Tuesday, October 14, 2008
What happens to UK big banks now?
If existing shareholders (institutional investors and/or private equity and hedge funds as well as private individuals) do not take up the bulk of preference shares issues by RBS, HBoS and LTSB, government will end up with controlling or dominant stakes. The banks will then be subject to paying 10% to preference shareholders plus conditions curtailing the current bonus culture (though there is a prospect of FSA applying new remuneration rules more widely) plus pressures to refocus the banks on traditional banking (serving Main Street and away from City and Wall Street investment banking), with the anti-cyclical requirement that these banks maintain 2007 levels of lending to SME businesses and mortgages (especially first time, key workers etc.) As loan defaults double and triple maintaining 2007 levels may not be easy to do or to compute, to 10-11% Tier 1 from 6% recently (a big jump)? But, just as spectacularly, what happens to the foreign branches and the banks' investment banking arms? Will they be sold off? Will they have to be sold off because they will not be able to compete effectively in global capital markets? I am reminded of the calumny experienced by NatWest Markets and BZW ten years ago.
Both banks, the biggest investment banks in London at the time, were under enormous pressure from analysts pressing for break-up. Both banks sought to dismiss concerns that globally medium- sized investment banks such as NatWest Markets and BZW were unable to compete with better-capitalised rivals. Attributes needed to be a global players included balance sheet strength and ability to deliver a wide range of finance solutions, for which fully integrated groups combining commercial and investment banking expertise seemed essential. NatWest wrote to the bank's largest investors, offering to meet to explain the bank's strategy. Both banks were under increasing pressure from shareholders to improve the returns from their investment banking arms to match those of the retail arms. They also argued that to succeed in investment banking requires the highest quality senior management. In the end major parts of both NWM and BZW were simply shrunk and sold off cheap, after which NatWest became a relatively simple target for RBS.
Both banks had important global market shares in certain lines of business, NatWest in capital markets, especially FX, and BZW in securities (both were the UK's finance sector national champions at the time and for many years until 1997), and yet, one way or another, with undue haste to please the analysts it seemed, these banks were grossly and ineptly dismembered by the retail bankers much like they might simply deem delinquent loan agreements. They banks had, in my opinion good systems and above average "leadership and vision", good enough to attract the best with superior internal training and audit regimes, though NatWest's CEO at the time said of his bank that top quality management was lacking at NWM. In fact, the demise of the investment banking arms of both banks appeared to me at the time to be partly an internal political victory, however pyrrhic longer term, for the banks' retail management over the high-flying investment bankers. The mutual dislike and misunderstanding between retail and investment bankers is age-old, cultural and visceral. I foresee something like that happening again now.
There is no doubt that major problems exist in the risk management and internal dysfunctionalities (silo-thinking profit centres) of large investment banks. The accounting systems alone are inordinently complex as are the range and balance between human and computerised decision-taking. These issues have been tested brutally to destruction by the wholly unexpected severity of the credit crunch (a 1 in a 100 event). But, these issues can be fixed (subject of next blog). The calumny would be the simple expedient of drawing a line under the debacle and simply letting go of the problem or selling off to willing buyers in a buyer's market!
Can big banks survive without investment banking arms? Over years, Barclays after several changes of top management re-built investment banking as Barclays Capital. NWM had its investment banking rebuilt under RBS, inheriting the major structured finance arm Greenwich Capital that arguably lies at the heart of much of its present problems (alongside the 'bridge too far' purchase of ABN AMRO's investment banking).
The destruction of NatWest Markets and BZW was a great mistake. I hope the same does not happen again, under government pressure this time, though I fear that for technical reasons that may prove unavoidable? HSBC and JP Morgan and others will be the major beneficiaries and they and others must already be running the rule over what of especially RBS's enormous assets and investment banking teams they could buy cheap. HBoS will be merged/sold to LTSB and RBS looks like its new leadership will have sell-offs as a top priority?