Monetary Institute

Since Mr Bini Smaghi joined SocGen, the financial markets in Europe have gone from soaring highs to a much more tentative and unpredictable environment. “The fears of a long period of low interest rates have become reality, fanning concerns of a long-term Japan scenario,” he says.

“While volatility is down overall, it has changed in nature. There are more sudden shocks now, which is more difficult to navigate,” Mr Bini Smaghi cautions. The situation has forced the bank to address its strategy explicitly through a restructuring plan. For the investment bank, the changes in volatility more than the low interest rate environment are negatively impacting profitability. In response, SocGen is refocusing on its strengths, while pulling away from parts of the business lacking critical mass.

Size matters

SocGen has two major franchises servicing large corporate and institutional clients under its global banking and investor solutions arm: global markets and investor services, and financing and advisory. In 2018, SocGen’s overall return on normative equity dipped to a five-year low of 7.8%. It targets a return on normative equity of 11.5% to 12.5% by 2020, by cutting costs and driving up revenues from strategic and thriving business units.

The bank is a leader in many areas covered in financing and advisory, such as equity derivatives, cross-asset arbitrage and structured products, with particular strengths in the infrastructure and energy sectors. It is looking to grow operations in structured and asset finance, as well as in investment banking and transaction banking.

While margins on corporate lending are low, this area forms a key part of an investment bank’s relationship with its clients, providing revolving credit facilities and term loans among other services. SocGen aims to be more selective about its relationships in this context, making sure capital is allocated optimally to balance risk and maintain strong ties to strategically important clients.

The biggest changes will come in the markets and trading segment called 'Flow'. This accounted for about 25% of SocGen’s risk-weighted assets (RWAs) in 2018, but only contributed 5% to its returns. The bank will close its over-the-counter commodities business and its Descartes proprietary trading desks, downsizing its fixed-income and currencies unit. The goal is to reduce RWAs by €8bn by 2020, with a €2.3bn decrease already achieved in the first quarter of 2019.

“Flow needs size for it to be profitable. At this stage there are better ways for us to allocate capital and resources,” says Mr Bini Smaghi. “Investors in this type of market are looking for complex and tailor-made solutions, rather than off-the-shelf fixes.”

US vs Europe

When it comes to size, US banks tend to have the upper hand over European peers. Ten years on from the financial crisis, US institutions have grown in terms of both balance sheet and valuations, but European banks have generally become smaller.

“An increasing number of European banks are pulling back on certain trading and investment banking services, which is not ideal from a macroeconomic standpoint,” says Mr Bini Smaghi, who adds that capital markets activity has to be part of a bigger universal bank model in Europe to be sustainable. “The US benefits from a huge domestic market and the banking sector is more consolidated, while in Europe both banks and the capital markets are more fragmented,” he says.

In some ways, this works to the advantage of European banks, however. “As our capital markets are not as deep, there are fewer standardised products on offer in Europe. It is easier for us to build and tailor products, the demand for which is on the rise,” says Mr Bini Smaghi.

Risk running riot

Despite sharp financial shocks in February and December 2018, the cost of risk is at record lows everywhere. “The [global] economy is showing a lot of resilience and the world is flooded with savings. This huge amount of liquidity is looking for yield and willing to take risks to get it,” says Mr Bini Smaghi.

Despite political tensions in the Middle East and Iran, a shaky oil market and the noise around US trade wars with China and Mexico, markets have remained relatively sanguine. “The abundance of liquidity puts everything under water and things move slowly. It would take a tsunami to upset the equilibrium,” says Mr Bini Smaghi. In this case, central banks would likely intervene to limit damage, he adds.

The extreme swings on the listed markets have set in motion a mass defection to private markets, which has grown exponentially in the past few years thanks to the popularity of packaged securities such as collateralised loan obligations. Securities in these areas are less correlated, but are also largely untested in a protracted economic downturn scenario, according to Mr Bini Smaghi. They are highly illiquid, which has been shown to be a huge weak spot in times of crisis.

“If the valuations of these assets decline and trickle down to affect household incomes, then we will have a big issue on our hands,” he cautions. Valuations are still high and many developed countries are running at a surplus, but the amount of good assets being issued, such as bunds, is decreasing as a result. This is driving even more investors looking to escape inflation into the private market.

Reinvigorating Africa

As the future of financial markets is becoming increasingly unpredictable, SocGen is keen to leverage existing strengths. There are a few niches where the bank can fill a gap in the market, by diversifying and increasing its services to companies. “As the traditional banking business is challenged, we are looking to improve asset-based financing for companies, for instance through fleet management,” says Mr Bini Smaghi.

In geographical terms, the investment bank participates in global capital markets, with hubs beyond Europe, in the US, Japan, Hong Kong and Singapore, among others. SocGen has a rich tradition of banking in Africa, where has done business for more than 100 years. It is one of the few international and non-African banks with a large presence on the continent. SocGen operates in 19 countries, mainly in French- and Portuguese-speaking countries, but is expanding further into places such as Ghana and Kenya.

“Our presence in the retail banking sphere is very strong. In the future, we want to focus on expanding services to corporates on the ground,” says Mr Bini Smaghi. “Africa is a fantastic area for growth, a very dynamic place.” However, it is also a delicate place to be in terms of compliance and risk management, he concedes.

A great advantage of doing business in Africa is the sense of urgency and willingness to change, says Mr Bini Smaghi. There is a much smaller burden of legacy systems, making the area ripe for rapid technological advancements. SocGen’s expertise in the energy sector makes in uniquely well-equipped to finance the energy transition in Africa going forward.

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