The new international banking order is starting to take shape. The globalisers’ ideal of a handful of universal giants stretching across every geography and banking the world has been slain. McDonald’s-style uniformity is set to be replaced by à la carte diversity. The notion of ‘too big too fail’ has been replaced by the concept of ‘too big too save’. Regional and specialised banks are in the ascendancy and regulation is heading towards both broad centralised principles ‘with teeth’ while accepting that regulators must have considerable national scope.
The next big event on the horizon is the G20 meeting in London in April, where more flesh may appear on the bare bones that were hung together at the institution’s first meeting in Washington last November. These include tackling such issues as reform of the International Monetary Fund; the challenges of regulating financial institutions across borders; the role played by credit ratings agencies in the financial system, as well as the bonus culture of investment banks.
At the World Economic Forum’s annual meeting in Davos in January, the future of banking was at the top of the agenda and debated vociferously on several panels. With senior leaders from Russia, China, the UK and France all present, it was inevitable that certain Davos conclusions will be fed into G20 outcomes. Powerful speeches from both Russia’s prime minister Vladimir Putin and China’s premier Wen Jiabao emphasised their dissatisfaction with Western financial systems and the role they see them having played in perpetuating the crisis. Rating agencies were singled out by both leaders for blame and can expect to be on the receiving end of edicts in April.
Upside, downside
But as is customary at Davos, just as much profundity could be found off the platform as on. Bankers from key institutions in the emerging markets were professing that they saw as much upside as downside from the current situation. While funding might present challenges for some, others were taking advantage of the retreat of international banks to increase their market shares. Technologies blamed for contributing to the crisis, such as securitisation, are still being embraced by these new players, who are in a strong position to learn from their misuse by others and extract the best. Basel II, discredited by some, remains a strong guiding force for modernising banks and universality is regarded as key to delivering the full range of banking services to increasingly demanding customers.
The concept of ‘narrow banking’ – some have called it ‘stone age banking’, others ‘classical banking’ – whereby banks revert to doing traditional deposit taking and lending while complex structuring and proprietary trading becomes the preserve solely of investment banks, is not a direction that the world’s emerging and growing banks are heading in. With a number of global banks somewhat discredited, regional banks and national champions have a great opportunity to pick up the slack and it seems unlikely that G20 leaders representing key emerging markets will seek to restrict them. This, after all, is their chance to reshape the global banking order with their own banks and it would be shortsighted to lose the opportunity.
There is a growing realisation, however, that banks moving overseas can create huge liabilities that may eventually find their way back to the home government, as happened most spectacularly with Iceland and to a lesser extent with EU countries such as the UK, Ireland, Holland and Germany. As one central banker said: “Banks are international in life but national in death.”
In his introduction to a Davos panel on ‘The Bank of the Future’, Adair Turner, chairman of the Financial Services Authority, the UK regulator, identified three key themes to shape the discussion – the interest in the concept of narrow banking that could take banking back to a Glass Steagall type of separation between investment and commercial banking (Glass Steagall was the US regulation created as a response to the 1929 crash and only finally repealed in 1999); the prospect of a reversal in the globalisation process with international banks pulling back credit lines from emerging markets and focusing, sometimes at the behest of their own governments which are now shareholders, on their domestic markets; and the lack of a binding international treaty in banking such as exists in the trading arena with the World Trade Organization (WTO).
The idea of narrow banking begs the question as to what it should and should not include. Only a small part of banking activities created the current problems; the vast array of services are demanded by customers who like a one-stop shop. Rather than a reversion to narrow banking, what seems more likely is that the global bank concept will be replaced by substantial regional and universal players.
There were only a handful of banks with pretensions to being truly global anyway. One was Citi, which is now considering separating out the higher risk US consumer and securities businesses from its international commercial banking. Another was Royal Bank of Scotland, which is busy scaling back as part of its restructuring, leaving HSBC – which never moved too heavily into investment banking and picked geographies very carefully – as the only real contender.
Making predictions
But not everyone is predicting the demise of the global players. In a report on the future of the global financial system, commissioned by the World Economic Forum and released just before the annual meeting, five types of business model are expected to dominate – scale globals, focused regionals, private banks, merchant banks and alpha risk takers. “Scale globals will likely be part of a small, super class of global liquidity providers,” says the report. “They will use their deposit-funded, fortress-like balance sheets, global footprint and trading infrastructure to maintain or become major liquidity providers across markets and asset classes.”
The regional universal bank will become the dominant force, however. Alessandro Profumo, CEO of UniCredit, says: “Commercial banking must be focused on commercial banking. Advisory work is key for us but the proprietary trading parts of investment banking are not manageable in a commercial bank.”
UniCredit’s major markets are Italy, Germany, Austria and Poland so it is far from being global but Mr Profumo thinks that size is important. “It is very important for our customers to have a large European bank in front of them because we can reduce costs, improve the quality of service and provide economies of scale.”
But without a doubt, there will be more diversity of model and, in fact, the reversion to tradition may be more in terms of values than a precise product set. Klaus-Peter Gushurst, a senior vice-president of the consultant Booz& Co, says: “Looking back at 18 years in the financial services industry, there has been a dilution of the old-style bankers. They are gone because they did not deliver the return on equity. They didn’t take the risks to move aggressively into equity and derivatives markets. If you compare financial services to other industries, it was the industry the most disconnected with society. If you look at compensation and incentive schemes, this disconnect will now have to be closed.”
Georges Pauget, CEO of Credit Agricole, thinks that the term ‘universal’ is misleading. “We speak about universal banking but in my view it’s not the best way to describe what is happening. All of the European banks are universal but all are different. When you speak about a universal bank, you mean diversified but that doesn’t define the unique characteristics of each model and between the different models found in the US and Europe,” he said in an interview prior to the Davos meeting.
Among the new and varied universal banks operating cross-border, regionally but not globally, will be many emerging market players. Some are being hit by the liquidity squeeze as the international banks cut credit lines, but at the same time, they are benefiting from the retreat of the competition.
Just prior to Davos, the Institute of International Finance issued a report on capital flows to emerging markets, highlighting the contraction of bank lending. “While all components of net private capital inflows have recently weakened, it is not surprising that the most significant drop in prospect is for net bank lending, which is forecast to shift from a net inflow of $167bn in 2008, to a net inflow of $61bn in 2009, a $227bn negative swing. This would be a dramatic reversal from the peak year of banking sector net flows, of $410bn in 2007.”
Refinancing challenges
Andrei Kostin, chairman of Russia’s VTB, described to The Banker the challenges of refinancing even a government-controlled bank. VTB borrowed $26bn internationally with $7bn falling due for refinancing both last year and this year.
“Our problem has been the international debt market. We borrowed $26bn around the world and this year we need to refinance about $7bn and we can’t refinance that. Last year was the same and in the last quarter we had to substitute foreign loans with domestic sources,” he said. “The major problem, as for the rest of the Russian economy, is foreign loans.”
Last year, VTB received $28bn from the government in the form of subordinated and non-collateralised loans and shortly after this interview Russia’s prime minister Vladimir Putin approved a second wave of bank recapitalisation, with VTB receiving another $28bn, increasing the government’s stake in the bank. Mr Kostin says that the increased role for the state in the Russian economy is only temporary, allaying fears that the government could use the crisis to reassert its position. But he fears that non-performing loans may rise from the current 3.8% into double figures by 2010 as the economy turns down. The bank’s Tier 1 capital in preparation for this is a healthy 16%. Despite this situation, VTB expects to increase its loan book by 30% this year.
Global phenomenon
Mr Kostin thinks that the get-rich-quick mentality fuelled by abundant liquidity before the crisis was a global phenomenon, not just a Western one. “It is time to reassess without being too extreme. It is not to say that everything was done wrongly. After all, the world economy had substantial growth over these past years. Russia changed, Moscow changed. They built a lot of houses and offices. But we all became a bit careless and we need to reassess.”
VTB does not intend to shy away from the financial technology that has been developed over the boom period, such as securitisation. In the mortgage business, for example, there is a lack of long-term funding. “If we could securitise the best mortgages and sell them to a Russian state-owned pension fund, or Fund for National Well Being [the sovereign wealth fund] that would be a way to get long-term liquidity and to provide more funds for mortgages,” says Mr Kostin.
“There is no other way [than securitisation]. You can talk about better regulation and limits but if you deprive banks of the ability to securitise, that will create huge problems for the development of markets.” VTB has done one securitisation of $100mn of residential mortgages, which was sold internationally.
This is also the sentiment of Credit Agricole’s Mr Pauget, who is also chairman of the bank’s investment banking arm Calyon. Calyon sustained considerable losses due to the crisis and has been restructured to concentrate on structured finance, brokerage and fixed income.
“We will focus on the activities in which we have the best track record and critical size. It is obvious that the OTC [over-the-counter] market will be hugely reduced. When you have a major confidence problem between the banks, you obviously can’t exchange options due in three to five years,” said Mr Pauget. “But in securitisation, we kept our team and I am convinced that securitisation will start in the next few months, not in the same shape, and with less complex products, but it is obvious that we need securitisation as well as other vanilla products such as rates and swaps.”
Far-sighted banks are seeing the current crisis as an opportunity as much as a problem. Jacques Der Megreditchian, head of investment banking and markets for Russia’s Troika Dialog, says: “We are facing a difficult period but there will also be opportunities over the next few years. The finance industry will have to change and maybe we will see a new Glass Steagall-type separation of deposits from the market risks. International banks will be looking less at emerging markets and going back to their home countries. This provides opportunities for a bank like ours with operations in Russia, Ukraine and Kazakhstan. We should take away market share from the global banks.”
Troika is building on its traditional cash equities and fixed-income business with futures and options products and foreign exchange services for corporates. Primary issuance will be slow but there may be windows of opportunity in June and July and between September and October, says Mr Der Megreditchian. He anticipates that the fall in asset values will also make Russia more attractive for inward investment as the environment stabilises.
Emerging winners
Another impact of the crisis is that leading emerging market players are finding it easier to recruit international-class investment bankers. But if you quit Turkey’s Garanti Securities to join an international house, don’t look for an easy return. Metin Ar, president and CEO of Garanti Securities, says that it does not accept back bankers who previously left for competitors.
“Two and three years ago, we had serious difficulties with losing people to the international investment banks; now, unfortunately, some of them are not employed – but they cannot come back. There is no room and we don’t take back people who leave us,” he says.
The Turkish banks find themselves in a buyers market for staff, following the collapse of Lehmans and the departure or scaling back of other competitors.
“The investment banking advisory business has decreased but so has the competition,” says Mr Ar. “Recently, we have been concentrating on energy and doing three transactions simultaneously in that area.” Infrastructures, toll roads and energy are all busy areas for banking in Turkey.
The retreat of the international banks has improved loan spreads, he says. “Previously, we were earning 2% on spreads, now we are earning 5%. If you have money available today, you can cherry-pick your customers and this also helps our corporate banking and investment advisory business.”
Countries which have avoided the financial crisis the best are those that were most de-linked from the world economy or those that experienced a financial crisis relatively recently and were operating under stricter rules. Turkey falls into the latter category and its banks will be among the most profitable anywhere in 2009.
“Many international banks are losing money. All of the Turkish banks, including Garanti Bank [the commercial bank to which the securities house is affiliated], are making money with returns on equity ranging between 15% and 25%. Our return on equity is the highest but all the other banks are doing well and we think this is going to continue in 2009,” says Mr Ar.
“One factor has been the strength of the Turkish regulator BDDK, which was very stringent and watched the banks very carefully, not allowing them to make mistakes or create any side pockets of activity,” he says. “At the end of 2007, when the first glimpses of the credit crunch surfaced, BDDK gave advice to all shareholders that they should not distribute any dividends. It was just advice, not compulsory, but everyone took it. Last year they got even tougher and in December BDDK said that payment of dividends would need approval from the BDDK first,” adds Mr Ar.
The new international banking order is reshaping the back office as well as the front office. “From our business perspective, we are seeing new geographies opening up,” says Ashok Vemuri, a member of the executive council with the consultant and outsourcer Infosys. “Our typical focus has been the US, the UK and Australia but, increasingly, we are getting invited to the table with the Nordic banks, banks in continental Europe, Latin America and Asia.
“The Chinese banks have so many operations mixed up and they need someone to come and unravel it all. It is not about labour arbitrage but about cost and efficiency. Most of the banks have grown haphazardly and in silos. Someone has bought certain software and certain products, and there is no documentation as to what is behind these systems. One task is this unravelling, the other is strategy road maps, and how can we leverage the information technology to drive more products through it as compared to the banks in the West, which are essentially looking at cost savings and for post-merger integration work.”
The great unknown in the reshaping of banking is the regulatory code that may appear. Bankers, such as Yang Kaisheng, vice-chairman, of Industrial and Commercial Bank of China, remain committed to implementing Basel II in their banks, yet there is the anticipation that something much more binding will appear following the G20 leaders meeting in London in April.
To adopt or not
As Chukwuma Soludo, governor of the Nigerian central bank, says: “Basel is a set of principles that you can choose to adopt or not adopt. If you don’t adopt them there are no sanctions for non-compliance. This is different from the WTO, for example, where lack of compliance is actionable.”
One of the fears raised at Davos was of financial protectionism, with banks keeping liquidity at home and governments regulating their own financial sectors very strictly and so preventing cross-border flows. The UK’s prime minister Gordon Brown has warned about the slide into financial protectionism.
Can the G20 make a difference? The greatest challenge of the G20 is to co-ordinate macroeconomic policy; the greatest worry is that it gets too deeply involved in financial market regulation and comes up with something too restrictive and unworkable.
Yet in some areas, banks may welcome some kind of collective enforcement – in the areas of bonuses, for example, where if an institution acts unilaterally, it loses out to competitors. Whatever the outcome, banking as we knew it during the past two decades is over.
