Excellence in Banking - Revisited!

Excellence in Banking – Revisited!

Steven I. Davis

Excellence in Banking – Revisited!

Also by Steven I. Davis BANK MERGERS: Lessons for the Future EXCELLENCE IN BANKING INVESTMENT BANKING: Addressing the Management Issues LEADERSHIP IN CONFLICT: The Lessons of History LEADERSHIP IN FINANCIAL SERVICES MANAGING CHANGE IN THE EXCELLENT BANKS THE MANAGEMENT FUNCTION IN INTERNATIONAL BANKING THE EURO-BANK

Excellence in Banking – Revisited! Steven I. Davis

© Steven I. Davis 2004 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2004 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 1–4039–3623–4 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Davis, Steven I. Excellence in banking—revisited / Steven I. Davis. p. cm. Rev. ed. of: Excellence in banking. c1985. Includes bibliographical references and index. ISBN 1–4039–3623–4 (cloth) 1. Bank management. I. Davis, Steven I. Excellence in banking. II. Title. HG1615.D39 2004 332.1’068—dc22 10 9 8 7 6 5 4 3 2 1 13 12 11 10 09 08 07 06 05 04 Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

2004042097

Contents List of Tables and Figures

vii

List of Abbreviations

ix

Introduction and Background

xi

1

The Excellent Banks

1

2

Lessons from the Past: Two Turbulent Decades

7

3

Shaping the Business Model

21

4

People and their Culture

35

5

The Leadership Factor

51

6

Sustaining Revenue Growth

59

7 Managing Size and Complexity: The Challenge Becomes Acute!

75

8 Execution and Client Service

85

9 10

11

Cost management Technology Customer service Attracting and retaining the best people

86 90 92 93

The Profile of Risk

97

How the Excellent Banks See the Future

109

The consolidation process More demanding clients The importance of asset management Credit derivatives as a threat An independent perspective from our bankologists

109 116 117 118 119

Our Own Reflections and Forecasts

123

Managing size and complexity Cross-border mergers The outlook for consolidation in general

126 127 129

v

vi Contents

The profitability of retail banking The outlook for risk management Changing the culture

132 133 135

Appendix 1: Profiles of the Excellent Banks

139

Appendix 2: The Business Principles of Goldman Sachs

157

Bibliography

159

Index

161

List of Tables and Figures Tables 1.1 2.1 2.2 6.1 6.2 11.1 A.1

The excellent banks: selected data as at December 2003 4 The excellent banks 1984–2004 8 Excess value creation in financial institutions 1999–2003 10 Citigroup climbs global league tables 1999–2003 66 European bank mergers: revenue synergies promised (as percentage of combined revenue) 70 Customer lethargy and relative competition in the UK 133 Key performance metrics 1999–2003 140

Figures 1.1 4.1 6.1 7.1 8.1 8.2 9.1 9.2 11.1 11.2 11.3 A.1 A.2 A.3

Prospective ROE drives stock valuation The Handelsbanken client wheel Cross-selling and customer commitment in European banking Growth in assets and employees: three excellent banks Comparison of bank cost/income ratios 2002 The Economist survey: rating of investment banks in client service Banana skins: the top ten 1996–2003 Cycle of US non-performing loans Thousands of US banks sustain attractive returns over the past decade Superior retail banking returns in many European markets The impact by sector of the use of credit derivatives (notional amounts) Citigroup income by product and geography Fifth Third 2003 revenue contributions by business lines Goldman Sachs 2003 contributions to net revenues vii

5 48 62 76 88 94 98 101 131 132 134 142 144 145

viii List of Tables and Figures

A.4 A.5 A.6 A.7 A.8

HSBC contributions to 2003 pre-tax profit by customer group and by geography Svenska Handelsbanken operating profit by business area UBS 2003 contribution by business group UniCredito divisional contribution to net income Wells Fargo earnings contribution by line of business

147 150 152 153 155

List of Abbreviations BNC BPE CEE CEO CFO CIBD COO CSFI FDIC FICC GCIB GDP HR IPO IT M&A PCP RAROC ROE SBC SHB SME TNS UBS VAR

Banco Nacional de Credito Immobiliario Banco Popular Español Central and Eastern Europe Chief Executive Officer Chief Financial Officer Corporate and Investment Banking Division Chief Operating Officer Centre for the Study of Financial Innovation Federal Deposit Insurance Corporation fixed income and commodities Global Corporate and Investment Bank Gross Domestic Product Human Resources Initial Public Offering information technology mergers and acquisitions Partnership Compensation Plan risk-adjusted return on captial return on equity Swiss Bank Corporation Svenska Handelsbanken small to medium-sized enterprise Taylor Nelson Sofres Union Bank of Switzerland value at risk

ix

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Introduction and Background In 1984 we wrote a book entitled Excellence in Banking, which analysed a dozen banking institutions across the world selected on the basis of their perceived outstanding qualities and performance. A clear response to the Waterman and Peters volume, In Search of Excellence, which did not cite any such examples in the banking world, it was followed in 1988 by a sequel, Managing Change in the Excellent Banks. More than fifteen years have now passed since we researched this last book, and the banking world has changed beyond recognition. Truly global banks with a universal product range and hundreds of thousands of employees comprise a new business model. Traditional investment banks have been marginalized or threatened by former commercial banking entities. The advent of stockholder value with its imperious demand for reliable and significant growth is threatening particularly the leading national banks in Europe and other midsized markets, presenting them with the choice of either extending their successful business model beyond their traditional boundaries or losing their investor appeal. The past 20 years have shown that excellence in banking, at least in the sample chosen by our panel of experts, has proved extraordinarily difficult to sustain. As we shall discuss in Chapter 1, only a small fraction of the banks featured in the 1980s books still exist as independent entities and continue to be viewed as excellent. Our response has been similar to that in the two earlier excellence in banking books. A series of in-depth interviews with the top management of nine banks selected by our independent panel of ‘bankologists’ explores the issues they face in sustaining their excellent ratings as well as their view of the future. These are supplemented by parallel interviews with banking experts across the spectrum, including banking consultants, analysts, rating agencies and senior bankers. And we have factored in our own experience as banking strategy consultants plus the insights from our other books researched since 1988 on the specific topics of bank leadership, the bank merger process, and the investment banking world which has xi

xii Introduction and Background

become increasingly integrated into our definition of ‘banking’ since the 1984 book. The objectives of this volume are threefold. 1 To evaluate the lessons from the changes in our list of excellent banks: specifically, why have so few banks survived as independent entities and sustained their superior rating? 2 To trace the evolution of issues faced by bank management and their solutions to these issues. How has best practice evolved over the past two decades? 3 To reflect the views of our interviewees as well as our own thoughts on the future shape of the banking world. What will be the key success factors behind excellence in the next three to five years? We wish to express our grateful thanks to the roughly 40 senior bankers interviewed, as well as our fellow bankologists (analysts, consultants, rating agencies and other experts) who have spent their careers studying the banking world. As in our previous books on bank management, we much prefer to let our interviewees speak for themselves in direct quotation rather than paraphrase or opine on their views! Thanks are also due to Stephen Rutt and his colleagues at Palgrave Macmillan who have supported our efforts over the years. This will be the tenth of our books they have published. Finally, a personal note of thanks to my loyal colleague of 30 years, Brenda Jenner, whose many skills have included that of shaping this volume into what you now have before you! The book begins with Chapter 1, which analyses the process of selection, interview approach and profile of the nine banks selected by our independent panel. Chapter 2 then takes a step back into history by studying the lessons posed by the ‘fallen angels’: that is, the majority of banks profiled in the 1980s books which do not appear in this one. In Chapter 3, we examine the business models of the current excellent banks to learn how they achieve competitive advantage. The key related issues of culture and people are then profiled in Chapter 4 in an effort to evaluate the change management challenge faced by many. Chapter 5 reviews the issue of leadership to determine how individual leaders have shaped their institutions. The central issue of sustaining revenue growth is then examined in

Introduction and Background xiii

Chapter 6 to determine how individual banks are addressing the demands of investors for continued earnings growth. Chapter 7 studies another current issue faced by the larger, global banks: how to manage the size and complexity inherent in their current business model. This is followed by Chapter 8 on the issues related to execution: managing costs and technology as well as the business processes needed to execute the chosen business model. Chapter 9 then tracks the evolution of risk as a management issue and compares today’s perceptions with those of the 1980s. We summarize in Chapter 10 the views expressed by our management and analyst interviews on the future shape of the business of banking and the issues they pose for today’s management. Finally, Chapter 11 presents our own thoughts on these issues, how they might be resolved, and the key success factors for excellence in the years to come. We must also tackle the critical question: to whom is this book addressed? The obvious response is students of banking in the broadest sense: graduate students, newcomers to the banking world, consultants and researchers. But our fond hope is that it might also be useful for bank management itself, as a reasonably objective and thorough appraisal of where banking has been, where it is now, and how it might evolve. London

STEVEN I. DAVIS

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1 The Excellent Banks

‘Could you suggest the names of about 10 banking institutions whom you regard as the best managed in the business, regardless of size, location or business profile?’ This was the question we posed in late 2003 to about 15 leading banking consultants, buy- and sell-side analysts, and specialists in rating agencies. We call these individuals ‘bankologists’; they are people who have spent most or all of a long career studying banks across the sector and making their living by providing independent, thoughtful insights to their clients. We made no effort to define further what we meant by ‘best managed’, although the phrases ‘best practice’, ‘best of breed’ and ‘best positioned’ often came up in the ensuing discussion. In effect, we found that most of the 10 who ultimately accepted the challenge had their own selection process: banks they knew well and admired, others which they knew less well but which had distinguished themselves against their peers over a period of decades, and some which represented a reasonable selection of geographies and business models. Some had difficulty identifying ten banks, while others went on at some length! From the lists provided, we identified ten banks which received at least a substantial minimum of votes from the ten panellists (essentially the same methodology used in the two previous excellence in banking books written in the 1980s). As our goal is not to award prizes, but rather to shape a collective view of best management practice in the banking world, we have not identified the scores for each bank. 1

2 Excellence in Banking – Revisited!

Are there more intellectually satisfying means of selecting the best managed banks in the world? Most panellists felt that our ad hoc approach was the only realistic one. Others, however, pointed out that past financial performance, usually as measured by the increase in stockholder value (generally defined as the stock price movement plus dividends per share), over a reasonable time period is the only true benchmark. Most of our panel, however, questioned this approach. It relies heavily on the start date chosen for the data series, but more importantly reflects only past performance as determined by the stock market. It is thus in effect driving with the rear-view mirror, while our focus is on today’s profile of excellence and the superior results one might obtain in the future. As pointed out by one of our panellists, a leading sell-side analyst: ‘Excellent management doesn’t necessarily reflect the best stockholder value. What the investor wants is high ROE [return on equity] and earnings growth; share performance comes afterward!’ Another approach is to take the individual ratings awarded by the major rating agencies: the perceived risk of the bank as a stand-alone institution without considering possible support from regulators and others. This was clearly the starting point for the rating professionals in our panel, yet we sensed that even in these cases the individual involved was injecting his own personal views as well. On balance, given our objectives we feel the method chosen is as good as any alternative. There is no magic in the number of banks chosen (nine), yet this provides a sample of banks based in the key geographical areas of the USA and Europe as well as three of the major categories into which analysts are increasingly segmenting the banking world: truly global institutions with a universal product range, commercial banks in major national markets, and monoline or specialist investment banks. What is missing from our sample is the vast universe of smaller, locally-based banks which fall off the radar screen of our panellists. This is understandable given their perspective of serving major investors with minimum size criteria, but it is nevertheless a flaw in the selection process. In Chapter 11, however, we make an attempt

The Excellent Banks 3

to redress the balance by pointing out how, in aggregate, such banks can demonstrate truly superior earnings performance, customer service and management quality. One can also regret the absence of banks based outside the USA and Europe. Several of our panellists suggested leading banks in Korea, Australia and Brazil, but sadly none of them won a substantial minority of the overall votes. One can also debate the inclusion of pure or monoline investment banks in our sample. In the 1980s excellence books, our panellists largely ignored them as being outside the banking world. As portrayed in Davis, Investment Banking – Addressing the Management Issues (2003) and countless other research efforts, however, the pure investment banks are very much a part of this world today. To summarize the selection process, we repeat the objective of the exercise. It is not to award prizes or predict future financial performance but rather to establish an interview sample which, however imperfect, can reasonably be expected to offer useful insights into the management issues currently being faced by leading banks, the solutions which are being applied to resolve them, and the possible outcome in terms of the future shape and profile of the business. While our panellists did select ten banks on the basis described above, sadly we were not able to arrange interviews with one of them. The nine banks thus comprising our interview sample are listed in Table 1.1, along with a brief statistical profile. Appendix 1 offers a more detailed description of their history, business profile and financial record. Our sample includes the two banks which are often paired together as rivals in the emerging segment of global/universal institutions: Citigroup and HSBC. UBS is widely seen as a European champion which may well join that select band. In the category of leading regional commercial banks with essentially a national focus, our list includes Wells Fargo and Fifth Third in the USA as well as UniCredito, Banco Popular Español and Svenska Handelsbanken in Europe. And finally, Goldman Sachs represents the segment of specialist/monoline investment banks. Figure 1.1 provides a different profile for our excellent banks. A well-established correlation exists between a bank’s price/earnings ratio and its prospective return on equity. The higher the prospective

4

Table 1.1 The excellent banks: selected data as at December 2003 Segment

Institution

Investment Banking

Goldman Sachs

Global Universal Banking

Citigroup HSBC UBS

Regional Commercial Banking

Wells Fargo Fifth Third UniCredito Banco Popular Español Handelsbanken

Equity Number of (US$ billion) employees (000s)

2004E ROE (%)

Price/ 2004E book

Projected Market annual capitalization EPS growth (%) (US$ billion)

22

19

14.8

2.08

7.7

50

104 74 28

260 215 67

19.7 13.6 20.9

2.31 2.34 2.78

12.0 14.7 17.0

253 173 91

34 9 10 3

140 19 69 13

19.4 20.4 19.7 23.8

2.49 N/A 2.08 2.97

10.4 N/A 11.3 11.2

98 32 34 14

7

10

15.2

1.59

9.0

14

N/A ⫽ not available E ⫽ Estimated EPS ⫽ Earnings per share Source: UBS, DIBC calculations, company data, Citigroup

The Excellent Banks 5

return, the higher will be the price paid over book value by investors. Figure 1.1 provides this key relationship for seven of our nine excellent banks as of the end of 2003. Our excellent banks thus fit closely the trend or regression line linking price/book to projected ROE. Goldman Sachs, HSBC and Handelsbanken are close to the 15 per cent for the average bank in the global sample provided by UBS, while Wells, UniCredito, Citigroup and Banco Popular lie further out on the trend line. Our interview process usually involved a day of in-depth, off-therecord, one-on-one conversations with three or four members of top management. We were thus fortunate to interview six Chief Executive Officers (CEOs) or Chairmen as well as other senior executives with responsibility for key functions such as retail banking, corporate and investment banking and human resources. Our interview approach was to start the dialogue with two questions to frame the subsequent conversation: what are the major management issues of concern to you, and how do you see the business of banking evolving in the next three to five years? From this dialogue emerged what have become the headings for Chapters 3–10 which follow. Not all of our interviewees felt strongly about each of these topics, but enough did to merit a broader discussion. There is inevitably overlap between the chapters, and we Figure 1.1 Prospective ROE drives stock valuation

Price/book Valuea

5 4 3

HSBC

2

Wells Fargo Banco Popular Citigroup

Goldman Sachs

UniCredito 1

Svenska Handelsbanken

0 0

5

a

10 15 20 Prospective ROE 2004

25

end 2003 price divided by projected 2004 book value Source: UBS data

30

6 Excellence in Banking – Revisited!

could have aggregated several of them. Culture and people can arguably form part of a business model, for example, while the chapter on execution naturally relates to people, risk management and leadership. Yet we have tried to reflect as best we can the emphasis placed on the issues by our interviewees. These interviews were supplemented by similar off-the-record conversations with members of our panel, other banking experts and senior bankers with a particularly interesting perspective on the issues involved. But before turning to these issues, let’s take a few steps back in time to review the fate of our previous interview samples in 1984 and 1988.

2 Lessons from the Past: Two Turbulent Decades

‘We would have had to do it [the merger with First Union] eventually.’ John Medlin, former CEO of Wachovia A comparison of the current list of excellent banks with those of 1984 and 1988 mirrors both the transformation of banking as well as the perspective of bankologists. We cannot pretend to any intellectual rigour in such a comparison. While panellists were asked the same question on each occasion, the number of banks on each list are not comparable: from 16 banks in 1984, the number has been reduced to nine in 2004. Moreover, the definition of ‘bank’ has been expanded to include investment banks. We nevertheless feel some generic observations can be made. Table 2.1 compares the three lists. Mergers and acquisitions of banks subsequent to their appearance in an earlier list are indicated so that the reader can determine which still exist as an independent entity and are therefore eligible for inclusion in subsequent excellence lists. The first conclusion is no news to any reader of the financial press: the global trend towards consolidation has taken its toll of excellent banks as well as their peers. Of the 12 excellent banks in the 1988 list, four have since been acquired (Bankers Trust, JPMorgan, National Westminster and S.G. Warburg), while two others have merged with peer banks (UBS with SBC and Wachovia with First Union); this represents an attrition rate of 50 per cent due solely to the consolidation process. Admittedly 15 years is a long period of time, but the Darwinian impact of consolidation has clearly transformed the sector. The term ‘overcapacity’ has become almost synonymous with 7

8 Excellence in Banking – Revisited!

Table 2.1 The excellent banks 1984–2004 1984

1988

2004

Citigroup HSBC Swiss Bank Corporation Union Bank of Switzerland

Citigroup HSBC

Citigroup HSBC UBSa

Bankers Trust JPMorgan Wachovia Toronto Dominion Bank of Tokyo (merged) Bayerische Vereinsbank (merged) Deutsche Bank Security Pacific (acquired) Sumitomo Bank (merged) TexasCommerce Bank (acquired) Barclays Bank SE Banken

Union Bank of Switzerland (merged) Bankers Trust (acquired) JPMorgan (acquired) Wachovia (acquired) Toronto Dominion

Deutsche Bank

Credit Suisse National Westminster (acquired) PNC Financial S.G. Warburg (acquired) Wells Fargo Svenska Handelsbanken Banco Popular Goldman Sachs Fifth Third UniCredito Notes: Banks merged or acquired subsequent to interview date are indicated accordingly Current bank name applied as appropriate for earlier dates a UBS in 2004 is the result of a merger between the old Union Bank of Switzerland and the Swiss Bank Corporation

the word ‘banking’, and consolidation has been a major structural consequence of this overcapacity. Within this universe, the attrition due to consolidation around the investment banking sector has been particularly acute. The disappearance of S.G. Warburg, Bankers Trust, the former JPMorgan and the old Union Bank of Switzerland can be largely attributed to

Lessons from the Past: Two Turbulent Decades 9

less than totally successful efforts to sustain their independence in the battle to climb league tables and win market share in this fiercely competitive business. We discuss below in more detail the struggle of individual excellent banks and possible explanations for their loss of independence. The second transforming influence has been the advent of stockholder value as the dominant theme of investors and its consequent impact on management behaviour. Over the past two decades, international institutional investors have accumulated, from a modest base, an estimated 30–40 per cent of the outstanding stock of most major banks in Europe and other markets as well as an even greater voice for change in the metrics of success. Physical size is yesterday’s benchmark. Today’s mantra is stockholder value, which essentially is an increase in the price of one’s stock plus dividends received. The result has been a change in perception of what constitutes excellence. We sense that the choice of excellent banks in the 1980s was heavily skewed towards larger banks whose rating was more a function of size and likely levels of external support than management quality and earning power. Thus the Japanese banks dropped off the 1984 list in 1988, while in 2004 a number of mid-sized commercial banks such as Fifth Third, Banco Popular Español and Handelsbanken appeared for the first time, despite having outperformed their peers regularly over the two decades. The gold standard for today’s institutional investor in bank stocks is thus an institution which can boast reliable growth in annual operating earnings, preferably from organic sources, and ideally in the double-digit range. The nine banks in our latest excellence list fit this standard like a glove. Thus the consultants Mercer Oliver Wyman in their 2003 annual study conclude (p. 9): ‘Experience has taught us the hallmarks of firms that are likely to outperform their peers: ● an unequivocal focus on economic returns; ● organic growth driven by innovation; and ● serial acquisition and rapid integration into a market leading platform.’ The firm cites as an example of this profile one of our excellent banks, Fifth Third. While any ranking based on historical stock market performance is open to dispute, we note that four of our

10 Excellence in Banking – Revisited!

excellent banks are listed in Mercer Oliver Wyman’s ranking of those who have provided the highest excess (over the risk-free rate) value creation over the past five years. Table 2.2 summarizes the top ten financial institutions in this metric. The evolution of our excellence sample raises several other observations. First, our panel’s choices in several cases have been less than brilliant in the light of 20–20 hindsight. In 1988, for example, the panel picked the old Union Bank of Switzerland and dropped Swiss Bank Corporation, the institution which ultimately in 1997 acquired it and has since been restored to our current list. The entry to the list of Credit Suisse Group in 1988, just before Credit Suisse First Boston (CSFB) suffered massive losses in the USA, and that of National Westminster to replace Barclays were, with perfect hindsight, unfortunate to say the least. Second, the risk factor – whether reputational, credit or market – has taken its toll of excellent banks since the 1980s. Chapter 9 explores in more detail today’s perception of this issue, but at this point one can simply note that three stalwarts on the 1988 list – Bankers Trust, Toronto Dominion and Credit Suisse – all suffered from serious losses in the 1990s and early 2000s which ultimately Table 2.2 Excess value creation in financial institutions 1999–2003 Name

SPI*

Value created (US$billion)

1 2 3 4 5 6 7 8 9 10

167 181 124 167 422 107 120 146 106 187

116.1 47.7 43.8 38.8 30.1 27.4 19.7 19.0 18.4 17.5

Citigroup Royal Bank of Scotland Wells Fargo HSBC Holdings UnitedHealth Group Bank of America Barclays PLC BNP Paribas UBS Société Générale de France

*SPI is an index comparing individual stock performance on a risk-adjusted basis to the median in the 400-company universe on a five-year rolling data series. Source: Mercer Oliver Wyman (2004)

Lessons from the Past: Two Turbulent Decades 11

resulted in their restructuring (Credit Suisse), acquisition (Bankers Trust) and, arguably in the case of Toronto Dominion, exclusion from the current excellence list. Thus Toronto Dominion, for so long a leader in lending to specialist sectors such as energy and communications, suffered serious losses in 2002 when the businesses went through a difficult period. And a former Credit Suisse executive we interviewed in the 1980s now expresses his frustration at their losses suffered in New York: ‘The First Boston people in New York saw the big Swiss milk cow. They saw the potential of derivatives to make wine out of water by posting liabilities into the future. It became a nightmare.’ What conclusions can one draw from such apparent miscues? Quite apart from the difficulty of comparing the various lists, one is inclined to be forgiving in a world where investors are regularly surprised by problems known only to top management until they hit the headlines. The readers of the financial press in 2004 will recall the names of Worldcom, Parmalat and Enron. The bottom line from this statistical comparison is that only two banks – Citigroup and HSBC – have appeared on all three lists with some sense of corporate continuity, although each has expanded by merger and organic growth to an entity barely recognizable today from its profile in the 1980s. Today’s UBS can be regarded in the same vein as a merger of two banks (the former Union Bank of Switzerland and the Swiss Bank Corporation), one of which has appeared on the list on each occasion in the 1980s. However one classifies these three global institutions, they have been the beneficiaries of the consolidation wave and, as we discuss in subsequent chapters, should continue to be so in the future. Finally, one should note that four banks which had appeared on both lists in the 1980s and retained their corporate identity – Deutsche Bank, Toronto Dominion, PNC and Credit Suisse – garnered only one vote among them on this occasion. In sum, banking is a consolidating and dynamic industry which remains difficult even for the experts to read! We turn now to examine in more detail how individual excellent banks on the 1988 list addressed these issues of consolidation and stockholder value. To provide an informed perspective on these

12 Excellence in Banking – Revisited!

issues, we have interviewed a number of the senior executives involved in the decision-making process, including several we met in 1988, as well as independent bank analysts and other experts. Dominating the strategic challenges for most of our 1988 excellent banks was the issue posed by the integration of the capital markets and commercial lending. In 1994, we prepared a global study entitled Global Investment Banking: Which New Players will Make the Team? (Davis et al., 1994). Recognizing the threat to their core commercial banking business from disintermediation, over 30 banks analysed in this report had committed themselves to becoming serious competitors to the traditional investment banks led by the dominant US ‘bulge group’ such as Goldman Sachs. Virtually all of the leading commercial banks in the USA, UK, France, Germany, Japan, Spain, Switzerland and Italy thus aspired to convert their lending-based corporate skills and relationships into a more broadly-based relationship embracing the debt, equity and advisory businesses. Our conclusion in that study was that few of these aspirants would make the grade, but one in particular – JPMorgan – had the requisite culture, product capability and corporate relationships to do so. The bank also happened to have been the unanimous choice (the only one) of our 1988 panel for our excellent list! To quote this 1994 study, ‘We believe that JPMorgan is the only aspirant in recent years to join the leading US investment banks as a truly global securities firm.’ Underpinning our conclusion was that Morgan had the strong risk management and derivative skills, strong and committed top management leadership, a fully integrated global structure, the ability to attract and retain superior people and competence across a broad range of products. So why did JPMorgan in 2000 feel it necessary to merge with Chase Manhattan? Clearly displacing rivals such as Goldman and Morgan Stanley would be a difficult mountain to climb, but most observers in the early 1990s felt the bank was already close to the summit. We encountered a number of emotional as well as hard-headed responses, but four seem in aggregate to summarize the strategic

Lessons from the Past: Two Turbulent Decades 13

dilemma facing JPMorgan. The first is expressed by a JPMorgan veteran still with the merged bank: ‘I’m sad that it happened, but we’re a far stronger bank than we were on our own. Sandy Warner [the CEO] had to deal from a very tough hand, but he got $32 billion [the purchase price] for a company 90% of whose profits were derived from trading, including lots of proprietary trading. We didn’t make a penny in equity and M&A [mergers and acquisitions], partly because of the high cost level. Fund management and private banking were 5% ROE businesses. So derivatives and prop trading paid the bills. We had lots of good, smart people but needed lots more capital and clients. Chase brought the capital and clients. How did we get here? We missed some opportunities when we had the competitive advantage. At one point we were bigger [in market capitalization] than Merrill, Citibank and Morgan Stanley. What were our mistakes? We were too inward looking, a little cocky and snobbish, very conservative, and feared screwing up a very special culture or going outside our area of expertise into, say, retail banking. We wanted to build it ourselves.’ Another perspective is supplied by Allan Munro, a senior adviser in the consulting firm Greenwich Associates with responsibility for commercial banking (and also a former JPMorgan banker):

‘They moved too quickly into investment banking – not a bad idea, but they thought that their customer relationships were so strong that it would be easier than it was. They therefore abandoned their core banking business – using their balance sheet – too quickly. Thus they took away any differentiating factor which could have been used to elbow their way into investment banking. Corporate clients looked to them as a corporate bank, while Citibank and Chase were 800 pound gorillas who used their balance sheet to push their way in. Morgan became too vulnerable to market factors. They could have competed in debt capital markets, using their credit with chief financial officers, and they also had distribution relationships with correspondent banks and insurers. It was different in equity and M&A; they had the reputation but not the equity skills, and the revenue flow from the blue chip clients wasn’t available to them fast enough to compete in the US.’

14 Excellence in Banking – Revisited!

Ray Soifer, a former banker and now a US-based banking consultant, opines that: ‘Morgan’s strategy wasn’t big and bold enough to be competitive. In the equity business, after 10 years of trying to build, they had world class expenses and middle market revenues [according to Morgan’s CEO]. In hindsight, why not an acquisition? Their answer was “We aren’t good at acquisitions.” Morgan had not done a major acquisition since 1959. Arguably their commercial banking culture was too ponderous – not fast enough. In sum, it’s tough to build an investment bank out of a commercial one – tougher than they anticipated.’ The final word belongs to Walter Gubert, the London-based Chairman of the global investment banking business of the merged JPMorgan Chase and a veteran of Morgan’s struggle to join the ranks of the global leaders. Regretting our panel’s decision to exclude JPMorgan Chase from the excellent list, he makes some sound points: ‘I firmly believe we are one of the excellent banks. Just look at what’s happened to market shares in investment banking recently. JP Morgan Chase is in the top three or four in every major category – the result of bringing together advisory capabilities and balance sheet capacity. We have a combination of expertise and staying power. Look who’s gained market share recently – Citigroup, Deutsche Bank and ourselves. JP Morgan could have made it on its own, but if we wanted to be better positioned and sustain our vision, a merger made sense. Clients are getting fewer and bigger through the merger process, sector by sector, and they want to deal with fewer banks. In a complex world, they want a few key relationships – banks with broad shoulders and staying power. That was the rationale for the merger, and the merger was exactly what the doctor ordered. When I see clients today, we’ve got behind us the clout we never had before.’ In sum, Morgan’s management faced an enormously difficult decision over the issue of whether to merge, but the result was ultimately consonant with the forces of consolidation and stockholder value. Another case study of one of our 1988 excellent banks fighting the investment banking wars was that of Bankers Trust, which ultimately

Lessons from the Past: Two Turbulent Decades 15

was bought by Deutsche Bank in 1999 as a vehicle for entering the US market. Facing the same challenges as JPMorgan, Bankers Trust lacked the corporate client base of Morgan but was a leader in the derivatives market, a pioneer in allocating capital via the riskadjusted return on capital (RAROC) model, and boasted a charismatic leader in Charlie Sanford, who featured in our book on leadership in financial institutions (Davis, 1997). While the bank’s reputation was stung in 1994 by lawsuits from clients accusing the bank of misleading them on the risks from complex derivatives, Sanford left behind him on his retirement in 1996 a profitable bank which subsequently suffered losses in 1998 in Russia and other markets before being sold to Deutsche Bank. The bank’s fate has provoked a remarkably wide range of epitaphs. Sam Theodore, the head of rating agency Moody’s financial institutions practice, opines that: ‘Bankers Trust was well managed, particularly with its RAROC and credit risk management processes. But it focused only on investment and corporate banking and had a high risk profile. If you have good risk systems, you think you are masters of the universe. That’s what happened: first there was the 1994 hit and later losses in Russia and other emerging markets.’ A more negative slant is voiced by Jim Freeman, a leading US investment banking consultant: ‘Bankers Trust was out on the derivatives extreme – far out on the risk spectrum. They went down the creative path too far, and, like stranded salmon, they died.’ Perhaps the most balanced view is expressed by consultant Ray Soifer, himself a former Bankers Trust executive: ‘The roots of its problem go back to 1914 when it lost its raison d’être [as a trust company]. They’d been trying to reinvent themselves ever since! They tried to be a junior grade JP Morgan, and then they entered the New York retail market but lacked scale. In investment banking, they pioneered the origination and distribution of loans and the derivatives business. But their strategy was dependent on the lower end of the credit spectrum, and they became dependent on the capital markets for earnings. The competition

16 Excellence in Banking – Revisited!

had a more diversified earnings stream, which ultimately did them in as they became dependent on high risk sectors like high yield and emerging markets.’ A final case study of one of our 1998 excellent investment banks is that of S.G. Warburg, the leader in UK investment banking but a midsized player on a global scale which was ultimately sold to today’s UBS. David Scholey, who managed the four-way merger in the 1980s which created Warburg and who was CEO until just before its sale to Swiss Bank Corporation, explains the thinking which lay behind the decision to sell: ‘It goes back a long time. Not long after I joined Warburg in the mid-1960s, I became aware that Sir Sigmund believed that eventually his firm would become part of a bigger organization. There were frequent flirtations with partners of the best quality! Once the Eurobond business developed on a large scale, it became a bus we couldn’t get off. We were increasingly at a bigger and richer table but with a smaller pile of our own chips! When Big Bang came, we slowly got rid of our non-banking business to focus all our resources on investment banking. Having combined with partners to build a multi-capacity group, the next major move was a major international combination, and we and Morgan Stanley picked each other. It ran into difficulties with a debacle in December 1993 – a terrible blow to what could have been a marriage made in heaven. We then had no option but to wait it out, and in a few months were fortunate to find ourselves with our old friend Georges Blum and with a new friend Marcel Ospel in Swiss Bank Corporation, whose subsequent development into today’s powerful UBS is truly remarkable.’ These case studies of three of our excellent banks, each of whom had a legitimate claim to a role in the global investment banking world, bear witness to the powerful competitive positioning of the US investment banking leaders such as Goldman Sachs and Morgan Stanley which had invested heavily in building global franchises in the 1990s. A similar wave of consolidation has taken place in the commercial banking sphere. One of the victims among our 1988 excellence list was National Westminster, at the time one of the most highly rated of the UK clearing banks. How could such a bank with a massive

Lessons from the Past: Two Turbulent Decades 17

retail business earning over 20 per cent return on equity have fallen prey in 2000 to one of the two hostile bids made for it? The explanation offered by a former senior banker there demonstrates the power of stockholder value in deciding a bank’s fate: ‘There were two reasons for losing our independence. First, we were engaged in a five-year retail transformation programme to improve our productivity. Our client service would have improved, but it was a long, expensive and complex process. Essentially the market isn’t geared for five-year change programmes. Management was seen not to have demonstrated enough progress. Secondly, top management was determined to do a major transforming acquisition in the financial services sector. We had a strong acquisition currency and made what was seen as a hugely overpriced agreed bid for the insurer Legal & General at its peak share price. It wasn’t the ideal transaction– synergies really were marginal – and there was tremendous investor impatience.’ The result was separate hostile bids from the two Scottish banks, and Royal Bank of Scotland not only acquired a bank much larger than itself but also became a role model of success in UK bank merger integration! A happier ending for one of our excellent commercial banks in 1988 was that of Wachovia in the USA, which under the leadership of its CEO, John Medlin, had become a role model as a successful, conservatively managed regional bank. Having retired in 1993, Medlin recounts the strategic thinking of his successor which ended with a friendly merger of equals in 2001 with First Union, a fellow North Carolina-based bank: ‘Wachovia bought several banks in the 1980s and 1990s but emphasized quality, not size. To maintain quality, we didn’t grow as fast as NCNB [another Carolina-based bank] and First Union, who made more and larger acquisitions. Meanwhile Wachovia did well in expanding into Virginia and Florida. In the late 1990s, the competitor banks in the Southeast were much bigger. Wachovia needed to spend the same on IT [Information Technology] costs with our $60–70 billion in assets as one with $200–300 billion, so there was a need to accelerate growth. In 2001, they looked at the US

18 Excellence in Banking – Revisited!

banking landscape, including banks in other regions, but they had different cultures. It made more sense to merge with banks in the same operating climate. Bud Baker [Wachovia’s CEO] had a good relationship with Ken Thompson [the CEO of First Union]. Selecting the CEO was not a problem as Bud was about to retire at 62. The two banks together were number one or two across the Southeast. So it was better to merge with them than someone who was further afield to get the synergies. Bud and Ken developed a merger plan – as painless as possible. So it was a storybook merger, which is fairly unique in banking! There was no great urgency to do the merger, but we would have had to do one eventually. It was a bold and visionary proposition which has proven very successful.’ The history of these excellent banks thus mirrors the key trends in banking over the past two decades. Efforts by commercial banks to transform themselves into universal institutions with a strong investment banking capability have met with few successes due to muscular resistance from the incumbents, the limitations of the existing culture, the difficulty of acquiring or recruiting top talent and a host of other barriers. Only Citigroup among our 1988 sample has successfully climbed the investment banking mountain with a business model we shall discuss in the next chapter. The story of Credit Suisse and its absence from our current excellent list is a fascinating one. While its rivals struggled to build a USbased investment banking capability, Credit Suisse already owned a US bulge bracket firm: the former First Boston. And its highly regarded management team in the 1990s included Josef Ackermann, now CEO of Deutsche Bank and a highly respected leader of this contender for global banking honours. One of our interviewees in Credit Suisse for the 1988 book, a former member of the bank’s Executive Board, tells a story of failed leadership: ‘Something went wrong. We were rightly admired for the quality of our senior management. If you look across the Swiss banking scene today, you will see former Credit Suisse bankers everywhere; it’s not true for SBC [Swiss Bank Corporation] and UBS [Union Bank of Switzerland]. The bank lost too many of them. Why is Josef Ackermann the head of Deutsche Bank today and not Credit Suisse? It’s a valid question.

Lessons from the Past: Two Turbulent Decades 19

Our strategy failed. First Boston wasn’t a bad idea but it was badly executed. The Chairman [Rainer Gut] and others did not have power over the investment bank. Buying Winterthur was a stupid idea. We had a good Executive Board but it should have done much better. Unlike the Board in the post-Chiasso period, we didn’t work as a strong team. There was too much ‘divide et impera’; too much power in the Chairman, who had ultimate power, and the individuals on the Board neutralized each other. The test of a good CEO is how he resolves his succession, and in this Rainer Gut failed. It was a pity. He brought in an outsider, who was very smart and hard working but didn’t have the banking experience and credibility necessary for this position.’ The demands of institutional investors for sustained earnings growth with a low risk component have fuelled a merger wave which has obliged even a successful commercial bank such as Wachovia to seek a merger partner. For banks such as Bankers Trust with a less than stellar risk management record, or NatWest with a perceived management weakness, the investor welcomes a merger led by a stronger management term. On the positive side, three of our old standbys from the 1988 excellence list remain in 2003. Why have they succeeded? One cynical answer is that of Chris Ellerton, global banking strategist in UBS’s equity research department: ‘Banks get into problems as often as not by being too clever for their own good. Corporate history suggests that many banks remain in business in spite of and not because of themselves. There is fantastic durability in the business models. Being successful often means not screwing things up.’ We hope that there is more to excellence than this, but the lessons of the past two decades should be etched in our minds as we read the following chapters!

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3 Shaping the Business Model

‘We’re the new model.’ Senior Executive, Citigroup

One phrase dominated the dialogue with our interviewees which we had not heard in 1988: ‘our business model’. While we don’t pretend to a textbook definition for the phrase, we have taken it in banking to mean the particular combination of client/geographic/ product mix as well as culture, client focus and execution processes which should produce a lasting competitive advantage. This is not far from the phrase ‘strategic positioning’ which was the topic of a chapter in our 1988 book, but with an important difference. Then many of our interviewees also voiced the query, ‘What business are we in?’ The corporate bankers were understandably worried about disintermediation from the capital markets and the perceived need to have an investment banking strategy, while retail bankers were concerned about competition from the asset management and life insurance businesses. In the intervening years, these questions of positioning have been largely resolved – with varying degrees of success – so that today the overriding challenge is to refine and execute the strategy (or, as is now the phrase, the business model). The following chapters will address specific dimensions of this overall challenge, but here we shall briefly summarize the key ingredients of the business model and how each of our excellent banks defines its particular execution issues. 21

22 Excellence in Banking – Revisited!

In this context, the key issues of concern to our excellent management teams include the following: 1 How do we export a successful domestic commercial banking model to other geographic markets? 2 How do we improve customer service to differentiate ourselves from competitors? 3 How do we adapt our corporate and investment banking model to meet the challenges of the new universal competitors such as Citigroup? 4 How do we establish a brand which ensures client loyalty? 5 What role will acquisitions have in this model? 6 How do we manage the inevitable geographic/client/product matrix implied by a global business? Let’s start with Citigroup, the largest banking institution in our sample, and one with arguably the newest and most admired business model. By successfully grafting investment banking acquisitions on to a global corporate and consumer bank, the Chairman, Sandy Weill, and his team have achieved not only a truly universal institution but also one which has generated sustained earnings growth and a high ROE in a difficult operating environment. This strategic nirvana is reflected in the unsolicited accolades for Weill in our 2003 book on investment banking as well as admiration in the current interview series from peers such as UBS, JPMorgan Chase, Goldman Sachs and HSBC. A senior staff executive at Citigroup expresses management’s pride in its achievement and awareness of its uniqueness thus: ‘Since the 1999 legislation in the US breaking down product barriers in financial services, we’re the first modern company; we’re the new model. There’s tremendous scrutiny of us and tremendous excitement; no one has really put commercial banking and investment banking together. Others will try to copy us, but we’re so far down the playing field that we don’t need to look back. The financial sector is consolidating and we’re a consolidator. The corporate and investment banking model is working; the clients like it. There are no peers for Citi! The challenges are all inside the group. We sit in meetings and see the potential of what we’ve built. Our problem is to get

Shaping the Business Model 23

out of our own way. We have all the products and are in about 100 different countries with the potential to cross-sell across countries.’ His enthusiasm is echoed in London by Sir Win Bischoff, Chairman of Citigroup Europe and a member of Citigroup’s Management Committee: ‘On the consumer side, with all credit to John Reed and Walter Wriston, we’re the largest global retail bank, much bigger in earnings terms than the Global Corporate and Investment Bank [GCIB]. The GCIB has gained a terrific position in the past three years, and our research shows we are well ahead of our competitors in most business lines. The challenge is to translate that into something that is lasting. Part of our success is to have successfully managed the lending process to assist our investment banking efforts. The issue is whether, when companies are healthier, we can retain our market share.’ In New York, Hans Morris, Chief Financial Officer (CFO) for the GCIB, acknowledges the group’s strengths and points to some of the items on their ‘to do’ list: ‘Citigroup has the deepest product array of any financial institution serving the largest 2000 corporate clients in the developed markets, which enables us to provide certain services that only we are capable of delivering. When we do this well, we have incredibly deep vertical penetration in a client – as IBM does, from shop floor to boardroom. Our trading businesses are similar in breadth, and we believe we have more customer flow than any of the monoline investment banks. The issue we discuss is expanding this and increasing the proprietary trading we do.’ HSBC, the only other bank which has made our excellence list three times in its original corporate form, has the Citicorp business model very much in its sights as it grafts a home-grown investment banking capability on to a well-established global corporate and consumer bank. Its CEO, Stephen Green, who took over the top management slot in 2003 after 21 years in the bank, describes the current model and the challenges it poses: ‘In the past five years HSBC has grown largely by acquisition, adding roughly 100,000 in staff to bring us to 230,000. It’s a big extension of our

24 Excellence in Banking – Revisited!

business: including a new market in Mexico and HFC in consumer finance. You can look at the bank in two ways. First, an extraordinary, balanced platform operating in 79 countries; our challenge here is to make it perform to achieve maximum efficiency and stockholder value. For each customer segment, there’s opportunity for organic growth. Second, an opportunity to develop the brand in all respects for each of our five customer groups, including the new one of consumer finance. We can grow each of them. For example, we have the largest international middle market business of any bank – over 2 million clients. The most interesting synergy, which will take time, is to develop consumer finance in other markets like Mexico, Brazil, China, India and Turkey. There’s lots, lots to do!’ For Green, the decision to unite all the former brands of a decentralized organization under the HSBC label has been a landmark one: ‘From a standing start in 1998, the impact in terms of brand recognition has been extraordinary. We’re behind Citi in the global top 50 brands as measured by the Interbrand survey, but we’re the only British brand in that 50. There’s more to be done to finally establish the brand as a customer experience in all markets with differentiated service, earning a reputation for integrity and strong commitment to corporate and social responsibility.’ HSBC’s Chief Financial Officer, Douglas Flint, emphasizes the bank’s willingness to take the long view: ‘We worry about the long term. All managements have the same challenge: having the discipline to make investments today whose benefits won’t be realized for two generations. We’re not portfolio managers; Fidelity can do that. It takes tremendous discipline to say “What do I bring to this investment?” It’s about avoiding damage to the business model long term even if it costs something in the short term. And maybe only half of these decisions will work out well. Investments like China, India and Brazil can only pay off in 15–20 years. It’s easy to do the me-too deals, like bancassurance or fund management.’ Bill Dalton, the recently retired head of the personal financial services (retail) business segment, emphasizes the opportunities from moving from a pure geographic focus to one of global client segments:

Shaping the Business Model 25

‘The whole has become greater than the sum of the parts as a connected global enterprise. Now we’re driven by the market. In the past we at Midland Bank [part of HSBC] were kidding ourselves; we had no interest in what happened in Hong Kong. It’s very simple stuff: we tell people that the real stockholder value is in the HSBC group.’ Arguably the biggest challenge to HSBC’s business model is building a fully-fledged investment banking capability on the back of strength in fixed income and treasury products. The co-head of the Corporate and Investment Banking Division (CIBD), Stuart Gulliver, summarizes the task facing him and his co-head, John Studzinski: ‘We’re rolling out on a global scale our strategic plan in Asia for multinational clients. The leading competitors do it better! In equities, the old model from 1986 of commission-based research is out: instead, we’re pushing two priorities: corporate finance and trading mandates. There’s a substantial headcount reduction; we need fewer and different people, with tighter research and trading ideas. The strategy is to turn it and push it out to clients with a risk-based approach.’ Our third global excellent bank, UBS, also faces the challenge of executing a business model largely based on acquisitions of people as well as firms. In both its wealth management business, where it is the largest in the world, and its global investment banking entity, client focus and selling a unified brand across the bank are two key targets. Its CEO, Peter Wuffli, analyses the transformation: ‘In the nineties our focus was on transformational development through large deals: O’Connor, Brinson, SG Warburg, the SBC–UBS merger and finally Paine Webber. Now we are committed to organic growth. Many analysts love acquisitions but will never admit it. We’re sometimes accused of being boring! The integration model is a work in progress. There are no short cuts. The concept goes back to the pre-merger UBS/SBC. We had a big debate and knew it would be hell: “Why are we doing this?” But we decided that it wasn’t worth the effort if we didn’t succeed in building one firm. The goal is to be integrated with the client as the centre, being served across all

26 Excellence in Banking – Revisited!

businesses and leveraging all synergies. It was a huge leap of faith – incredibly far from reality – at the time. We calculate the economic benefit of integration at about 15–20% in added value.’ The renowned Goldman Sachs business model is evolving under pressure from its larger global rivals as well as the need to sustain revenue growth. Their Managing Director, Lucas van Praag, explains: ‘The business model has evolved. Goldman Sachs started as a trading firm and still is one. Competitive pressure to use our capital is intense. Some people like to suggest that Goldman Sachs is a hedge fund with a banking business attached to it, but the reality is much different. It is difficult for observers to separate client facilitation from pure proprietary trading. Grasping the dynamics of the business is essential to understanding how firms like ours operate. Increasingly, for example, fixed income transactions require us to acquire risk from clients although we clearly have no interest in holding a proprietary position. We’ve also successfully emphasized other business activities, like asset management where we were a relatively late entrant. The challenge from large commercial banks has increased and our response has been to focus on our core franchise businesses including mergers and acquisitions, and IPO [Initial Public Offering], equity, and equity-link underwriting as well as developing a strong position in high yield-securities. But we don’t want to be number one in everything – pursuing market share in areas that offer little or no profitability makes no sense to us.’ Jide Zeitlin, the Chief Operating Officer (COO) of the Investment Banking Division of Goldman, describes how the model is being adapted: ‘What areas have contributed disproportionate earnings during the past several years? Many of our trading oriented businesses, particularly within fixed income as well as currencies and commodities. Our investment banking business has successfully weathered a difficult market, in large part, by aggressively reducing expenses. Our banking business is profitable – increasingly so. Meaningful growth in profitability, from these levels, must now be driven by revenue growth, not further cost reductions. Can we drive revenue with our legacy investment banking practice alone? Our legacy businesses are important and clearly have room for material growth, but this business alone cannot offset any meaningful declines in trading revenues were the

Shaping the Business Model 27

yield curve to flatten or credit spreads to widen. The most attractive opportunities for incremental revenues lie at the point of convergence between the capital markets and traditional investment banking. An increasing proportion of our most significant projects involve the firm aggressively using its balance sheet, in public or private markets, to facilitate client objectives. This is very different than the primarily agency business in which many of us were reared. Over the next six to eighteen months, you will see many firms, perhaps including ours, take steps to structurally more closely align their investment banking businesses with large parts of their corporate-facing trading businesses. An example of this convergence of our trading and agency businesses took place with a client who is in a very cyclical industry. This client needed to raise funds to refinance existing high cost debt and to finance large capital expenditures. Given this client’s depressed stock price and cyclical earnings, they were not prepared to sell equity and they could only raise limited incremental funds in the fixed income markets. But, because our commodities traders understood the market for this client’s products, our firm was willing to write a series of put options, where we bore the risk for our own account. Our options guaranteed the client that, if its earnings fell below a prescribed level, we would make them whole up to that level. With this added security, fixed income investors now had greater protection against our client’s earnings volatility. With this protection, investors were willing to lend more to our client at a lower cost. We took principal risk in advancing our balance sheet in a muscular fashion. Our client was able to access the capital markets to raise acutely needed liquidity in a volume and at a cost that otherwise would not have been achievable.’ Goldman’s Vice-Chairman, Robert Steel, puts the business model change in broader terms: ‘In the past investment banks led the way to securitization and as a result gained business from what historically had been the province of commercial banks. Now commercial banks like Citigroup have come after that business using capital commitments as a new business tool. Twenty years ago, 80–90% of our revenues came from agency business; today a large proportion has some form of capital commitment, either as a back stop or committed lending!’ In the world of regional commercial banks, the business models of the excellent banks tend to be better established with superior client

28 Excellence in Banking – Revisited!

focus, well-established brands and a proven ability to integrate smaller acquisitions. The challenge in the EU thus tends to be whether the model can be exported to other geographic markets to sustain revenue growth. Svenska Handelsbanken (SHB) in Sweden has a decentralized, branch-based model which is the envy of many of its peers in terms of its ability to provide not only excellent client satisfaction ratings but also an impressive cost/revenue ratio, low credit losses and steady growth. Introduced by its former CEO, Jan Wallander, in the early 1970s, the basic model continues to function successfully under the current CEO, Lars Grönstedt. Grönstedt articulates the challenges faced by his model: ‘In a mature financial market like Sweden, growth becomes a challenge, as it is hard to see many segments that can grow faster than GDP [gross domestic product]. Some banks will do mega mergers, but SHB is not a believer. You can’t control this kind of growth. We believe in organic growth supported by some acquisitions. For successful organic growth, structure is important: the issue is how fast you can grow without losing control in terms of people, loan losses, reputation, etc. [Another challenge] is market share. You have to be secure in the model. There was price competition in deposits, and we lost market share. We decided not to launch a high yield savings account. We were vindicated; our market share recovered, but that wasn’t obvious at the time. Our model has the customer at the centre, not products.’ Lennart Francke, currently head of control and accounting but also former head of credit, points out the dynamic of the Handelsbanken model: ‘The most important factor in our performance is the model, supported by our culture. Outsiders think there was one big change in the early 1970s, but there have been lots of them, not because the environment has changed, but also because there’s an internal dynamic in the model. For example, we couldn’t decentralize everything at once in the 1970s, so some products like custody and foreign business were integrated later. Our big challenge is to stick to the model but also to develop and improve it. When you think about a problem, there are always alternatives. There have been mistakes, like applying our pricing model to Stadshypotek [a mortgage

Shaping the Business Model 29

bank] after the acquisition; we found after about a half-year that it was too complicated for such a big institution. It’s not just a model for Sweden; it has worked in other Nordic countries. They’re different and we’ve coped with the differences. Its strength is its flexibility and power to cope with differences. In a sense it’s similar to franchising – with the constraint that you never allow people to invest in their branches!’ Another highly successful and well-established commercial banking model in Europe is that of Banco Popular Español, Spain’s third largest stockholder-owned bank. As in the case of Handelsbanken, the model was introduced in the early 1970s by its current co-Chairman, Luis Valls, and has since generated not only steady earnings growth but also regularly the highest ROE of any major European bank. It is also a branch-based system but focuses on the SME (small to medium-sized enterprise) sector and features affinity group packages which target the unique needs of the particular client group. Banco Popular’s Chief Financial Officer, Roberto Higuera, explains why the old model needs modifying to sustain the bank’s remarkable earnings record: ‘In the late 1970s we changed our model to concentrate on the retail market in Spain. It’s still roughly the same model, but now we’re making a very important change. We were focused on the corporate market – in particular the SME – and the people in the branch network are oriented to serve these firms. We don’t want to destroy the SME business, but we want to build the retail segment. We’ve already begun to build our home mortgage book, and we’re promoting the deferred payment debit card to expand the retail client base. We’ve already got five million retail clients, and we see consumer finance as an unexploited market – a good complement to our corporate business. It’s taken years to build the technology, the client segmentation and the credit scoring skills. But all this requires different human skills from servicing SME clients, which involves in-depth knowledge of the client situation to make credit decisions and following short-term developments closely. In our existing business, a good affinity group client might buy seven products on average. While products are important, our focus is the customer and understanding the customer relationship.’

30 Excellence in Banking – Revisited!

While Banco Popular and Handelsbanken have business models which have been tested over three decades, that of UniCredito in Italy dates only from 1998 and is based on the merger of a number of disparate savings and commercial banks. A strong management team led by its CEO, Alessandro Profumo, has now restructured the bank along customer segments in an effort to win market share by offering a level of customer service which would be unique in Italy. While UniCredito has built a successful network by acquisition in Central and Eastern Europe (CEE), management is concerned about the ability to export the model into more developed markets. Alessandro Profumo describes the bank’s principal challenge as follows: ‘We have to demonstrate that our strategy is a good idea! The concept is that the customer becomes more sophisticated; therefore banks must be excellent in know-how and competitiveness. Thus you need a specialist organizational structure to provide better quality service. The logical sequence is increased market share and a premium market price and increased sales of the group. It hasn’t yet been demonstrated in financial services that there is a clear correlation between quality of service, specialist advice and market share. We haven’t proved this ourselves, but I’m sure we’re right! In Italy there’s a huge demand for service quality which leads to more customer satisfaction. The key is brand-recognition of the quality of a brand, rather than extracting cost synergies. Higher productivity means you’re not forced to do deals and risk overpaying. Expansion into the CEE isn’t enough. In five years we’ll become a multicountry player in the EU. There’s room for creating value in cross-border consolidation. The key is the separation of production and distribution in many different areas, with a factory in products like fund management, investment banking and treasury. Only distribution will be local.’ His colleague Roberto Nicastro, who now heads the retail bank but formerly created UniCredito’s network in the CEE, elaborates on the correct business model: ‘Our innovation in New Europe (the CEE) was to travel a path not yet beaten out: cross-border retail banking. Retail is a local business. Only a few banks can do it – the Spanish banks in Latin America and HSBC and other pan-European/global banks. You can think of two approaches: as a financial

Shaping the Business Model 31

conglomerate with totally empowered management, or using the same model everywhere. We’re somewhere in between. We’ve found a complex but more effective solution: the matrix. Top management and functional centres of competence for credit risk, IT, etc. It’s a complex challenge to make it work, but it’s the only way to end up having “UniCredito inside” in each country and still adapt to local diversity.’ Pietro Modiano, UniCredito’s head of corporate banking, extrapolates the strategic dilemma for ‘best of breed’ banks such as UniCredito which attract imitators who then narrow the gap with the industry leader: ‘At a certain point, your future growth will be lower than in the past. The laggards tend to grow faster. You’ve been successful but they haven’t. The stock price of excellence doesn’t rise in relative terms, and you find yourself in the trap – the paradox of excellence! If you stop growing faster than the others, your market price falls. Sooner or later the market will believe you can’t sustain it, and you have “excellence with a falling stock price”. If you’re the owner of a company, you can be happy with a growing dividend tied to the value of a successful company, but stockholders look at the market price! The easy part of the job is done – improving best practice. Now you have to invent best practice in every field, which may not be sufficient. How can you be perfect everywhere? I don’t know! The immediate challenge is to be better than what we’re praised for – running a new divisional group model. Then we have to plan a new phase of growth in Italy – which is out of our control, and decide what we do internationally.’ One of our two excellent US regional banks is Wells Fargo. Formed in 1998 by a merger of two large regionals based in California and Minnesota, Wells under the leadership of Richard Kovacevich has grown organically and by the acquisition of smaller US banks to become the country’s fourth largest banking institution. Its focus is the retail and SME markets, and it is admired for its strong top-down marketing-oriented business model. Dick Kovacevich, the CEO, articulates Wells’ business model and the challenges it poses for management in the following terms: ‘It’s all about revenue. You can’t consistently grow over the long term as we have without growing revenues. Banking is only growing at roughly the rate

32 Excellence in Banking – Revisited!

of GDP growth. Therefore you need to take market share. Our target of 10% revenue growth is truly a stretch target; we should be able to grow profits up to 50% higher than revenue growth. Why are we winning market share? Because we’re passionate about selling. If you do anything passionately for 15 years [his tenure as CEO] you’ll make it! You can’t sell eight products per customer [their long-term target] unless you’re the customer’s choice for investment products. Narrow-based companies are forced to take excess risk because, even when you know macroeconomics will go against you, no one knows when, or has the guts to tell the stockholders “I’m going to slow down the business”, because you’ll get killed by the competition. But a diversified financial services company has choices; if you slow one business down, you can make up for it with other businesses. You may not grow as fast as a pure play, but there’s steady growth over time.’ Dave Hoyt, who has responsibility for Wells’ corporate banking business, profiles their concentration on middle market companies: ‘Our value added is to deliver relationship banking. I would estimate that 80 per cent of our middle market clients are privately-owned. There’s a gap for people like ourselves with local delivery, continuity and local decision-makers. Do we deliver? Complexity rises with cross-selling; it’s harder to deliver service with a broader range of products. More complexity makes it harder to connect all the dots. In the middle market we have 55 regional corporate banking offices staffed by mid-market bankers, mostly credit-led. The issue is how to grow the relationship.’ His colleague, John Stumpf, with responsibility for the bank’s retail function, highlights the difficulty in sustaining revenue growth: ‘Our key issue is repeating double-digit revue growth. You can only do it if you can win and hold the business. Keeping it is as important as acquiring it. To win business in the long term, you need to develop a relationship model with team members [the Wells staff]. There’s a correlation between engaged team members and satisfied clients. Great products are not good enough if the service is just average. You can’t fail at the point of contact.’ Fifth Third is one of our rare excellent banks which is totally content with its well-established, highly profitable and steadily growing

Shaping the Business Model 33

business model. The CEO, George Schaefer, describes his happy state: ‘There’s no fancy strategic plan. Everybody understands the business model: it’s 99% basic execution. Banking is a pretty simple business; there are no manuals like nuclear physics. It’s just rate times principal times time! We run the business in a decentralized way. The competition has a line of business model, whereas each of our 17 affiliates has a local CEO and the selling is local. The model was established before I arrived. We tell the banks we acquire: here’s the way we operate – and it works! Why change the model? It all depends on how hard you want to hustle. We’re in the Midwest or the old Rust Belt as it is called, and accustomed to recessions. We’ve got the fifth best margin [25%] on revenues, and we’re here in five Midwest states with only 7% of the market. In our home state of Ohio alone we compete against 200 other banks, 120 thrifts [savings banks] and 570 credit unions. It’s still very fragmented, which represents tremendous upside.’ While each of our excellent banks has a different business model and is at a different stage of executing this model, what is striking are the common issues so many of them face. Dominating the ‘wish list’ is providing superior client service, which is the key to cross-selling and winning market share. Co-ordination across the organizational structure is another, especially for banks which have grown largely by major mergers. And extending a successful commercial banking model to new markets is a particular challenge to the European regional banks. The growing divergence between retail and corporate banking is clear from the comments above. Retail banking continues to be a relatively straightforward business where client service and local relationships are the critical success factors. In corporate and investment banking, however, the evolution of the business model begun in the 1980s continues as Citigroup (and possibly other universal institutions) successfully graft an investment banking activity on to a corporate client base. We now examine in more detail how the excellent banks address these and other issues as they execute their business model in practice.

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4 People and their Culture

‘You always need values … the question is whether they are real.’ Sandy Weill, Chairman, Citigroup Each of the business models described in the previous chapter draws heavily on the bank’s culture, whether existing or envisaged. In our 1988 book, Managing Change in the Excellent Banks, two chapters were devoted to people and their culture: one focused on managing different cultures, the other on meritocracy (an ideal culture where the best and brightest people are motivated and rewarded according to their merits). Both themes were largely driven by the strategic imperative at the time to build an investment banking capability on a commercial banking base. Today the dominant strategic theme is to create a customeroriented culture in which the client not only receives superior service but also is motivated by an attentive and informed salesperson to buy more products and services from the same provider. Thus crossselling and service quality underpin most of the retail as well as investment banking strategies of our excellent banks. What, however, is culture? Perhaps it is not only necessary to define it but also to dig a bit more deeply into the nature of the beast and, more importantly, how it might be changed if the current one is deemed dysfunctional for the bank’s chosen business model. In our earlier books, we have simply accepted culture as ‘the way we do things around here’, or more precisely as ‘a complex set of values, beliefs, assumptions and symbols that define the way a firm conducts its business’ (Barney, 1986). A bit of academic research, 35

36 Excellence in Banking – Revisited!

however, yields a host of different definitions and models. The one which resonates for us, however, is the model developed by Edgar Schein of the Sloan School at the Massachusetts Institute of Technology (MIT) which differentiates between artefacts, values and assumptions. Artefacts are the visible, physical manifestations of culture: offices, overt behaviour or a way of dressing. More important – and durable – elements, however, lie beneath these artefacts, such as the values of an organization: normative, moral and functional guidelines that help members deal with certain situations. These values over the years have proved useful for the organization and thus become embodied in an ideology or organizational philosophy which serves as a guide for dealing with the real world. Most relevant for our purposes, though, are the deep-seated assumptions which underpin these values: what Schein calls ‘unconscious, taken-for-granted beliefs, perceptions, thoughts and feelings – the ultimate source of values and action’ (Christiansen, 1999). Especially in a mature organization (such as a well-established bank), these are particularly well embedded and, therefore, difficult to change. They are not debatable. And if they are questioned, there is an enormous release of anxiety and defensiveness. With regard to mature organizations, Schein (1988, p. 314) points out that ‘the most important elements of the culture have now become embedded in the organization’s structure and major processes … The culture now comes to be taken for granted … It is more difficult to decipher the culture and make people aware of it because it is so embedded.’ What might this imply for banking? Is banking different from other organizations? Our research detected virtually no systematic study of banking cultures. But McKinsey & Co. have embarked on a series of some 15 cultural change projects, of which several are banks. Colin Price, McKinsey’s head of organizational practice in London, summarizes his experience: ‘Banking isn’t different from other businesses. It might have been because of the risk factor or public scrutiny, but basically their product is customer satisfaction – essentially dealing with intangibles.

People and their Culture 37

Culture and leadership have low priorities for most banks. Things we used to hear from industrial companies a long time ago we still hear from banks, such as “If we have good products, the rest will follow”, and “Just tell people what to do.” If you look at the time top bank management spends on building a culture versus other tasks (like lending money or marketing), you’d see the difference. When you go from the top ten in a bank down the line to thousands of employees, there’ll be cultural problems. But at GE they don’t talk about a “problem down the line”. My own conclusion is that, in two to three years, a fanatically dedicated leader can change the culture in a bank. Our clients have spent a lot of time and money on this, but it’s all about good leadership.’ What are the values and assumptions in banking which might hinder the implementation of the business models of many of our excellent banks? Judging from the behaviour patterns which our interviewees wish to change, they could include the following: ●

●

●

●

a dealer or investment banker who assumes that, since he arranged or booked the deal, it is his, and he should reap the benefits regardless of the assistance of his colleagues; a product specialist who focuses on his expertise area at the expense of joining in a marketing effort to win some business from actual clients; a branch banker who joined the bank to lend money but is unhappy when told he must market a broad range of non-lending services; and a country head who sees no reason why he should introduce a highly paid product specialist from head office he does not know to a client relationship he has carefully nurtured over the years.

Thus the culture to which most of our excellent banks aspire is one in which the aggregate benefit to the bank is the ultimate goal as opposed to the ‘silo’ or ‘my business’ thinking which tends to prevail in many banks. Collaboration across business units for the good of the bank is thus rewarded. The customer is truly king, and superior service will enhance that relationship as well as generate revenues from cross-selling. Reviewing the relevant chapters in Managing Change from 1988 in this context makes depressing reading. The Chief Executive of Credit

38 Excellence in Banking – Revisited!

Suisse Group, Robert Jeker, talked of his total commitment to three values – speed, friendliness and competence – which did not outlast his tenure and certainly did not prevent massive losses being incurred in the New York investment banking businesses on high risk ‘bridging’ transactions and derivative exposure. At Bankers Trust in New York, Al Brittain as CEO communicated the value of ‘common purpose’, although subsequent behaviour by some of his independent-minded dealers was anything but that. And at Citibank, the head of North American corporate banking explained that he was ‘working on’ bridging the gap between corporate and investment bankers in the group, a theme still on the agenda 15 years later in a transformed Citigroup. Among the other excellent banks in 1988, creating a common, meritocratic culture with values shared across the bank was also a goal in National Westminster, HSBC, Deutsche Bank, Toronto Dominion and the former Union Bank of Switzerland, but the results achieved by that generation of leaders were modest at best. Even where the culture is a positive one, as in the case of the former JPMorgan, we have seen in Chapter 1 how Morgan’s culture based on ‘doing the best business in the best way’ arguably was a barrier to change as it debated in the 1990s the arguments for and against a merger. One of our analyst friends in New York, referring to the bank, speaks of a ‘Shakespearean tragedy. What creates a great institution bears the seeds of its downfall.’ Yet our excellent banks today have returned to the offensive even more determined to incorporate new values and assumptions in the behaviour of their colleagues. Understandably this offensive is even more relevant for banks which have grown largely by acquisition across geographical areas and businesses. And by and large they are using the same change management tools that have been part of management’s armoury for decades: intense communication from top management on values and behaviour, recruitment and indoctrination, reward systems and leadership behaviour. Let’s start with Goldman Sachs, whose meritocratic and clientoriented culture is a role model for its peers in the universal and investment banking sectors. Its culture is underpinned by 14 values which were established in the 1970s and which stand out as an example of effective corporate governance. Appendix 2 lists these values, which are repeated in each of the firm’s annual reports and in

People and their Culture 39

our view are unique across the banking world in their durability and frankness. The list begins significantly with the commitment to put the clients’ interests first. John Andrews, a Goldman Managing Director, views the firm’s culture as the key management issue: ‘We understand better than anyone else that everything comes out of people and the culture they operate in. The issue is how to sustain a culture with 20,000 people on the payroll. If we get it wrong, nothing else matters.’ The Vice-Chairman, Bob Steel, a 28-year veteran of the firm, talks of the role of the firm’s values: ‘The culture has developed over a long time – it shapes our behaviour. The hardest thing in our business is when you must choose between doing a piece of business which requires bending some of our values or passing on that opportunity. It’s where the rubber hits the road – pushing the envelope, knowing that someone else will do the deal if you don’t. That’s when your values get tested. I don’t like the thought of not winning! But if you start compromising your business standards and values, it becomes a slippery slope.’ Jide Zeitlin, a member of Goldman’s Partnership Committee, describes the role played by the firm’s PCP (Partnership Compensation Plan), which was established subsequent to the IPO to recreate some of the advantages of the old partnership: ‘Our culture, our fundamental values are relatively unchanged. We have sought to maintain an ethos of working across, not solely within, silos. We refer to it as “eating off the same plate”. There are roughly 300 men and women in the PCP, with participation determined by performance and, to a much lesser degree, tenure. Half of the pool is awarded on the basis of points in the pool that are set every two years so as to encourage working for the whole firm. The remaining half is discretionary and varies widely by individual.’ Adds his colleague, Lucas van Praag: ‘One of our strengths is an extraordinary buy-in to the culture. It’s a function of an exhaustive selection process. We’re looking for the very

40 Excellence in Banking – Revisited!

best – people who will challenge the status quo, but not in a disruptive way; people who embrace the ethos of fair play but also have energy and enthusiasm. Teamwork is probably the most identifiable external indication of our culture; the word “I” is rarely used. This is not the place to be if you want to be a star.’ Living up to the 14 values has also been a challenge. Van Praag continues: ‘You struggle with the beast inside you every day – it’s a sort of muscular religion! The values set out the firm’s expectations and they also provide a road map. People are expected to stop and think about what they are doing and what is morally right and good for the client. That said, there have, sadly, been lapses, like embracing the Internet bubble, where with hindsight we should have realized it was too good to be true!’ HSBC is a particularly interesting case study of building new values and assumptions on a traditional conservative commercial banking culture. One of our panellists (who voted for HSBC’s inclusion in our excellence list) comments: ‘HSBC has managed doggedly to maintain a culture of personal judgement, management unencumbered by sophistication, but still stockholder-valuebased management.’ A more negative but trenchant comment comes from another banking consultant: ‘HSBC has retained its culture despite its growth. But it is one of the greatest bureaucracies I’ve ever seen in my life! This is not meant to be negative. It is the methodology they use to control a far-flung empire without breaches in behaviour leading to unexpected losses!’ For Green, the CEO, diversity and collegiate collaboration are key dimensions of the solution: ‘We have different career paths but common training in the UK. Senior management contact comes very early and is interactive. Basically there’s no secret or surprise in management development. Nurturing culture is a significant task which is never finished. You need a different balance in each

People and their Culture 41

customer group between customer and geography. There’s a need to share best practice in each segment. Every culture in the world is represented in our work force, and we can deal with clients on an international scale. There are two ways to look at the situation: either we enforce uniformity of policies on staff or we celebrate richness and diversity and build on that. The first can’t be done, and the second is more fun and profitable! Cross-posting is one solution, and we don’t do nearly enough. It’s hard to get it right. You need Human Resources working with the businesses. There’s no great secret: graduate recruitment, cross-posting and an eye on the potential of future leaders.’ His colleague, Douglas Flint, acknowledges culture as a major issue: ‘The flip side of the top 30 people in HSBC having worked together for a cumulative total of about 800 years is that a very substantial portion of our colleagues has been here less than five years. If success is due to agreement on goals and values, how do you ever sustain them when the group is so big? People have to work together in many different ways – to be collegiate and avoid the empire building in which people fight each other and the customer loses out. So the biggest issue in bringing people into the family is culture – in our case being a team player, being collegiate.’ On the corporate and investment banking side, change management is the dominant theme. Stuart Gulliver acknowledges that: ‘It’s a huge challenge. You need to choose people who are collegiate without diluting everything. You need a compromise – combine local presence with global product strength – the old Federal model. The local guy has the relationship but needs outside specialists. The glass of water is only half full, and we’ve got a long way to go to leverage these strengths. I’ve brought in 11 people from the Asian business – all agents of change, disciples. We’re letting 40 people go. There’s lots of communicating around the network, going for early wins, focus on successes, etc. the key is personal relationships– the glue that holds HSBC together. We WILL pull this off!’ His co-head of CIBD, the former Morgan Stanley investment banker John Studzinski, faces the daunting double challenge of being a newcomer to HSBC as well as being charged with building an equity and advisory capability virtually from scratch:

42 Excellence in Banking – Revisited!

‘We’ll hire the right hundred people, cherry picking those with the right culture and able to offer the right service proposition to the client. My biggest challenge? People have to trust me – they stand on my and Stuart Gulliver’s shoulders. It’s not about having a big team, but having the right team. We can create a boutique in a global framework.’ Retail banker Bill Dalton addresses a dramatic cultural change needed in branch management: ‘For a century young men in Britain coming into the bank assumed their future was lending; credit authority was tattooed on their forehead – a macho thing! But 50% of our commercial clients don’t borrow! Now his job as a relationship manager is to look after the client’s overall needs, not just make loans.’ UBS is another global bank trying to drive change in a diverse group of newcomers to the organization. Their CEO, Peter Wuffli, points to client focus as a critical element in the change process: ‘Our client relationship officers may be close to their clients, but they often forget to ask for business! What can we do? We’ve progressed in the past few years but have a long way to go. Client work starts at the top of the bank. We’ll have maybe 100–150 joint client business plans each involving maybe 100–150 people across the organization. Plenty of projects to create awareness. But really it’s motherhood and apple pie! No bank brand is perceived as being client-focused. People have to know and trust each other. It will take two–three years of calling together. You’re asking, for example, someone who has been developing relationships in the Arab Gulf for 20 years to bring into the relationship an investment banker he doesn’t know. Some people say: “Why don’t you just tell him what to do?” I’d be disappointed if he then agreed to bring the investment banker in! It starts at the top, and we’re half way there.’ For the Chairman, Marcel Ospel, who has shaped today’s UBS, the challenge is culture, but maintaining, rather than changing it: ‘In the past 10 years we’ve enjoyed a very entrepreneurial culture and managed with a high degree of meritocracy and intellectual honesty in

People and their Culture 43

resolving issues. We’ve successfully fought bureaucracy despite our size, and we’ve had success in managing the integration process.’ In UniCredito, another organization built recently largely by acquisition, Roberto Nicastro repeats the mantra about the importance of people. ‘Our biggest challenge? It’s always the same – people, their selection and management, the soft stuff – getting the right DNA. They tend to be the stars and they have to work as a team. You have to ensure that they’re always motivated. If you succeed, there’s no limit to your growth and what you can achieve. In my old job running the CEE region and my new one in retail, I’ve learned that you not only have to create the team, but all must use the same approach to functioning as a team – from the top down to the tellers in the branch. It doesn’t always happen, but it’s the overarching challenge. We’re not selling soap, but rather services and solutions, which is heavily impacted by those on the front line. Concepts are the same across borders, but how you translate them is different – taking local culture into consideration. From Procter and Gamble to Goldman Sachs, there are a lot of things you can standardize, but not a hospital or bank, which have a heavy service component.’ For his colleague, Andrea Moneta, cohesiveness among the top team is a critical success factor: ‘We have to keep the management team as cohesive as it is now. We lost our head of retail [Luca Majocchi] without trauma – a very good performance. The secret? We don’t fight each other. Lots of people are very smart and work hard, but you also have to respect each other and share a common vision and culture!’ Pietro Modiano describes their success in integrating the acquisition of Pioneer, a US fund manager, in the light of the double challenge of a cross-border as well as a cross-functional transaction: ‘People said you can’t execute a fund management take-over or change the culture of a fund manager. We did both. We selected people – it was both friendly and selective – and gave the impression that the

44 Excellence in Banking – Revisited!

new Italian owners weren’t politicians! We kept the best colleagues – as we do everywhere. We changed a lot, but the best people were happy. Our ideas were clear, and we changed management to give the impression of unified leadership.’ Our perennial excellent bank Citigroup has undergone a cultural transformation since 1988 from the Citibank we knew then. Its chairman, Sandy Weill, the architect of both the new structure and its cultural values, points to the success of the handover following his retirement as CEO: ‘Citigroup’s strength is measured by the management transition: all the key people are still here and present in the new model, unlike the situation in other companies after a major transition. We’ve got a great business model which will be hard to copy. Our values are not just four words on Lucite on everybody’s desk. Each sector has its own meaningful values and targets. You always need values – there’s a compelling case. The question is whether they are real!’ Hans Morris, the CFO of the corporate and investment banking arm, describes in more graphic detail what he terms the ‘secret sauce of Citigroup’: ‘What’s the difference between Citibank [before the Travelers merger] and Citigroup? The former had lots of talent. Some has left, but I think we’ve done a good job of capturing talent and giving it more opportunities to excel. What’s the secret sauce? It was the contribution of the Travelers culture: intellectual honesty of the numbers; clear accountability; and entrepreneurial zeal: “We can do anything we set our minds to do.” This is a talent-driven business: good people want to work here.’ Another Citigroup executive, who joined at the time of the merger, confirms this view: ‘We were a mutt of a company when we started after the merger. In five years we’ve become incredibly entrepreneurial, truly global in the way we manage the company. The top people are hands-on managers, very numbers-oriented, with terrific discipline.’

People and their Culture 45

For Sir Win Bischoff, the cultural challenge remains: ‘We need to test the thesis: how do you keep a group of people together in better times? How to make sure people feel Citigroup is a not a behemoth – OK to work for in tough times, but you leave to join Goldman Sachs or a boutique in better times. It’s a cultural challenge in the GCIB.’ Fifth Third has become an icon in commercial banking for a powerful sales culture with an intense focus on the client. As in the case of Banco Popular and Handelsbanken, it goes back several generations of management. The CEO, George Schaefer, explains: ‘An ingrained culture of trusting capitalism inside the company works well. We’ve found that when our expectations are clear, you keep score and publish the results, the measure of success is well-defined. This helps eliminate some of the arrogance; if we had been in Texas we might not have survived the 1980s! My two predecessors made major contributions to shaping our culture of hard work, cost control, sales and hustle. Bill Rowe provided two core values: pristine credit quality and expense control. After him, Clem Buenger in 1979–89 turned the place upside down. He had two themes: you needed to work hard to grow the business, and you had to instil a sales culture.’ For Bob Niehaus, Executive Vice-President (EVP) with responsibility for the retail affiliates: ‘The big management issue is people in terms of developing current employees and recruiting new additional talent consistent with our growth strategies.’ Executing the client-focused, marketing-oriented culture of Wells Fargo is a central challenge to Dick Kovacevich’s team. The retail head, John Stumpf, talks about the client relationship function: ‘You need a great leader in the workplace that recognizes and advocates diversity and is willing to invest in team members. We measure turnover and engagement – for example “do you have a best friend at work?” You have to treat the customer like a friend – help them navigate through a big bank like Wells. If someone calls up and asks for euros for a trip, it’s not

46 Excellence in Banking – Revisited!

enough to give him the 800 [telephone] number but also ask “When and where can I deliver them?” How is a customer treated in stores? Is the customer welcomed and thanked for the business?’ On the corporate side, Dave Hoyt discusses the ubiquitous problem of organizational ‘silos’ in banks: ‘When we put the group together [in 1998], the old Wells was more silooriented. People needed to get on the same page. It was the biggest change since the merger and took lots of time. The intelligent ones understood that revenue growth is the key. The vast majority of people now have grasped the concept; it comes with time and collaboration. We’ve made a lot of progress, but still have a long way to go to improve the continuity between groups in the wholesale function. We have a large number of client groups; how do you manage the continuity between them? Continuity of people is the biggest factor. Most of my direct reports have been around for about 20 years or more, and decisions are made close to the client.’ Pat Callahan, the human resource head, describes the central role of communication: ‘We say “people are our competitive advantage”, but in reality we’re hiring from the same talent pool as Bank of America and others. And we don’t always hire the top end of business graduates. Therefore we have to do something different to get unusual performance. It’s the cultural challenge for HR [human resources]. We have turnover on the front lines like any retail company. How do you give the right kind of service – the fundamental people issue? Cultural change doesn’t require decades. There was a perception that we had different cultures from past mergers, but we’re now seeing coherence in the network. How did we get coherence? The message is clear: it comes from commitment at the top. The CEO repeats the message over and over again. The cultural message is part of all our messages: crossselling, financial goals, etc. People love hearing Dick [Kovacevich] talk – but 95% of what he says he’s said before. Consistency over the long term drives cultural change. We track it every 18 months with a full-company survey of all employees – all 135,000 people! They did get the message. For example 89% of the people like the kind of work they do. There’s room for improvement, like the ability to solve a customer’s problem quickly – it’s still too hard.’

People and their Culture 47

The good news for these excellent banks is that culture change can and does take place in their peers. But it does take time – decades, in fact. In the commercial banking sector, both Banco Popular Español and Svenska Handelsbanken began in the early 1970s to create the client-oriented culture which continues to sustain their outstanding performance. And the key individuals who sparked the transformation are still active today: Jan Wallander of SHB who has just written a book about the transformation, and Luis Valls who is still co-Chairman of Popular. As Wallander explains in his book (2003, p. 17): ‘The fundamental problem one is faced with when organizing a company is how to get a number of people to co-operate with in each other in a harmonious way and move towards an established goal with enjoyment, commitment and even enthusiasm … steering by means of positive signals is one of the central concepts of the Handelsbanken “philosophy” … a bank manager’s job is to make sure that the people who work in his or her office think it is a pleasure to go to work every morning.’ Michael Zell, a Handelsbanken veteran who now runs the key Central Sweden region of the bank, describes how the culture actually works in practice and possible issues for the future: ‘The wheel [see Figure 4.1] is clever; it ties everything to the client. We don’t do budgeting, but we do have activity plans for customers – what to emphasize for individual relationships. In the region we start with branch plans for our 82 branches, then turn these into individual plans for each employee: “If this is the branch plan, then what about you?” This plan is followed frequently by the branch and regional heads. Annually there’s a comprehensive discussion, a substantive evaluation with salary reviews at the year end, broken down by unit. It’s all negotiated by the branch manager; we don’t give him any ground rules or maximum imposed from the centre. It’s a very local exercise. If the other parts of the wheel have been performed well, with good feedback and review talks, the actual salary decision is a no-brainer. For some, however, it can be very upsetting. It works better than I thought it would. The role of the branch manager has changed. He used to be the number one business developer. Now he’s more like a coach, spending lots of time on feedback, working on plans, salary reviews, etc., which used to be decided at central level.

48 Excellence in Banking – Revisited!

Figure 4.1 The Handelsbanken client wheel

Business plan process

Salary Dialogue Review

Business plan Customer

Planning dialogue and performance review

Individual follow-up Action Plan

Source: SHB

If you do it well, you get so much more out of people. Their salary development is in their own hands. But there are negatives in this empowerment too. It’s very demanding; people have to look after themselves. If not, there’s no place in SHB for you. What are the issues for the future? Are we becoming fat and lazy? Are we hungry enough? Part of our success is that we’ve always asked ourselves that question! It’s better to be Avis, but we’ve been Hertz for a very long time! Are we careful enough with recruiting and development of people? Can we attract the best in class? Lots of our people won’t move from one location to another – are these the people who will move mountains!?’ Lennart Francke describes a reversal of roles in the traditional dialogue between the centre and the branches: ‘The central functions [including his] are closely scrutinized by the operating units, who are the buyers of their services. The head office units really have the operating units’ fingers in their eyes; they have to prove they can add value.’

People and their Culture 49

Banco Popular’s culture, which has been shaped since the 1970s by its co-Chairman Luis Valls, is profiled by Personnel Director José Luis Luengo: ‘We think we have the best people in the banking system. We recruit only people with a university degree and usually put them to work for their first few years in branch assignments. We say that “They start in the kitchen”. Our key values are ethics and client focus. The word “client” is written in big gold letters – like a brand – on their forehead! The client isn’t just king – he’s an Olympic God! People are proud to work at Banco Popular – it’s like the old JP Morgan, and we pay market salaries! But our people have to sell – it’s a major success factor. We have branch managers in their mid-20s who have full responsibility for all the clients in the branch. Our internal studies show that we have the highest customer satisfaction measure of all Spanish banks; clients feel closer to our bank. Our main issue in human resources is career planning. We want to keep people until they retire and place them in jobs in accordance with their skills. So our major task for the future is to define the necessary competencies and evaluate our people accordingly. We want to move them around the network, both in terms of geography and function. Thus a regional manager approaching retirement might have worked in 10 to 20 different branches.’ So the bottom line from these excellent banks is that there is full agreement on the kind of culture needed to execute the business model, whether a retail or investment banking function. ‘People who sell’ are essential across the banking spectrum. And the examples of Handelsbanken and Banco Popular, at least in the retail arena, prove that such a client-focused, high performing culture can be created by a determined, consistent top management effort. But the big issues are the time needed for such a transformation (we shall return to this issue in the final chapter), and the leadership factor, emphasized by Colin Price of McKinsey, which is addressed in the next chapter!

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5 The Leadership Factor

‘My main mission as CEO has been to create one vision and set of values.’ Peter Wuffli, UBS What kind of leadership runs the excellent banks? Are banking leaders different from those in other businesses? What is the track record over time of leaders in the excellent banks? Fascinated by these questions, in 1997 we wrote a book profiling some 20 CEOs in financial institutions who were widely viewed as successful leaders. Our conclusions were interesting but not particularly surprising. Leadership style (for example, democratic versus dictatorial) was much less important than ‘walking the talk’: that is, actually performing in line with recommended behaviour. We found that leaders in banking do roughly the same things as those in other organizations: focus on a firm strategic course, listen with empathy to what is going on around them and display great energy in communicating and executing the agreed strategy. We also determined that years, if not decades, are necessary for durable cultural change. A leader’s values are important, but they can be soft (respect for the individual) or hard ( achieve profit targets). Good communication skills, physical presence across the organization and a simple message are to be recommended. Among those leaders profiled in 1997 are a pair – Luis Valls of Banco Popular and Marcel Ospel of UBS – who continue to chair two of today’s excellent banks. More recently, we were delighted that our panel’s judgement was vindicated by the 2003 Financial Times survey 51

52 Excellence in Banking – Revisited!

listing the top 50 most respected leaders in the world. Only two bankers were in the list, each heading one of our excellent banks. Alessandro Profumo of UniCredito ranks thirty-first (after not even appearing in the previous survey!) and the ubiquitous Sandy Weill has the forty-ninth slot. So what have we learned about successful leadership from the interviews for this book? How in particular have they managed the cultural change demanded, or sustained a successful existing culture? How important, for example, are leadership style, tenure and cultural values? Let’s start with Peter Wuffli, CEO of UBS, who has the task under the leadership of Marcel Ospel of implementing massive cultural change: ‘Since 2001, my main mission as CEO has been to create one vision and set of values. We’ve changed the Executive Board and really established a team only since last July [2003]. The Executive Board is 100% behind the agenda; as CEO I can choose the team! We need alignment at the lower levels also so that people know and trust each other, and share client and talent relationships. Positioning the brand [to a standard “UBS”] has been the biggest decision. It’s important because it’s the ultimate feedback from the businesses – the belief in one name. Discussions in the past were all about “Do we have commitment to the group?”; there was always concern about being spun off. Now the investment bankers really buy in. Paine Webber [the US broker] has been the biggest surprise: a dramatic change for them as a US household name. Our people were actually asking for the change. We’ve learned a lot about branding. Ninety per cent of it is what the brand stands for. It was initially very controversial, but in the end it was totally smooth. For me it was the ultimate test; management has bought in!’ In sharp contrast, Lars Grönstedt of Handelsbanken has a very different challenge: to adjust the decentralized, Swedish-oriented commercial banking model established by Jan Wallander 30 years ago to the demands of the market today. Asked about the changes he has made to this model, he quips: ‘Had I been a revolutionary, I wouldn’t be President and CEO today! I’ve just adapted the model to different times and provided a little bit more

The Leadership Factor 53

direction toward growth – more explicit focus on international, investment banking and life insurance. For example, Jan Wallander in the 1970s wrote a monthly letter to all branch managers. Now I write it to all employees. I’ve had a good return from it; all 10,000 employees now feel they are in direct contact with the CEO. I’ve consciously spent more time on business outside Sweden. There’s been no big change in the management team. Our strategy document “Our Way” is up for review; it won’t change much in terms of objectives, etc., but we need to clear out the undergrowth of things that were added and which sounded good at the time.’ UniCredito’s leadership challenge is perhaps best described by one of CEO Alessandro Profumo’s senior colleagues, Andrea Moneta: ‘Profumo and his team run the bank. If you talk to Profumo about any aspect of the business, he knows the detail. But if the empire grows too much and too fast, you risk losing that deep knowledge of the business – you risk losing control. Don’t bite off more than you can chew. You have to measure the management capabilities against growth appetite and to invest in the former to finance the latter. This is precisely what UniCredito does!’ As mentioned above, Profumo was listed as the highest-ranking bank leader in the Financial Times 2003 survey of fellow CEOs. Rarely is a large bank so closely identified with the skills and personality of its CEO. Dick Kovacevich’s passion for growth and customer service drive Wells Fargo’s culture as well as its strategy. One of his senior colleagues offered us some unsolicited praise of their leader: ‘Dick is the best value in banking today, the most gifted leader in business without exception. He’s strong-willed, intelligent, eschews the pack, and makes tough, unpopular decisions. It’s the difference between “Go” and “Let’s go!” You’re part of his team … We have a leader – Dick – who cares passionately, and spends time in the field where the reality is.’ Another strong leader on the US banking scene is George Schaefer of Fifth Third, who has headed the bank for the past 16 years. For

54 Excellence in Banking – Revisited!

him, leadership is synonymous with directing and enforcing from the top Fifth Third’s rigorous sales and cost reduction efforts: ‘If someone is below plan, I’ll ask him for an action plan. Everyone knows and understands the expectations. We break it all down. They drive each other. We move the bar up! If you’re at the bottom of the performance scale, there’re a lot of people looking at you! And it applies all the way up the organization. We had a meeting of the 17 affiliate Presidents and I asked them for their suggestions of a target for loan growth. They suggested a 20% increase. I told them “We’re going to double that. Let’s see what happens.” After a few months, 20% of them had exceeded the new goal; they figured out how to do it!’ As his CFO, Neal Arnold, puts it: ‘George has an almost maniacal focus on daily execution. He knows the numbers [relative performance] of his people!’ The comments of his colleagues give some idea of their CEO’s leadership impact. His long-standing colleague, Bob Niehaus, explains: ‘George’s leadership goes back to his days at West Point [the US Military Academy] where the top student sat in the first seat in the first row and the rest in the appropriate order. It’s carried over into his lining up our 950 branches in order of performance, so everyone knows where everyone else is. If you’re at the bottom, you can call the people at the top for help. Everyone wants to be part of the winning team.’ Brian Lutes summarizes the position from the standpoint of Fifth Third’s human relations function: ‘You don’t want to miss your numbers; you just can’t!’ The issues of diversity and change management facing Stephen Green at HSBC are massive. When asked what his leadership priorities are, he responds: ‘HSBC is a broadly-based institution with five customer groups, but each has its own priorities. HSBC is both large and complex. It can only work on the basis of teamwork. We have a strong sense of collective management; people who have worked together for years, but who are also able to take in new talent like John Studzinski. On the one hand, there’s collective management but also an openness enabling us to bring in talent at the senior level when it’s appropriate.’

The Leadership Factor 55

Shaping the new investment banking strategy has been one of his particular priorities. John Studzinski points out that: ‘Co-heads on Wall Street are a political accommodation. This isn’t. Stephen [Green] is the architect; he knows no one could do it on his own. The two of us [Studzinski and Stuart Gulliver] together in a change management context are pretty formidable.’ In the world’s largest banking institution, Sandy Weill at Citigroup has left his leadership mark despite retiring from the chief executive slot in 2003. In our investment banking book written in 2003, the unsolicited accolades from our interviewees for him and the institution he led surpassed those for any other investment banking leader: see the selection of quotations taken from Davis (2003) below. ‘They are winning mandates with their combined CIB model.’ – Nordea ‘Sandy Weill is obsessed with cost control.’ – Boston Consulting Group ‘They’re continually questioning what they do; they’re the most driven people I’ve ever seen.’ – Greenwich Associates ‘Citi has both the balance sheet and the bull terrier mentality.’ – Lehman Brothers ‘Sandy Weill is the real winner [in the acquisition game].’ – JPMorgan ‘Sandy Weill seems to walk on water.’ – NM Rothschild ‘Citi is on the way to becoming the truly global investment bank; and Sandy has an incredible eye on the dollar.’ – First Consulting ‘They have the products, but not yet the client model.’ – Morgan Stanley ‘Another success story for multiple acquirers.’ – Lehman Brothers One of his senior colleagues comments on Weill’s decision to retire: ‘Sandy saw that the business heads are working well as a team. We’re now in a transition period. The authority is in the businesses – five business units including international, who meet weekly in the Executive Committee.’

56 Excellence in Banking – Revisited!

In Banco Popular Español, the influence of its co-Chairman, Luis Valls, remains strong, some years after taking the leadership of the bank. As Roberto Higuera explains: ‘There’s a weekly meeting of either of the Valls brothers and the other members of Executive Committee of the Board, but it’s designed to monitor the business from a strategic standpoint. There have been a number of CEO changes in recent years, but the model has been a consistent one, and Angel Ron as CEO and head of the Executive Management team runs the bank on a daily basis.’ Although Mr Valls is well into his seventies, however, our interview with him in 1996 would indicate that his views continue to carry significant weight in the decision-making process! The leadership concept at Goldman Sachs is deeply embedded in the firm’s unique culture. While individual CEOs – and co-CEOs – have come and gone over the past few decades, their successors emerge in a meritocratic fashion from the ranks of career Goldman executives and exercise strong influence from the top. Hank Paulson’s succession (he is the current CEO) is already in place in the form of one or more COOs. Lucas van Praag summarizes the firm’s leadership concept as follows: ‘The tone is set at the top. The firm has always focused on having a very deep bench, but also embraced the concept of co-heads running the firm and sometimes tri-heads running divisions. There is a very talented group of people below the division head level, which makes succession planning easier in some respects but can also result in some tough decisions. One of Hank Paulson’s challenges since the firm went public has been leading and motivating a group of senior people who are extremely wealthy and, frankly, don’t need to get up in the morning. The firm’s performance speaks to the success he’s had in this endeavour, and it also says much about the work ethic of the people at Goldman Sachs.’ His colleague, John Andrews, adds: ‘Two COOs have left recently, but it barely caused a ripple. The depth of talent is created by the culture: there’s no Sandy Weill or Phil Purcell [CEO of rival Morgan Stanley]. Goldman still operates like a partnership;

The Leadership Factor 57

people still feel ownership. Goldman works hard at sustaining a very collegiate environment; people are promoted, assessed and paid that way over the years.’ Yet the CEO still exercises strong authority. Jide Zeitlin points out that:

‘Our Management Committee is comprised of approximately 30 individuals, including division heads, our Chairman, our President and our ViceChairman. This committee meets weekly, broadly reviewing key matters across the firm. Hank Paulson runs the Management Committee. Although the committee is constructed in a democratic fashion, Hank clearly has the last say on any matter of importance.’

So what conclusions can we add from these profiles to the findings of our earlier research? First, with regard to tenure, today’s leaders have been in the job for a wide range of time periods, from a few years up to George Schaefer’s and Dick Kovacevich’s 15–16 years in the job. What is more intriguing, however, is the influence of the architects of the current business model who remain either on the Board or otherwise personally close to the current CEO. Thus, in the case of Handelsbanken, Banco Popular, Citigroup and UBS, it is reasonable to assume a high degree of continuity of strategy and execution between the architects of the business model and their successors. Second, the cultural values promoted by these leaders remain similar to those articulated in our earlier research: communication and collegiality, discipline, customer focus, selling and personal responsibility for results. Given the standard business model’s emphasis on customer focus and service, this is no surprise. Third, however, we are even more conscious of the central role of the leader in an organization passing through substantial change. The pressures on today’s CEO from investors, regulators and competitors are a multiple of what they were when we first started writing about excellence in banking. And we are only too aware of the number of years needed to embed a culture such as that of Handelsbanken and Banco Popular. An excellent

58 Excellence in Banking – Revisited!

recent survey of corporate leadership by The Economist (2003b) concludes that: ‘Financial markets continue to harbour exaggerated expectations … To expect bosses consistently to deliver double-digit growth is to ask the impossible.’ And, to put it all in perspective, we have the dismal view of McKinsey’s Colin Price: ‘Banking is the Rust Belt of leadership! Banks are very poorly led institutions. Talent isn’t the problem – banks have a rich core of talent – but it’s a leadership problem. Eighty per cent of what we’ve done [as consultants] in six to eight banking interventions is the same: performance management and responsibility, top team alignment, simplify structures, etc. Half of them are successful, half aren’t. The difference is leadership!’ So what conclusion should we draw? Is the leadership of our excellent banks truly in a league of its own in the Rust Belt of banking? We don’t know, but we are certainly impressed by the messages – and more importantly the results – of the leaders we interviewed. We shall revert to some of these themes in our final chapter.

6 Sustaining Revenue Growth

‘Banking is a revenue-starved industry.’ Robert Albertson, Sandler O’Neill Sustaining revenue growth is the issue which dominates the strategic thinking of all of our excellent banks. It merited a chapter in our 1984 book (‘Penetrating New Markets’) but has assumed even more importance to banks in developed markets where banking is a mature industry whose revenues are widely assumed to grow at the rate of GDP increase (perhaps 3 per cent per annum over the economic cycle). The veteran bank analyst, Robert Albertson, of the specialist investment bank Sandler O’Neill argues that: ‘Banking is a revenue-starved industry. What can you do about it? Can you really generate more revenue growth than the others? Are your skill sets really exportable? Or should you sell out? People like HSBC and Citigroup have shown they can grow revenues!’ As we shall discuss in Chapter 8, cost management remains important, but the consensus of our interviewees is that costs can usually be managed as a function of the rate of revenue growth. While impossible to measure, one of the key drivers of this enhanced emphasis on revenues is the role of the international institutional investor: in effect, the leading US and UK institutions who now set the valuation standards for bank management. In the 1980s one could at least argue that a well-managed bank in Europe 59

60 Excellence in Banking – Revisited!

generating enough earnings to support a reliable dividend would satisfy the needs of the local investors who held the bulk of the stock; but not in the twenty-first century, when the mantra of the dominant institutional investor is reliable annual earnings growth, preferably from organic business and preferably in double digits over the intermediate term. How do our excellent banks meet this challenge? We discuss below the principal strategies:

●

● ●

cross-selling: marketing additional products to the existing customer base; innovation: winning market share in new products; mergers, acquisitions and expansion abroad: a new customer base.

Cross-selling has become a mantra for virtually all of our excellent banks. The logic is clear: if one has a loyal customer base, why should that customer not buy additional financial products from that reliable supplier? In recent years, banks in general have come to appreciate the value of a ‘brand’ which presumably supports this linkage, and our excellent banks are no exception to this belated recognition of the importance of branding. A seminal research project in Europe in 2002 sponsored by Smith Barney Citigroup, summarized in Figure 6.1 (pp. 61–2), actually tracks the cross-sell ratios in retail products of leading European banks, including several of our sample, broken down by type of product. Conducted by the Taylor Nelson Sofres (TNS) group, the survey is based on over 30,000 interviews with the customers of over 100 retail banks in 12 European countries. It focuses on customer commitment as determined by the answers to a questionnaire. The resulting commitment profile by bank suggests, in the view of TNS, an ability to extract higher prices, to enjoy higher customer retention and to gain a higher share of a customer’s business. The degree of commitment ranges from the most positive (entrenched) to negative (convertible). Interestingly, two of the three top-ranking banks in Figure 6.1 are Handelsbanken and HSBC, while UniCredito falls near the bottom. Wells Fargo is one of the most articulate advocates of the crossselling strategy. Dick Kovacevich explains the theory and some of

Sustaining Revenue Growth 61

the issues involved in broadening the product array to include non-traditional products: ‘When customers put their hard-earned money down, you must have good customer relationships – with serious, well-trained people. Customers have so many choices. You can’t do eight products per customer [their long-term goal] unless you’re the customer’s choice for investment products. And these will only increase in importance. The more difficult task is not the client with $100,000 or more to invest but the one with at least $1 million. He already has a relationship, not with a bank, but a broker. There are two challenges: to convince them that the bank is the place to do their business, and then to do it with Wells. As we peeled the onion, we realized that we were ignoring the $100,000 client by going for the elephants. We designed a system to sell only mutual funds to good banking customers and give good service. We’ve hired over 500 bankers to do this and will end up with several thousands eventually. It’s an opportunity – the seed corn for elephants! Because we do other business with them, it’s highly profitable and low in incremental cost. It might take longer to get to $1 million in customer funds, but in five years we’ll see the results. It will also enhance the client’s sense of relationship value. You can’t use strict cost/benefit analysis. As for attracting existing successful brokers to us, we’ll peel the onion until we find the answer, I can’t say when. If it takes 100 years, we’ll figure it out!’ Svenska Handelsbanken has equally aggressive cross-selling objectives as well as the top ranking in the survey profiled in Figure 6.1. Lars Grönstedt discusses their efforts to grow organically not only in Sweden but also in other European markets: ‘For successful organic growth, structure is important: the issue is how fast you can grow without losing control in terms of people, loan losses, reputation, etc. We’re devoting lots of time and effort to speeding up organic growth in the Nordic countries and the UK – reducing bottlenecks, etc. But the proof of the pudding is in the eating, and we’re just starting to serve the pudding! Our UK experience [their first start-up outside the Nordic region] is still very encouraging; the UK is 2% of our profits. In Sweden, brand consultants don’t like us! We’re ranked as the number one banking brand, but we don’t spend one single advertising penny promoting it.’

62

Figure 6.1 Cross-selling and customer commitment in European banking 100%

80%

60%

40%

20%

–

6% 12%

Handelsbanken 7%

ForeningsSparbanken

10%

HSBC

13%

20% 24% 21%

20%

40%

60% 50%

32%

26%

45% 36%

30%

40%

26%

11%

24%

39%

25%

Dexia

13%

24%

39%

23%

Bank of Ireland

16%

24%

39%

21%

SEB Nordea

RBOS

15%

26%

ING Group

14%

28%

Danske Bank

15%

28%

39% 33% 39%

20% 25% 19%

21%

23%

34%

23%

Den norske Bank

21%

22%

36%

21%

Fortis

21%

23%

37%

20%

Lloyds TSB

Societe Generale KBC Allied Irish Banks Barclays HBOS

18% 13% 17% 15% 21%

25% 32% 28% 31% 26%

39% 36%

17% 20%

36%

19%

36%

17%

34%

20%

80%

100%

63

18%

Abbey National

30%

32%

21%

32%

21%

Credit Agricole

15%

33%

BNP Paribas

20%

30%

34%

Intesa BCI

23%

29%

36%

Monte dei Paschi di Siena

31% 20%

Credit Lyonnais

24% 38%

28%

BNL

30%

SCH

30%

30%

Sanpaolo IMI

29%

31%

24%

Banca di Roma

37%

15% 12% 12%

33% 32%

10%

31%

11% 14%

26%

6%

34% 28%

11%

ABN AMRO

32%

30%

25%

13%

BBVA

31%

30%

28%

10%

31%

UniCredito

34%

45%

Deutsche Bank

29%

6%

20%

Commerzbank

54%

25%

15%

HypoVereinsbank

57%

25%

14% 4%

Convertible

Shallow

6%

28%

5%

Average

Entrenched

Note: Due to rounding may differ slightly from reported entrenched and convertible customer percentage Sources: European Bank Health Barometer and Schroder Salomon Smith Barney

64 Excellence in Banking – Revisited!

His colleague, Michael Zell, is a firm advocate of cross-selling: ‘We only sell products if we think they are good for the customer, like retirement savings. Our concept is one of 100% share of wallet, and we’re confident of the quality of our products and services. We believe strongly in the concept of one-stop shopping. We don’t directly order the branches to increase market share, but we use internal benchmarking to motivate them. The branch manager understands our displeasure! If you only sell one product to a customer, it’s easier for him to go elsewhere. We have a way to go [in cross-selling]. We had fallen victim to the myth that all of our customers did 100% of their business with us. Now we have a customer information system which shows they don’t!’ Packaging or bundling retail products has become a classic means for a bank to optimize its cross-sell ratio. The package is shaped to be both convenient to the client given his other unique needs (so-called affinity marketing) or simply offers a discount in the standard cost of one or more products in the package. Banco Popular Español is a role model in Europe for affinity marketing, with several hundred affinity packages offered to well-defined client segments. Roberto Higuera discusses the results and their plans for the future: ‘Our affinity clients represent about 9% of the total and buy on average seven products. Overall, we have a ratio of 3.2 products per client, but it would be 4.4 for established clients; our overall ratio has suffered because of our rapid growth in number of customers. While a good affinity client might buy seven of our existing products, for our new “golden mortgage” product we’ve achieved eight per client by offering a discount based on the number of products used. While products are important, our focus is still on the customer – understanding the customer relationship. Our mutual fund business is still underdeveloped, but now we’re outperforming the market. We don’t focus on wealthy clients in our private bank and affluent businesses. Our emphasis is on cross-selling investment products to our SME clients. There’s an imbalance: we have 70% of the corporate business of our SME clients but only 21% of their personal business. We have to do both and this offers us tremendous opportunities!!’ One of the key issues for investors is whether Banco Popular can export its unique retail model to other European markets as

Sustaining Revenue Growth 65

Handelsbanken has. The bank recently acquired a mortgage bank, Banco Nacional de Credito Immobiliario (BNC), which has a 3 per cent market share in Portugal. Higuera notes that: ‘It’s too early to tell from Portugal whether the model has been transferred successfully outside Spain. Portugal is similar to Spain with some differences in the average client’s size and priorities. But there’s no reason why it isn’t transferable.’ Fifth Third is the role model for many analysts of an ideal combination of growth by organic expansion and smaller acquisitions. It has succeeded in winning market share organically, for example, in its leading regional market of Chicago, while its largest acquisition, Old Kent Bank, was absorbed with a minimum of conflict and disruption. The company opened 58 new branches between December 2002 and January 2004. George Schaefer looks to revenue growth both from acquisitions as well as organic expansion: ‘One of the big problems in banking is that people try to buy their way to prosperity. We’ve made our share of mistakes certainly, but you make your money by running something; don’t believe the investment bankers! We tell the banks we acquire “Here’s the way we’re going to operate.” It takes years, not decades to build the model in new markets if you make decisions locally – perhaps five years to build this reputation in a new market. We took Old Kent out of the “line of business” model and installed local decision-makers – key seasoned bankers – to lead and grow their banks. How big an acquisition? There’s no magic formula. We’re an investor. Share prices go up and down; they aren’t a great standard of value. When we buy something, we have to be certain that we can grow revenues. If not, there’s no price that works. We proved this with Old Kent and put in place the right people and right incentives so that we could grow deposits. We didn’t change many people; we just kept score and people paid attention to revenue! Our branch manager doesn’t think about cross-selling but rather “How can I make more revenue from this customer?” It’s revenue generation, not crossselling. Just selling a new product doesn’t necessarily mean more revenue.’ Bob Niehaus, their retail head, adds: ‘It’s needs-based marketing, not the special of the month. It’s all about profiling – sitting down and listening to the customer. The local President has

66 Excellence in Banking – Revisited!

all product lines reporting to him, so there’s no “push back” – conflicting orders from different bosses – in getting the dots lined up.’ For human resources head, Brian Lutes, the talent pool is the major constraint on revenue growth and his principal challenge: ‘Given the bank’s rapid growth and our need to keep it going, bench strength is our biggest challenge going forward. We don’t have the luxury of hiring 400-plus college graduates to pollinate our organization … we need proven sales talent now that can sell!!’ For global banks such as Citigroup, UBS and HSBC who have expanded rapidly by geographic and product expansion, the crossselling challenge is a different one. In recent years Citigroup has become a role model for success in leveraging its corporate client relationships and massive balance sheet to win debt, equity and advisory mandates. Table 6.1 profiles this progress since 1999. Hans Morris describes some of the challenges and wealth of opportunities for the world’s largest universal bank: ‘In the developed markets, we need to deepen penetration vertically in a client – to provide top to bottom coverage. Under our existing strategy, the number of clients in these markets will only change incrementally. In the emerging markets, we have a much broader strategy – covering local corporates. We have literally thousands of corporate clients in Latin America. Table 6.1 Citigroup climbs global league tables 1999–2003

Global debt and equity Global long-term debt Global equity Global debt and equity: disclosed fees Global announced M&A Global equity trading Global fixed income trading Foreign exchange Cash management

Rank FY99

YTD 3rd quarter 2003

2 1 5 5 9 6 1 1 N/A

1 1 3 1 2 3 or 4 1 1 1

N/A ⫽ not available Source: Citigroup estimates, SDC, Institutional Investor, Euromoney

Sustaining Revenue Growth 67

Several of these can become global and join the top 2,000, but most corporates in emerging markets only need a simple set of products. We frequently discuss how we should marry these two strategies. It’s similar in transaction services; we’re big outside the USA in custody and cash management – the global player of choice, but we’re relatively minor in the USA.’ One of his senior colleagues adds another strategic initiative: ‘We have all the products and are in 100 countries. Before the merger with Travelers, planning targeted 2–3% market shares in all these countries. That’s changed: there will be a focus on fewer target countries like Poland and Mexico where we target 8–10% market shares and may do deals to win market share. We’ll place bets on a few EU countries. Our corporate and investment bank is a truly global platform; there’s no acquisition needed, but we’ll buy individual talent.’ In the retail world, his colleague Bill Dalton sees the same cross-sell potential: ‘We have nine million personal clients in the UK, with 800,000 commercial customers. Fifty per cent of HSBC clients have mortgages, but only 10% with us, and we have one of the best mortgage products around! Why can’t we get more? You have to have the right head set and infrastructure. We don’t talk cross-sell ratio, but rather customer base penetration. If we are making student loans, they want only one product – the loan – but that actually reduces our overall cross-sell ratio. With the demand for investment products growing, our goal is to keep our share of the pie. We worry a lot about our “very satisfied” customer satisfaction ratios, which are higher than those of the other clearing banks.’ For UBS, there is a contrast between the market potential in its traditional Swiss home market and that in wealth management in other European countries. Marcel Rohner acknowledges that growth in Swiss business is a challenge: ‘The Swiss market is reaching saturation: how much more can the economy consume!? We’ve repositioned our credit business. We have a natural 25% market share in Switzerland; but it’s not the end of the game yet! Given our size, we have an advantage in service delivery, with 24-hour access and

68 Excellence in Banking – Revisited!

multi-channel delivery that the savings banks can’t offer. We can sell third party products and have lots of relationships. When you do all these things, you can grow the business – but not at a double-digit rate!’ In contrast, in the US investment banking and European wealth management markets UBS is making great progress. Peter Wuffli notes with pride that: ‘In the US investment banking market, three years ago we weren’t on the map. Now we’re present across the board. In European wealth management we’re growing the business at 30–40% a year. It’s a successful project after several previous failures. The model seems to work: a growth mentality with ambitious leadership prepared to take risks. But it’s all motherhood and apple pie.’ Central to UniCredito’s revenue generation strategy in its home market of Italy is offering superior retail client service in a market not well known for that quality. Referring to the bank’s recent restructuring around client segments, Andrea Moneta describes the challenge: ‘It’s harder to differentiate the retail bank. Our new service concept is very simple: customer and employee satisfaction are linked: one drives the other. There’s a greater impact because of the number of employees and customers. We’re paying lots of attention to customer retention. Eight per cent of Italian families change their bank every year. If we don’t lose them, we could decrease the turnover rate to perhaps 4–5% a year, which would result in significant organic growth.’ Innovation is a quality not normally associated with commercial banking. Our excellent banks are relying largely on traditional banking products supported by a strong brand, which in turn is driven by superior perceived service quality. Packaging of such products to meet the demands of specific client segments is the hallmark of a few banks such as Banco Popular Español, which has invested in such innovative client segmentation. In the corporate and investment banking world, derivatives – instruments ultimately tied to cash products – have fostered innovation (as well as some noted corporate scandals) since they emerged in the early 1980s. Commercial banks such as the former JPMorgan and

Sustaining Revenue Growth 69

Bankers Trust attempted with some success to use derivative skills to penetrate the investment banking world, but ultimately the investment banks themselves have become the dominant force in such specialities as credit derivatives. Among our excellent commercial banks, however, one shining example of innovation is that of UniCredito, which has applied industrial techniques to the manufacture of standard derivatives for its SME and corporate client base. UniCredito’s corporate head, Pietro Modiano, describes his UBM (UniCredito Banca Mobiliart) unit’s success: ‘We imported methods from the manufacturing sector. We asked ourselves the question: can we run a derivatives business not as an institutional relationship but one appropriate for SME activity? It’s an industrial approach: a standard product, manufacturing process, building a central plant, financial engineers testing the product, embedding modules into place, accounting and marketing – all the elements of the decision-making process. And we’ve achieved a high quality advisory product for about 14,000 SME clients! We started in 1997 and have achieved euros 320 million in net income for 2003 – not bad for a start-up!’ Expanding market reach by acquisition or organic growth in new markets has been a hallmark of growth strategies among our excellent banks. HSBC, UniCredito, UBS, Citigroup and Wells Fargo have achieved their present market position largely through the acquisition route since the early 1990s, while both Banco Popular and Handelsbanken have made selective acquisitions. From our interviews we draw several conclusions on the value of expanding the revenue base by acquisition or penetration of new markets. First, the institutions which have been built largely by acquisitions now are focusing on organic growth. Having created a global platform, HSBC, Citigroup and UBS are understandably now concerned, as indicated above, with exploiting that platform. Socalled ‘fill-in’ acquisitions to complete a product line or geographic base will take place, but the banks are anxious to emphasize the priority given to organic growth, largely through cross-selling. Underpinning this preference, however, we detect the concern of investors for the risks attached to major acquisitions, in particular in new geographic and product markets. Overpaying for acquisitions,

70 Excellence in Banking – Revisited!

execution risk and the limitations of cross-selling synergies are very much on the minds of investors and their advisers, especially since some of the merger problems in the USA in the late 1990s. Extracting revenue synergies from mergers is both difficult to achieve and, with the best will in the world, to measure. While it is an article of faith for serial acquirers such as Fifth Third’s George Schaefer, the statistical record – at least in Europe – is not promising. Table 6.2 tracks the projected revenue increments from recent in-market mergers in Europe as a percentage of the combined pre-merger base. The highest recorded, the formation of UniCredito in 1998, was estimated at only 6.8 per cent of the pre-merger total. When compared to the inevitable dislocation involved in the merger process, the numbers are not overwhelming. In our recent study of bank/insurance mergers, we examined the surge of interest in the late 1990s for such cross-functional mergers in Europe, and its subsidence a few years later. Several transactions involving some of our former excellent banks marked the high point of this fascination. Thus National Westminster’s bid in 1999 for the UK insurer, Legal & General, resulted not only in the failure of the Table 6.2 European bank mergers: revenue synergies promised (as percentage of combined revenue) Transaction

Country

Date

Synergy

Credito Italiano and UniCredito Royal Bank of Scotland & NatWest Bank of Scotland & NatWesta Halifax and Bank of Scotland Banca Intesa & BCI CAER & Casse Venete UniCredito & BCIa DnB & Postbanken BES & BPIa Lloyds TSB & Abbey Nationala Banca di Roma & Mediocredito Centrale MPS & Banca del Salento BP di Verona & BP di Novara Barclays & Woolwich SanPaolo IMI & Cardine

Italy UK UK UK Italy Italy Italy Norway Portugal UK Italy Italy Italy UK Italy

1998 2000 2000 2001 1999 1999 1999 1999 2000 2001 1999 2000 2002 2000 2001

6.8 5.6 5.4 5.4 4.7 4.1 3.7 3.6 3.2 3.2 2.8 2.6 2.5 2.4 2.2

a

Aborted

Source: DIBC, company documents

Sustaining Revenue Growth 71

bid but sufficient investor displeasure that an unfriendly bid by a much smaller competitor, Royal Bank of Scotland, resulted in the bank’s take-over. Shortly thereafter Credit Suisse’s purchase of Winterthur was undermined by the collapse of the European equity markets and the need for the bank to bail out its acquisition. Several statistical studies (such as DIBC, 2003) of price behaviour before and after bids across segments of the financial sector have confirmed the preference for deals within the same sector where, arguably, the synergies are greater and the execution risk less. HSBC’s acquisition of Household International in 2003, however, flies in the face of this conventional wisdom. For one of the world’s most conservative banks to invest heavily in consumer finance, a sector in which it had little experience and at a time when consumer debt levels were ringing warning bells, the shock waves caused many experienced analysts to wave a red flag. Yet HSBC management is confident it has made a uniquely positive strategic move. Their Finance Director, Douglas Flint, explains the logic: ‘There’s a strategic rationale. If you look at any commercial bank, you’ll see that their greatest strength is low cost deposits, which they lend out at a margin. Their biggest risk is a low rate environment with a flat yield curve. They end up with concentrated risk on the loan side because there are few good borrowers. We’d all be in the same boat – history suggests the industry would find some high risk borrowers and lose a bundle. If you had a wish list, it would be scale, diversification of borrower and high margins – without repricing risk. The only business like that is consumer finance. Household is one of the world’s leading originators of small loans. The downside? The US economy tanks, but if it happens we all have problems!’ Second, there is a heightened awareness among both management and investors that acquisitions in developed markets are much riskier and less likely to add stockholder value than those in less competitive ones. Thus UniCredito has won acclaim for its expansion in Central and Eastern Europe, but in 2003 the news of discussions to acquire the troubled Commerzbank in Germany triggered a sharp decline in UniCredito’s stock price and the breaking-off of the talks. For banks such as Handelsbanken and Banco Popular Español, the commitment to preserve a successful culture virtually excludes a major M&A transaction, especially one in a new market. Building the

72 Excellence in Banking – Revisited!

revenue base is thus even more dependent on organic growth or small acquisitions in such a market, and when market share is difficult to grow in the home market, the alternatives are indeed limited. Lars Grönstedt of Handelsbanken establishes his growth priorities thus: ‘All of us will have to look at new products and geographic exposure. In the European financial institutions world, there isn’t much to acquire; most targets are too expensive. No cross-border concept has made sense; we’re all watching Nordea.’ With political and other factors limiting growth in its home market, UniCredito is another excellent bank constrained geographically. Its strategic move into Central and Eastern Europe has worked well both financially and in terms of exporting a successful business model. Roberto Nicastro explains how it has been modified to suit other environments: ‘We’ve succeeded with one challenge: the “capo” or leadership of the CEE units. Some people say you have to put power in the hands of one person. But we’ve created a dual leadership in each CEE bank: a local CEO and an expatriate COO. The people dimension of the capo carry complementary competencies: one who knows the local environment, the other bringing technical competence. Both have to have the right DNA: mutual empathy, team orientation, etc. And it’s worked well. How do we manage cultural diversity? The drive toward a unique business model should never be so obsessive as to forget that differences exist and should be appreciated. Thus you may need to coach a Bulgarian branch manager on “selling is beautiful”, but it’s nonsense to do it with a Turkish manager!’ As with so many other excellent banks, UniCredito is confident of the value of its business model. The challenge is to find the right environment in which to apply it. Andrea Moneta explains: ‘We can extract a lot of value in a larger environment. There are lots of opportunities outside Italy and New Europe [the CEE], and we’d be concerned if we missed them. We shall grow and extract value! It’s a matter of opportunity, whether Italy or international. We’re confident of our valuebased management and very disciplined. The real risk is not being able to extract all the possible synergies!’

Sustaining Revenue Growth 73

The jury is out on many of these initiatives to drive revenue growth. Cross-selling in particular is a goal yet to be achieved by many excellent banks (arguably the triumph of hope over experience); and the record of overseas expansion even by the best national retail banks is not brilliant. But we shall return to these issues in our last chapter and move on now to the problems created by growth: managing size and complexity.

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7 Managing Size and Complexity: The Challenge Becomes Acute!

‘It can only work on the basis of teamwork!’ Stephen Green, HSBC The bank merger wave of the past decade has created global giants which dwarf in size and complexity their peers of the 1980s. Figure 7.1 provides a comparison of the physical size of the three excellent banks present in our sample between 1983 and 2003. For all three, financial assets and number of employees are a substantial multiple of the 1983 level. From a management standpoint, it is the four- to five-fold increase in staffing which is particularly challenging. How can these giants be managed efficiently in a business where communication within the organization as well as with clients is a key success factor? Is it possible for one or more leaders to fully understand what is going on beneath them in the organization? Have today’s giants developed any new organizational processes to address these challenges? Our panellists and other banking experts are not convinced. Andrew Stott, head of Western Europe for the bank consulting specialist Mercer Oliver Wyman, cites the complexity of management as a major challenge today: ‘Perhaps the greatest challenge for large financial institutions is to maintain excellence as they grow and diversify, whether geographically or sectorally. The greater the diversification, the greater is the potential for a more disparate and heterogeneous culture, and from there, for losing control and quality. HSBC has achieved excellence historically during a period of significant 75

76

Figure 7.1 Growth in assets and employees: three excellent banks Total assets: 1983 and 2003 (US$1 billion) 1,400 1,264 1,200 982

1,000

1,066

800 600 400 200

126

58

48

HSBC

UBS

0 Citigroup

Number of employees: December 1983 and December 2003 300,000 260,000 250,000 215,000 200,000 150,000 100,000 65,929

63,700 44,100

50,000

14,300 0 Citigroup

HSBC Dec-83

UBS Dec-03

Source: Company reports

Managing Size and Complexity: The Challenge Becomes Acute! 77

diversification geographically, through a cadre of tried and tested, largely home-grown senior executives. Elsewhere Citigroup has instilled a culture of excellence which has stood it in good stead through its expansion across very diverse businesses. In contrast, what unhinges you is losing control as you diversify, as banks such as Barings and the old UBS appeared to experience.’ Ray Soifer agrees: ‘Banking continues to get more complicated; thus the Basel Committee is forced to write the new rules in a mathematical language few bankers can understand. Simply managing a bank requires a degree of complexity; it’s more expensive and takes place in a more volatile environment.’ The global head of Fitch Ratings’ banking group, Charles Prescott, points to the human challenge for today’s leadership: ‘You want to attract and keep good people, but a strong team means lots of strong egos. How do you manage these people? These are very big banks; how do they work operationally – product, geography, and client? Do they do it differently?’ At UBS in London, Chris Ellerton emphasizes the issue of complexity: ‘It’s not a problem of size but of complexity. The skill sets of CEOs are necessarily limited, but the skill requirements of leadership in diversified financial institutions are great. It’s possible that the CEO of a large financial institution doesn’t understand what’s going on in some corners of the organization and feels uncomfortable. The reaction? You de-risk the business as much as possible. But if you do, there’s a strategic risk because the competition can be much more focused in particular business lines and better able to assess risk and reward. It’s tough for the diversified business to tread the narrow path between being too risky and being too conservative. Which possibly explains why the stock market is reluctant to reward diversity, still less complexity.’ So how do our global excellent banks address these concerns? Let’s start with the world’s largest bank, Citigroup. Citigroup’s new threedimensional matrix is central to the issue of managing size and complexity. As Hans Morris explains:

78 Excellence in Banking – Revisited!

‘The matrix sounds very complicated, with separate reporting both to product and region. In a staff role such as the CFO, you can report to as many as three bosses. Yet it works, partly because the key people – Druskin, Prince and Maughn – get along well. Top management is acting and emulating their style. There’s been a remarkable change in a year; now people speak the same language; it’s not a product take-over of the regions.’ His colleague, Win Bischoff, places this structure in the broader context of the current regulatory environment: ‘The overall management challenge, with all the regulatory, oversight and corporate governance issues, is to ensure that the bureaucratic process doesn’t slow your ability to react to client needs. The risk is that you become too inward looking, with a control culture rather than one of getting the business. The Board and regulators understandably are preoccupied with governance, but the amount of oversight before you do a piece of business is frightening! While our new matrix structure was extremely painful to introduce, we came to the view that we needed a wider matrix. Here in Europe, with two CEOs for major businesses, we can localize lots of decisions formerly made in New York. We’ve put all of Europe under the two business heads. People feel they are part of Europe – a separate line of business. It engenders the feeling that “we’re a significant organization here in Europe.” The process is different, but there’s a greater identity in a smaller entity. Tensions exist but are usually at the level of communication for individual clients. It’s infinitely better than it was five years ago.’ At HSBC, the group’s traditional culture of trust and strong internal communication is vital. The co-head of the Corporate and Investment bank, John Studzinski, makes the key point: ‘Dealing with size and complexity has to start with leadership and the message delivered.’ Stephen Green, the CEO elaborates: ‘HSBC is both large and complex. You couldn’t manage it with only one or two people leading it. It can only work on the basis of teamwork. We have

Managing Size and Complexity: The Challenge Becomes Acute! 79

a strong sense of collective management – people who have worked together for years, but who can also take in new talent. Also, of the five heads of customer groups, three are also heads of major geographic units. So there’s a small number of people who can supervise the group’s business as a whole.’ On HSBC’s retail side, Bill Dalton speaks of managing the UK bank’s 55,000 in staff: ‘If you went into a branch and asked people what’s important, there’s an 80% chance they would say things like “Creating clear water between us and the competition”, or “Customers are number one.” We may not be singing from the same songbook, but at least we’re in the same bookstore! Our people know what the values are. We can sleep at night knowing people across the world in India are on the same wavelength. There aren’t a lot of fiefdoms in HSBC.’ At UBS, Chairman Marcel Ospel is concerned – like Sir Win Bischoff at Citigroup – about the possible impact of the bureaucracy created by the group’s size and complexity: ‘With size a large corporation risks being intellectually complacent. We focus on keeping intellectually honest and developing and improving our diversity, professionalism and intellectual property. We’ve protected our entrepreneurial spirit to ensure that the size of the organization doesn’t push us toward “mediocracy” and that we can organically grow the platform. The challenge now is a different one – to move from integration to organic growth.’ His colleague, Peter Wuffli, is more specific: ‘Entrepreneurial leadership is a big challenge in a world where compliance dominates the environment. Everything is scrutinized, and taking personal risk is not encouraged by detailed regulations resulting from factors such as Sarbanes Oxley and Chinese Walls. But also we’re a big organization with a tendency to bureaucracy, lots of committees and people saying “Let’s listen to him – he’s a smart person.” The result is complexity and delays. We need to speed up processes and be crisper. It’s OK to take controlled risks, be ambitious, get rid of overengineering. It’s a tough challenge and there’s no easy answer, but we constantly send out messages.’

80 Excellence in Banking – Revisited!

Complexity and size are also issues for the mid-sized excellent banks. At UniCredito, Alessandro Profumo (the CEO) explains: ‘We must keep the model – a holding company in different countries and central factories. The issue is how to retain the culture?’ Even a focused bank like Wells Fargo, which has eschewed businesses such as international and investment banking, must deal with complexity in its core retail and corporate businesses. Dave Hoyt points out that: ‘Complexity rises with cross-selling; it’s harder to deliver with a broad range of products. More complexity makes it harder to connect all the dots. Most clients should use lots of products and we want them to use lots of our products. The clients like it, but you need lots of training, because people sell what they understand. They have to know the nuts and bolts.’ For Goldman Sachs, it is size – that of its new global rivals and its own meteoric growth in the 1990s – which has been the strategic challenge. As Bob Steel explains: ‘The necessary drive for scale as we globalize our business model has changed the intimacy quotient of Goldman’s culture. It is a significant challenge, even more so than the IPO – in my mind. Managing scale is the greater challenge: going from 5,000 employees to over 20,000 in a short period of time. We have to accept the challenge by the globals.’ Lucas van Praag agrees: ‘There are two challenges – from Citigroup in particular and the more than doubling of the size of our own organization as we grew rapidly in London and focused on client service.’ Jide Zeitlin outlines the strategies designed to deal with size and complexity: ‘Goldman has a number of important firmwide committees that govern important aspects of our business. This committee structure leverages industry, geographic and product expertise in a relatively democratic

Managing Size and Complexity: The Challenge Becomes Acute! 81

fashion. In addition to committees that focus on key components of our business, we also use a committee to drive the development and strengthening of leadership capabilities. Our Pine Street Board is charged with this responsibility and is led by Steve Kerr who joined our firm three years ago from General Electric. Steve is our Chief Learning Officer.’ For John Andrews, the continued dynamic of size is a major concern: ‘Competitors get bigger. The size of balance sheet may create dumbness. It’s the third time in 17 years: first the Japanese banks, then American Express and the European banks, and now Citigroup. The old US “bulge” group of perhaps six firms is now perhaps two, three or four. The dynamic of the industry is fascinating – some firms have blown up, others did nothing and have been absorbed.’ Other voices from the banking world point up the challenges posed by these factors. Peter Mathias, a specialist consultant in client management, describes how the corporate banking world has changed: ‘The customers are becoming more specialized at the top end of the spectrum. The idea of an integrated banking relationship is becoming highly suspect. Many leading banks used to say that there was one guy who knew everything about the relationship. That was the 1980s model – the myth of an all-round relationship manager. Today the banks are too big and the clients too specialized. The largest clients are becoming banks in their own right, and each major unit has its own bank relationships.’ The veteran investment banker Hans-Jurg Rudloff, whom we interviewed at Credit Suisse in 1988 and who is now a Vice-Chairman at Barclays Capital, describes the dilemma of the global universal banks such as Citigroup: ‘Size is critical; you can’t operate in the global market without big size. There are lots of countries, and you have to be in everything to be a top ten player. How do you manage it? By division: each one has different needs and requires different skill sets. Someone like Sandy Weill of Citigroup needs to have people with different skills sets, but all with the same objective: that’s the art of Sandy!’

82 Excellence in Banking – Revisited!

A senior executive at one of Citigroup’s peers speaks with total frankness on the issue: ‘The challenge in many large banks – where we stumble and others succeed – is getting the right degree of organizational rigidity in the firm together with the right level of skills and entrepreneurial spirit at the appropriate levels of management. Citi are successful: they run the shop with a rod of iron in processes, management information and corporate discipline. A gold standard in how you look at performance of coverage officers. No one breaks the rules. The entrepreneurial spirit you’d like to have in a clientcentred organization is controlled and focused toward the client, rather than arbitraging the internal systems and performance measurement tools. Our problem is that we’ve never been managed with a rod of iron. We’re too nice a place. In Citi everyone focuses on doing business with clients. Here, we have duplication in organizational structure; too many people think they have the right to decide. The firm has sucked in large numbers of bright people, who have been able to create little kingdoms for themselves. We spend too much time on managing the business and not enough with clients.’ Pat Butler of McKinsey & Co. spells out the key differentiators for retail and wholesale banks in this respect: ‘As a generality, the success formula in retail banking is built on tight, disciplined and consistent execution – the tighter you can make it the better. In general, success in wholesale is more about entrepreneurship and strong values rather than rules, but with every generality there are important exceptions. There are some retail banks that are successful with loose, entrepreneurial management (look at FMD in South Africa). Equally, there are a few wholesale banks who pride themselves on discipline and rigour as much as values and entrepreneurship.’ Perhaps the last word on the issue of size and complexity should go to Lars G. Nordström, the CEO of Nordea, the largest bank in the Nordic region and, for many, a case study in lessons from crossborder mergers. Nordström took over in 2002 as chief executive of a four-country merger process which had begun in 1997 and had floundered under his predecessor. Anticipated synergies had failed to

Managing Size and Complexity: The Challenge Becomes Acute! 83

materialize, and the cost/income ratio refused to drop. When asked the advice he would give to banks contemplating a cross-border merger with its inevitable complexities, Nordström’s response is clear: ‘Our mistake was to be too polite in the early years. Each nationality was polite to the others. They would meet to discuss policy and make decisions, then each would go back home and adapt the agreed model to local circumstances. The result: increasing complexity and a ballooning of costs. My mission during the past year has been to go out and talk in terms of simple one-liners. A simple message: focus, speed, and performance. Reduce complexity – don’t try to handle it. Move from “too many” to just one. Maybe you should target unfriendly acquisitions: at least you get the issues out of the way before the deal is done!’ In sum, the challenge (particularly for the global banks with a universal product range) of size and complexity is a real one. There was no silver bullet in the 1980s, and the banks are even larger and more complex than they were then. We shall return to this issue in our final chapter, but we turn now to how the excellent banks address the issues of execution.

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8 Execution and Client Service

‘We have to have hungry people. You can’t train hunger.’ George Schaefer, Fifth Third This is the first chapter in our books on excellence to devote a chapter specifically to execution, which we define in the banking context as blending some of the elements analysed in the previous chapters – in particular leadership, culture and sustained growth – to produce superior client service at a satisfactory profit. Successful execution has always been on the minds of our interviewees over the years. In earlier book interviews, we frequently heard the homily, ‘Strategy is 10 per cent of the game, but execution is 90 per cent.’ In those days, however, many excellent banks were giving high priority not only to issues such as strategic positioning but also managing technology, striving to become ‘the low cost producer’, and ‘attracting the best and brightest people’. In this interview series, our banks have become much more focused on the key deliverable of these initiatives: specifically, superior client service. Understandably, banking has moved on since the 1980s, and best practice has been well defined. As we have seen in earlier chapters, there is little new under the sun in terms of building a new culture, exercising leadership and extending the revenue base. At a seminar in 2003, for example, the expatriate CEO hired to turn around a Communist-era savings bank in the Czech Republic pointed out that all of the retail techniques and methodologies introduced were off-the-shelf. Jack Stack, a former Chase Manhattan 85

86 Excellence in Banking – Revisited!

retail banker now heading Ceska Sporitelna, thus confirmed that: ‘There’s really nothing new about best practice in retail banking. It’s all about execution.’ We were almost tempted to entitle this chapter ‘good housekeeping’, bearing in mind the repeated quotes from senior executives such as Peter Wuffli and Stephen Green about motherhood and apple pie! In this chapter we would like to analyse some of the key issues in the execution formula. Many of our excellent banks are deemed ‘best of breed’ among their peers for their efficiency, client-oriented culture and profit performance. How do they do it in practice, and what are the obstacles they have still to overcome? We shall focus in particular on themes which in past excellence books have merited a specific chapter: ● ● ● ●

cost management; technology; customer service; attracting and retaining the best people.

Cost management Perhaps the most interesting of these themes is cost management. Several of our retail banks qualify as perceived leaders in regularly achieving the lowest cost/income ratio of their peers (the standard metric for measuring operational efficiency in banking). In the 1980s, many of our excellent banks were transfixed by the perceived threat of a lower cost producer, a competitor who could undercut them by virtue of unique technology or other advantage. That threat did indeed emerge in the 1990s in the form of the Internet and electronic banking. But banks responded, as they have so often, by co-opting the new technology in their own direct banks and selectively reducing their pricing. While some stand-alone direct banks such as ING Direct have built a profitable and sustainable business on the back of low pricing, in most cases the profit impact on incumbent retail banks has been very minor. Sophisticated investors have moved price-sensitive funds to direct banks, but changes in market shares have been marginal. The real winners in the cost/income sweepstakes, however, are excellent banks such as Fifth Third, Banco Popular Español and

Execution and Client Service 87

Handelsbanken, which still function with the traditional legacy operating systems but which are able to generate much higher revenues than their peers. Figure 8.1 ranks these banks and others against their leading competitors in the cost/income metric for 2002 (latest available data). Handelsbanken’s remarkable 2002 cost/income ratio of 49 per cent – well below that of its Nordic rivals – is thus driven by the use of this metric as a simple but effective overall performance standard. In SHB’s decentralized environment, each branch manager shapes his own product/client business plan but is measured against his peer managers on this ratio with a maximum target of 50 per cent: in other words, ensuring that revenues always exceed twice the cost base. Thus costs are only relevant when measured against the revenues they generate. In fact, our friends at Handelsbanken acknowledge that their measurement systems are not necessarily state of the art. Lennart Francke, the head of control and accounting, points out: ‘I was surprised that branch management has been satisfied so long with their traditional method of calculating profitability. They made the mistake of thinking that they “knew” who were the most profitable clients. Now they use our new customer information system for retail clients and say “Gee – we didn’t know that they were unprofitable.” Now we’re on our way to upgrade the corresponding system that we have for corporate customers as well. The culture isn’t all that numbers-driven. For Mr Wallander it was much more important to watch a few key figures. We look behind the figures; there’s no balanced score card here with hundreds of items.’ The discipline on branch managers is effective. Francke adds: ‘At the branch level the internal benchmarking isn’t just theoretical! It stimulates and incentivizes the branch managers.’ At another ‘best of breed’ European bank with one of the lowest cost/income ratios in the banking world, Roberto Higuera of Banco Popular Español also focuses on the relationship between costs and revenues: ‘We look at the cost/income ratio, not the absolute level of costs. If revenues are growing, we’re more liberal with costs. Costs used to be growing at 12–15% annually, but only because we were growing revenues faster. We

es St

at

ng

U

ni

te

d

Ki U

ni

te

d

en Sw ed

Sp

ly Ita

ai

n

an y G

er

m

ce Fr an

a ad an

(%)

C

Au s

tra

lia

do

m

88

Figure 8.1 Comparison of bank cost/income ratios 2002

110 Dresdner 100

90 Commerzbank Deutsche

CIBC

Abbey

80 TDB 70

B. of Montreal RBC

SocGen CCDF Credit Lyonnais Credit Agricole BNP Paribas

SanPaolo IMI BancaIntesa

Nordea BSCH

60 CBA WestPac NAB

B.Nova Scotia

SE Banken

Hypo

Unicredito

Swedbank

BBVA

50 Handels banken

ANZB 40

BPE

30

Source: Fitch Ratings, DIBC

HSBC RBOS Group Lloyds/TSB Barclays

JP Morgan Chase

Citigroup Bank One Wells Fargo BankAmerica

Execution and Client Service 89

don’t fall into the category of “low cost provider”. We’ve invested heavily in IT systems, CRM [customer relationship management] software and opening new branches. We’ve also had a number of voluntary redundancy schemes; currently we’re cutting back on headquarters staff, which accounts for 16% of the total. We aim to cut our cost/income ratio below 30%.’ The same formula drives Fifth Third’s view of costs, as George Schaefer explains: ‘Our cost per transaction is low, in part at least because of lower salaries in the regions. But the real answer is that we grow revenues twice as fast as other banks!’ Another ‘best of breed’ retail bank, Wells Fargo, also puts costs in a strategic context. Dick Kovacevich points out that: ‘If you can grow revenues above 10%, you’re OK – you don’t need a war on costs. But if revenue is anaemic, you won’t last. If you’re cutting costs to generate revenue, say to become the “lowest cost producer”, that’s OK too; cost reduction is not the objective. But to cut costs as a one-time action, there’s no revenue growth, and there’s a limit to it.’ In the global banking world, the new Citigroup management team is renowned for its ability to slash costs in an institution which had become a byword for duplication and extravagant spending on new systems. Hans Morris explains how his colleague Bob Druskin operates: ‘Cost cutting is part of the DNA of the organization. We look at where staff is not contributing value. Bob Druskin can smell if something is overstaffed. He has the skill set of a good process manager – gathering inputs, executing a game plan. And Bob can be extraordinarily decisive.’ A well-established rule of thumb in global investment banking is to maximize the variable portion of costs in a highly volatile business. UBS has done well in this respect during the recent downturn in volumes, as Marcel Ospel explains: ‘Our cost management policy has consciously not cut significant numbers of staff and thus ended up paying twice to attract them back. The trick for everybody is to keep the variable portion as high as possible.’

90 Excellence in Banking – Revisited!

While traditional bank analysts continue to regard the cost/income measure as a barometer of efficiency, more thoughtful observers are aware of the limits to cost-cutting in the context of the dominant need to improve and sustain customer service. Sam Theodore of Moody’s suggests a balance: ‘Cost management is an issue but don’t lose track of the goal: not just to be the most efficient but also to achieve sustainable profit growth. How much more can you cut in a market like Sweden?’ Robert Albertson makes the point in more pungent terms: ‘Has cost-cutting gone too far? Delivering relationship management may require spending more money to make it work. The customer is getting tired of “no-frill airlines”! We’re overdue for more customer-facing spending. In retail, the staff isn’t well-trained and clever – they’re high school kids. Corporate banking is different.’

Technology The role of technology has changed in the perception of many excellent banks since the 1980s. A chapter in our book in 1988 described the widespread concern over the sustained high level of IT spending and the difficulty of managing large, complex projects. These concerns have not disappeared, but management seems to have come to grips with its ability to use technology as a competitive tool. Douglas Flint of HSBC offers a typical view: ‘Technology will continue to be a focus but it will gradually become embedded in the banking business. In the past, lots of technology spending was wasted. In the future the business model will be technology and marketing applied to finance: a successful bank will have a strong brand as well as marketing and technological capability.’ Yet technology still is capable of hindering seamless execution even in the excellent banks. John Stumpf of Wells Fargo highlights the problem of technological glitches in the branch network: ‘You can get killed if you don’t do well “behind the curtain” [in the delivery system]. The plumbing and wiring isn’t good enough to give the client

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fantastic service. For example, in a call centre, if a client calls to say he’s lost his credit card, and you have to say that it takes four days to get a new one.’ His human resources colleague, Pat Callahan, confirms that there is room for improvement in customer service: ‘In our regular survey of all staff, an issue raised is the ability to solve a client’s problem quickly. It’s still too hard. And the staff is very much aware of the problem.’ Since our last interview series in 1988, the practice of outsourcing – using specialist third-party providers for processing and other functions traditionally handled by bank staff – has gained momentum. Banks increasingly have turned to joint ventures with specialist technology firms such as IBM to cut costs, increase the variable portion of these costs, and ensure that they benefit from new technological solutions. The latest chapter in the unbundling of banking processes is offshoring (essentially, transferring some functions physically to another environment). Thus Stephen Green of HSBC explains: ‘The Internet hasn’t gone away; maybe it’s finally come of age. It impacts the way we deal with customers. It means we can place more of our resources away from customers – essentially offshoring. We do basic processing and call centres now in Asia, but we’ll move up the value chain by adding research and financial reporting. You don’t need to be proximate to the ultimate beneficiary. It’s a sensitive issue if you’re an employee in a G7 country. It needs to be handled with sensitivity, but you can’t freeze frame the evolution of resources. It’s an issue all banks have to address, because if you don’t there will probably be someone more competitive than you.’ However, more conservative voices among the excellent banks remain deeply suspicious of reliance on third parties for a critical processing function. Björn G. Olafsson, Handelsbanken’s head of central business and IT development, is outspoken on the subject: ‘We won’t outsource core systems and development. It’s not a good idea. You find that in a few years your costs will rise. When you lock yourself into outsourcing you can’t get out. Add-ons start to appear. There’s a trend toward outsourcing but we’re not part of it! Handelsbanken’s IT operations are big enough to be efficient.’

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Customer service Actually delivering superior service and advice remains a problem for several of our excellent banks. Marcel Rohner of UBS describes the challenge in the wealth management business: ‘The real challenge is differentiation. We’re a service business; you can’t see or feel the product – it’s an intangible driven by people’s behaviour. We do the transaction business well, but the next level is advice, which is critical for private clients. You need to deliver a better experience. To get a uniform brand perception, you need to manage a large organization to deliver a consistent, high quality experience – that’s the real challenge. First we need to deliver services along client clusters – like a BMW series 3, 5 and 7. Second, and very simple, is defining the advisory process and how it should be delivered to the client. And third, you must identify best practice for a sales force management. For a non-financial person, delivering a consistent, high quality experience seems trivial. Hotels and other service firms have managed to do it. Financial institutions as a whole pose a tough problem. The ten critical elements are clear, and the enlightened advisers do it naturally. But the key is getting the middle people in the range to adapt best practice.’ Robert Albertson, a bankologist, echoes the concern of excellent retail banks such as Wells Fargo over the quality of customer service in retail banking: ‘In wholesale banking the banker can say “I want your business.” It’s difficult but doable, because you have a relationship manager who is on top of the client. But in retail, you have a teller or product specialist who isn’t highly educated or motivated – not up to a level to allow for cross-selling to work. You become a nuisance to the client! You don’t have the customer feeling comfortable with the bank. It only works if you inject more human intervention in the selling process. It’s the concept of service value added: the only value added is service quality.’ Dick Kovacevich agrees: ‘You can’t be superior in the long run without superior service. We’re not scoring as well as we’d like to – only average, and that’s not good enough.

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Why? Perhaps it’s because of all our mergers and conversions, the memories of which may linger about for years!’ His colleague, Dave Hoyt, elaborates: ‘We have a good ranking against the larger competitors but not as much as we’d like – especially against the smaller regional banks. It’s easier to deliver a simpler product set. Cross-selling complicates customer satisfaction. If the client has a problem, how do you solve it without bouncing around internally? We’re a big, complex organization, and sometimes it takes longer than we’d like to get action. We try to understand how the customers want to interact with us. Whom does the client deal with? We’re spending time with the client to find out whether it’s working. Complexity rises with the number of products.’ The execution challenge for a global bank such as UBS is of a different order of magnitude. As Marcel Ospel points out: ‘The problem now is to make sure we can deliver across the globe on a timely basis. Don’t get overly bureaucratic about many signatures – otherwise it becomes a bowl of spaghetti!’ One of the few publicly available sector-wide customer preference surveys is a 2003 study of over 1,000 panellists by The Economist. It rates the leading investment banks on a number of criteria, the most important of which (76 per cent of the panellists ranked it ‘very important’) is ‘customer service/understands needs’. Figure 8.2 provides the ranking. What is striking from this survey is the relatively high ranking of the new universal banks compared to the traditional monoline investment banks such as Goldman Sachs and Morgan Stanley. Any such survey has its faults, but it would appear that banks such as UBS, Citigroup and HSBC have made good progress in building a reputation for service in investment banking products in recent years.

Attracting and retaining the best people For many of our interviewees, people quality is synonymous with good execution. If execution is 99 per cent of the game for George Shaefer of Fifth Third, the right people are essential for the task:

Goldman Sachs

24%

UBS Warburg

18%

Merrill Lynch

17%

Lehman Brothers

17%

JPMorgan Chase

17%

HSBC

17%

ING

15%

Deutsche Bank

15%

Credit Suisse First Boston

39% 40% 44% 46% 37% 45% 46%

12%

Bank of New York

40% 37%

11%

ABN Amro

44%

11%

Nomura

8%

Unibanco

8%

Commerzbank

7%

BNP Paribas

7%

Dresdner Bank

45%

14%

Barclays Capital

Bayerische Landesbank

43%

22%

Citigroup

Société Générale

43% 42%

23%

Morgan Stanley

94

Figure 8.2 The Economist survey: rating of investment banks in client service

26% 33% 25% 33% 27%

6% 5%

31% 25%

Source: The Economist

Excellent

Good

Execution and Client Service 95

‘We have to have hungry people. You can’t train hunger. It’s the first generation wealth creators – the do-something crowd. They may have a small market share, but if you have hungry people we’ll overtake the competition. It’s better to execute a bad plan well than vice versa. We focus people on the next three inches, not grand ideas. Also, communication is a critical success factor: lots of people in big banks don’t talk to each other. When I get my executives to talk to each other, we make a lot of money. People think vertically; it’s not easy to change them – a lot of built-in resistance. You have to find time to talk.’ The task of human resources head, Brian Lutes, is to supply the people: ‘George is focused and ferocious about head count and productivity. We track our sales’ hires start date and their performance to plan. If they’ve been in the bank over a year and aren’t on plan, there’s something wrong. George looks to me to ensure those people perform or are coached on how to improve; otherwise move ’em out! There’s a relentless focus on human capital. It’s the only way to achieve the right pool of talent!’ At the other end of the product spectrum, Goldman Sachs also equates execution success with the quality of people. For Bob Steel: ‘Investment banking is a service business. “What can I do to help you?” It’s a place where a core value is to be a good listener and where the client has an experience which is really special. Has the culture changed? I don’t think of it as changing but rather evolving. When we were an American bank, we used to hire just white males from Ivy League schools – not today! We used to pass on our culture and values in an avuncular way. Given our size, we’ve had to organize and systematize the learning process for core values.’ The pressure on these special people is intense, especially after several bad years in the equity markets. Jide Zeitlin in the Investment Banking Division voices some of the questions on the minds of his junior colleagues: ‘Roughly 50 per cent of my colleagues have been in this industry for three years or less. Most of these individuals have only experienced a tough and

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challenging market. They have friends that have been fired. Compensation and other expenses have been cut. Those that have been here for longer periods of time have a more balanced – though still sober – perspective. Given these pressures, the question that some ask is: “Can Goldman Sachs maintain its distinguishing culture?” The focus on performance creates stress, but every one of us that works here believes that we are part of a unique organization at a unique moment in time.’ So the lessons of successful execution are clear. First, costs must be managed in relation to revenues; success in building the top line should drive efforts to control costs. In this context, the trade-off between costs and service quality is a critical one, and arguably many proficient cost-cutting banks have had to invest again to achieve superior service levels. And there is no magic organizational structure for successful execution. The ubiquitous matrix is still with us, but much more important is the discipline of a strong culture, good communication across the organization and reliable technology. People are also an essential success factor, especially at the clientfacing level, where a selling orientation is critical. Finally, while technology is an necessary ingredient in the delivery equation, banks since the 1980s seem to have found acceptable solutions in technology management, whether through outsourcing, joint ventures or simply by managing their own systems more effectively. Now we move to the final issue of managing risk, a hardy perennial for our excellence books!

9 The Profile of Risk

‘Reputational and cultural risks are more important than traditional financial ones.’ Robert Steel, Goldman Sachs Each of our excellence books has included a chapter on risk, and this volume is no exception. All bankologists know the classic one-liner of ‘Banking is all about risk’, but what fascinates us is the changing nature and perception of risk over the past two decades. In the 1980s books, two themes dominated. One was the menace of leveraged lending: breaking the old rules by financing capitalhungry borrowers like real estate developers and aggressive growth companies. Such warnings were duly justified in the early 1990s by massive write-offs of loans to commercial real estate developers in the USA, Europe and elsewhere. The second theme of the 1980s was the discovery of an independent credit voice: the senior credit officer whose ‘no’ was the final answer to an eager loan officer. Excellent banks such as Bankers Trust combined this voice with an innovation that has since become common practice: the RAROC tool to evaluate the relative risk of an exposure in terms of capital employed. Sadly Bankers Trust itself ultimately became the victim of overexposure to high-risk emerging markets and other borrowers, and it was ultimately sold to Deutsche Bank. So, what is today’s perception of risk by independent analysts and our excellent banks? Perhaps the best starting point is a data series initiated after our 1988 book and sponsored by the London-based think tank CSFI (Centre for the Study of Financial Innovation). On 97

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the basis of an annual questionnaire filled out by several hundred bankers, regulators and analysts around the world, it ranks the perceived seriousness of over 20 different banking risks. Figure 9.1 provides the rankings of this unique ‘Banana Skins’ survey since it originated in this format in 1996. Among other things, one notes the progression of ‘complex financial instruments’ from tenth in 2000 to the chief concern in 2003. The co-director of the CSFI, David Lascelles, who has prepared this survey since it first appeared, offers his independent view on the conclusions which might be drawn: ‘My own view is that there are two kinds of risk. One is the type which can be planned for with macroeconomic analysis, analytical processes, statistical models and so forth. The other is when lightning strikes: the rogue trader Figure 9.1 Banana skins: the top ten 1996–2003 1996 1. Poor management 2. Bad lending 3. Derivatives 4. Rogue trader 5. Excessive competition 6. Emerging markets 7. Macroeconomic threats 8. Back office failure 9. Technology foul-up 10. Fraud

1997 1. Poor management 2. European Monetary Union turbulence 3. Rogue trader 4. Excessive competition 5. Bad lending 6. Emerging markets 7. Fraud 8. Derivatives 9. New products 10. Technology foul-up

2000 1. Equity market crash

2001 1. Credit risk

2. E-commerce 3. Asset quality 4. Grasp of new technology

2. Macroeconomy 3. Equity markets 4. Complex financial instruments 5. Business continuation

5. High dependence on technology 6. Banking market overcapacity 7. Merger mania 8. Economy overheating 9. Competition from new entrants 10. Complex financial instruments

6. Domestic regulation 7. Insurance 8. Emerging markets 9. Banking overcapacity 10. International regulation

Source: CSFI

1998 1. Poor risk management 2. Year 2000 conversion 3. Poor strategy 4. EMU turbulence 5. Regulation 6. Emerging markets 7. New entrants 8. Cross-border competition 9. Product mis-pricing 10. Grasp of technology 2003 1. Complex financial instruments 2. Credit risk 3. Macro economy 4. Insurance 5. Business continuation 6. International regulation 7. Equity markets 8. Corporate governance 9. Interest rates 10. Political shocks

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or operational risk such as a terrorist attack. For these you can take any precautions you want, but one will probably zap you in the end! It happens with monotonous regularity. Recently it was a rogue trader in National Australia Bank. The category of “rogue trader” in the league tables after the Barings collapse [in 1995] was high; it gradually fell into the mid-20s ranking despite the fact that it’s a recurrent risk. It tells you something about risk: people think they are taking all the precautions but eventually they DO get zapped. At the end of the day, there’s no protection! But if you spread the losses over the banking system from one of these every 18 months or so, the risk of [something] hitting you is pretty small. Credit derivatives [a component of “complex financial instruments” for many] is top of the list for 2003. Is it different – perhaps a third category of risk? If you look at what people say about credit derivatives, there’s a string of quotes: “Where does the risk end up?”, “Is the system at risk?”, etc. But there ARE answers, and they aren’t on the other side of Mars! Lots of concern today over credit derivatives is based on ignorance of the unknown. The perception of the risk will probably fade away pretty quickly; at least we can get to the bottom of what it’s all about. It’s not the rogue trader category. People base their expectations on recent experience. It’s human nature. They have great difficulty focusing on the future. All you can really do is build on the experience of the past. The risk is something you don’t know about today!’ Several of our bankologist friends agree with Lascelles’ final point. Andrew Stott refers to the Banana Skins study: ‘It’s a second order of growth challenge. By definition you can’t predict them. For example, today offshoring [the transfer of operational functions overseas to lower cost locations such as Asia] is a key trend. What happens if these operations are shut down by political or labour unrest? What do you tell your customers about the integrity of processing? It’s a structural shift that’s now occurring: most banks want to cut their cost base, and offshoring is great for costs. But it’s potentially a huge operating risk, even with contingency planning.’ Ray Soifer agrees: ‘Look at the CSFI survey. Worries change! It’s things you don’t see that get you!’

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The reformulation of risk management by the proposed Basle II structure is a highly topical theme in banking circles as banks evaluate its impact on their capital requirements and competitive position, yet few of our analyst friends view it as a significant issue in the management of risk. Chris Ellerton of UBS expresses a common view: ‘The danger of Basle II as Royal Bank of Scotland pointed out in its submission to the Capital Committee is that risk management is confused with risk measurement. Many risk problems have occurred in the past because institutions have been too clever by half, not because they have been “unsophisticated”. Long Term Capital Management, Bankers Trust and Abbey National come to mind. Common sense and good judgement are usually more effective than complex systems and calculations; or at least complex systems are useless without common sense. HSBC has never struck me as being a particularly sophisticated bank but it has been very good at judging risk. Buying Household was seen by some as a very high risk deal for HSBC but HSBC’s judgement that the funding benefits it could provide would more than offset the credit risk was absolutely the correct call: Household was in the position it was in because of its funding, not because of its loan underwriting.’ Robert Albertson of Sandler O’Neill also argues for taking a longterm perspective on risk management: ‘The big risk is forgetting the lessons of the last downturn! Basle II is close to a non-event. Credit risk is not an issue at the current point in the cycle.’ His comment raises an obvious question. Have bankers learned from the credit disasters of the early 1990s, when many leading global banks would have been technically insolvent if their loan books were marked to market? The almost universal answer from independent observers is ‘yes’, pointing to the proliferation of risk management techniques now incorporated in the proposed Basle guidelines. This view is reflected in Figure 9.2. There are few aggregate measures of bank credit quality over the cycle, but the data gathered by the US Federal Reserve on major non-performing US loans and incorporated in Figure 9.2 seems to confirm that the long-predicted credit disaster in the USA from the recent recession and well-publicized corporate

The Profile of Risk 101

Figure 9.2 Cycle of US non-performing loans 18 % of Commitments

16 14 12 10 8 6 4 2 0 91 92 93 94 95 96 97 98 99 00 01 02 03 Special Mention

Classified

Source: OCC/Federal Reserve SNC Review October 2003

failures has not propelled the ratio of non-performing loans to the heights reached in the early 1990s. And the proportion of nonperforming risks carried by the banks has declined as credit derivatives have shifted many of them to non-bank institutions. Bankers do seem to have learned from past credit mistakes! An authoritative view is provided by Charles Prescott of the rating agency, Fitch Ratings: ‘Risk management has improved since, for example, the problems of the old Union Bank of Switzerland. But it’s still a big challenge. Derivatives is a big issue, especially with the enormous trading volumes. Top management MUST know what’s going on. Also, liquidity is an issue, with the banks providing liquidity for off-balance sheet structured deals.’ His counterpart at Moody’s, Sam Theodore, points up the relative nature of risk: ‘Risk is a relative concept. At some time, you have to take risks; there’s no such thing as a risk-free business. You have to relate it to experience and management’s track record – say, in Germany, Deutsche Bank versus the savings banks. There’s no secret recipe for risk management. VAR [value at risk] is a tricky concept with different ingredients, which is tough to compare across the sector.’

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John Leonard, a former sell-side analyst and now a fund manager at Merrill Lynch, also takes a relativist approach: ‘A key issue is managing risk appetite, especially in hot areas, which leads to concentration. It’s not real estate this time, but rather a question of how much you put into merchant banking, venture capital and private equity. Things “out of the blue” will get you from time to time. Reputational risk is also an issue. In the Enron case, it seems that some managements overruled their risk review units. In consumer lending, how far down the credit spectrum do you go?’ Robert Statius-Muller of Greenwich Associates also notes the improvement in risk management: ‘Risk management is not as big an issue as it was a few years ago. Many banks have cut back their balance sheet, so it’s more of an issue for the stuffees [institutions who have taken the risk on their own balance sheets]. But overnarrow focus can be a problem if your target market base is small. Asset focus will be key to excellence. There may be an issue of pipeline management if you forget about new business growth. You need to have a balance.’ With these views in mind, let’s turn to the perspective of our excellent banks. For Dick Kovacevich of Wells Fargo, risk management has strategic as well as operating implications: ‘There are two kinds of risk: first, “dumb” risk: like underwriting dumbly and hoping it works! Or taking interest rate risk. Bankers make dumb decisions, like syndicated loans where the risk reward is lousy. So we assume you’re trying to make good loans! The other risk is being a narrow-based company. One reason for our business model is that narrow-based companies are forced to take excess risk because, even when you know the macroeconomics will go against you, no one knows when, or has the guts to tell stockholders “I’m going to slow down the business” because you’ll get killed by the competition. Look at the Internet bubble. You knew it would burst simply using your common sense. With a narrow-based business you keep going until it’s obvious you have a problem. But a diversified financial services business has choices: if you slow one business down, you can make up for it with other businesses – you transfer resources. You may not grow as fast as a pure play, but there’s steady growth over time.

The Profile of Risk 103

We went to the diversified model as a result; we can slow or stop growth because we have alternatives. We’re constantly dialling down risk because we have alternatives. I’m too conservative; I’ve predicted six of the last three recessions! We’re not better at underwriting risk than our competitors; there’s nothing magic about it.’ His colleague, Dave Hoyt, adds a practical comment: ‘The key to credit risk isn’t technology but a customer relationship focus. By staying focused on customer relationships we’ve avoided a lot of losses.’ At HSBC, widely viewed as one of the most conservative banks in the world, different risk concerns understandably reflect the viewpoint of our interviewees. For its CEO, Stephen Green: ‘The overriding risk is not to put the brand at risk. There’s a house policy of not pushing the envelope, with a low loan to value ratio in lending, VAR limits, an independent credit function, etc. There’s a perception that the new risks in HFC [Household International] are higher. But consumer finance has a different economic profile from the rest of the bank: lots of direct marketing, automated scoring models, higher bad debts but also higher margins. It’s based on statistical ratios and is more readily predictable than lumpy corporate exposure: a higher level of non-performing assets but more predictable.’ His colleague, John Studzinski, with responsibility for the equity and advisory functions, agrees on the issue of reputational risk: ‘You can take a hundred years to build a brand like HSBC and then destroy it and your reputation in ten minutes. When you have global, high level dialogues for advisory and other businesses, the brand is all-important. You need people to embrace a culture of integrity. Reputation is the most important variable.’ For the CFO, Douglas Flint, with his experience of the volatile Asian markets, liquidity is the big concern: ‘Derivatives have improved risk taking but also allowed people to assume extreme levels of gearing. The nightmare scenario is that something unexpected happens; liquidity falls away, and there’s the spiral of failures which

104 Excellence in Banking – Revisited!

could have happened with LTCM [Long-Term Capital Markets] in 1998. All pricing models assume open and rational markets. People take liquidity for granted. And with a fragmented regulatory system, you have people trying to find ways to take the maximum risk for the least capital.’ UBS has a well-deserved reputation for risk management which can be traced back to its acquisition of the derivatives firm of O’Connor in the mid-1990s. Several of our analyst friends noted that the bank seemed to have dodged all of the major bullets flying about in global banking in the past few years. The chairman, Marcel Ospel, who has guided this risk management effort since its origins, looks to the future: ‘We’ve built a record of skilful risk management – not getting exposed to the scandals. But we need to develop – skilfully! – more appetite for risk. There are more players prepared to put the balance sheet at the service of the investment bankers. So you have to accept more risk. The trick is to diversify risk exposure across regions, sectors and clients – to avoid concentration of risk.’ His colleague, Marcel Rohner, reflects on the lessons of the old Union Bank of Switzerland, our excellent bank of 1988, which revealed massive derivative-related losses after being acquired in 1998 by today’s UBS: ‘The fundamental point of risk control is independent control of risk. This requires first and foremost transparent reporting of risk and, depending on the liquidity, ex ante or post approval of significant transactions by an independent control function. Risk culture is like a genetic footprint: shared experience and insights across the organization at all levels.’ To use the current phrase, ‘risk is part of the DNA’ at Goldman Sachs, which has often been described as ‘a hedge fund with a balance sheet’. Jide Zeitlin described earlier how Goldman’s business model is shifting to a closer relationship between proprietary trading and client transactions. His colleague, Lucas van Praag, describes the issues thus: ‘We’re taking on more risk as a function of facilitating trades for clients. From an external perspective, it’s hard to distinguish client facilitation from

The Profile of Risk 105

proprietary trading; many fixed income transactions require us to acquire risk from clients. It’s not necessarily long-term exposure, but it does lead to higher risk volumes for the firm. But we size our risk in proportion to our capital base and our overall earning power. The firm has a strong trading ethos and we think that our willingness to take significant trading risk for appropriate reward is one of our distinguishing features and a significant competitive advantage.’ Yet the veteran Bob Steel puts the different risks in perspective: ‘Reputation and culture risks are more important than traditional financial ones.’ As the largest and most diversified bank in the world, the view from Citigroup is equally comprehensive. Sandy Weill, who has personally borne the brunt of recent corporate governance encounters, summarizes his decades of experience: ‘Reputational risk is more important than credit or market risk. I hope it will be at least a decade before the events of the past few years happen again! We were the poster child of these events, but we’re still the most respected of all by our clients. In the long term, my biggest concern is credit risk in centrally-driven countries and the politics you have without the leadership of free enterprise. It happens in Asia as well as Argentina. We completely missed the boat on how bad the Argentinian situation could be.’ From his standpoint as CFO of Citigroup’s Global Corporate and Investment Bank, Hans Morris provides his perspective: ‘Risk is a very broad subject for us, and stress can emerge in unexpected ways; big moves in currencies can lead to treasury fails and perhaps cause problems for hedge funds. You need people with judgement who can sense the unexpected correlations.’ In the commercial banking world, the issue of risk takes a lower priority than others discussed in the previous chapters. Thus it barely surfaced in our conversations with UniCredito and Banco Popular Español, which is certainly a reflection of their superior credit record but also their focus on relatively low risk customer segments.

106 Excellence in Banking – Revisited!

At Handelsbanken, where annual loss provisions in recent years have been measured in single digits of basis points, Lennart Francke describes his experience as the former head of credit: ‘Credit is overwhelmingly the principal risk for SHB. It’s the risk of being in the wrong sector. When banks get into trouble it’s not because of mismanagement but because they’re in the wrong part of the market. SHB had serious problems in the early 1990s like the other Swedish banks, but we had fewer problems and we managed them better. Strategically, our model with its lower cost base permits us to have a lower risk loan portfolio. We’re happy with our current profit level and don’t need to assume big risks. There’s the usual credit dialogue between the lending units and the head of credit, but in the near-borderline cases he always wins the argument!’ In similar vein, credit risk for Fifth Third is the dominant preoccupation. Its CEO, George Schaefer, repeats the theme just articulated by his peers at Handelsbanken: ‘My predecessor Bill Rowe had to spend 25 years in the credit department before he could make loans! We’ve always had a good enough revenue stream and been tough on expenses, so we haven’t had to go out and do nutty loans. Getting paid for incremental risk is VERY hard. And we’ve kept our lending limits down to only $25 million.’ Yet in 2003 Fifth Third was struck by reputational risk, a particularly unexpected blow in view of its pristine record in traditional banking risks as well as its premium valuation multiple. Following the discovery of back office control problems, the bank was obliged to sign an agreement with its regulators which not only hit the headlines but also obligated the bank to forgo additional acquisitions during the period of the agreement. Schaefer’s colleagues agree that the bank’s reputation suffered a blow. As Bob Niehaus acknowledges: ‘The regulatory settlement was traumatic, but we gathered round and asked ourselves how to fix it. Our advisers told us that our reputation would carry us through – “Just put your head down” – and it did.’

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Brian Lutes discusses the strategic implications of having temporarily to forgo the revenue boost from acquisitions: ‘It caused tremors but we responded as a team by improving core processes, establishing infrastructures that never existed before, such as risk management and setting even bigger revenue and income targets that pissed off our Affiliate Presidents! Guess what? They are rising to the occasion, by delivering results, despite not being able to open branches at a rate we had planned, due to the regulatory agreement.’ So what can we conclude about risk management today from these reflections? First, risk remains a many-headed hydra whose tentacles reach out unexpectedly. Hence the view of David Lascelles and others that there will always be an unpredictable element of risk which favours those with a conservative posture and substantial reserves. Second, however, the tools to manage risk have improved considerably in the past 15 years. Who could have predicted in 1988 (by coincidence, the date of the first Basle agreement) that the second Basle accord will probably have incorporated the complex models developed by the larger banks? The challenge, as Marcel Ospel points out, is how to take on yet more risk with these tools. Our third observation is something which escaped us in the 1980s excellence books: the value of the traditional model of the successful retail bank. All of our excellent retail banks can rely on the steady profit growth and generous retail margins to avoid having to reach for a riskier but more remunerative loan portfolio. Our investment banks lack this particular cushion. Fourth, the old lessons of good risk management are still valid. Experience, judgement, diversification and independent, but aggregated, risk control remain best practice. There is little new under the banking sun except the tools of portfolio management, risk-based pricing, and volatility measurement which are now available to those who wish to use them. We are reminded of the quotation in our 1984 book from a senior Citibank banker: ‘We re-learn the same old lessons.’ We now turn to the future as perceived by our interviewees.

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10 How the Excellent Banks See the Future

‘There’s no value creation in cross-border deals … But deals will be done.’ Roberto Higuera, Banco Popular Español Our last question to our interviewees was a simple but hopefully thought-provoking one: how did they envisage the banking business in the intermediate term (say, the next three to five years)? Many responses constituted a simple restatement of their own bank’s strategy. Other interviewees had reflected deeply on the possible transformation of their business environment. Understandably, many focused on current developments such as the concern over credit derivatives, increased regulation and trends in consolidation. Taken as a whole, they constitute a fair portrait of the mindsets of today’s excellent bank management. And when the reflections of our bankologist friends are factored in, the result is a useful conclusion to the issues discussed in the earlier chapters. We have saved our own prognostications for the final chapter! Let’s start with the views of our excellent banks. Several key themes were repeated in the interview process, and we have grouped most of the feedback within these forecasts.

The consolidation process As in our previous research from the 1980s, the theme of continued sectoral consolidation dominated the horizon for most of our banking friends. These forecasts unanimously predicted a continuation of 109

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the Darwinian process of the struggle for market share and growth in an industry plagued for decades by overcapacity. Each excellent bank in this context has its own strategic view and concerns. The US-based banks, operating in a relatively unconsolidated market, accept – if not actually welcome – the process as part of their environment and strategic concept. On the other hand, our excellent European banks, with limited domestic consolidation opportunities, are deeply concerned about the threat and opportunity posed by cross-border mergers (their own as well as their rivals). Dick Kovacevich of Wells Fargo articulates a typical view of the consolidator bank: ‘I really believe that people will realize that we’re in only one business: financial services, not banking. The key decision is whether you’ll be broad or narrow-based. If you’re a traditional bank, you can’t only look at other banks as competitors. AIG [American International Group] will be nipping at you even if you don’t want to play in insurance. You have to look at the broader picture: what does all this mean for me? How do you go about it? If it’s an acquisition, that raises another set of issues. If you have a PE [price/earnings] ratio of eight, how can you become broadbased? Everyone has to go through the same process. Some will decide to sell out, which will lead to a rapid consolidation of the industry. We’re the only industry of size [financial services, not banking] where the largest has only 3% of the market. It may take a long time but it will happen.’ His colleague, John Stumpf, anticipates the mixed blessing of this merger trend: ‘Regarding mergers, the winners and losers will get separated, and the market will reward and punish accordingly. The price paid, skill of execution and revenue growth are paramount in mergers – they are hard work and few have the discipline to do them well. I have done 70 of them. They consume enormous amounts of energy, especially in getting the plumbing to work and winning the hearts and minds of the new team. Customers demand more now than six years ago with the Wells/Norwest merger; they demand better wiring.’ The CEO of a somewhat less diversified institution, Fifth Third, anticipates more of the same. George Schaefer looks at the world from the microcosm of his home state of Ohio:

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‘The banking business won’t change. It’s not far from what it was in Northern Italy in the 14th century. People bring you money and you lend it to them. But the era of big government is not over! More regulation will prevent the little guys from operating the way they used to – setting up new banks. It’s going to be very difficult for them to comply.’ His head of HR, Brian Lutes, draws the natural conclusion: ‘Talent management is the big issue facing the bank. Most bank CEOs regard HR as a personnel department. That was 30 years ago. Now it’s all about people, culture and execution.’ At Citigroup, the forecast is for continued industry consolidation with Citigroup participating on a selective basis. A senior executive’s crystal ball is essentially that of Citi in its role of trendsetter both in the USA and abroad: ‘The future is not hard to figure out for Citigroup; just project the past few years forward. No transforming mergers; we’re too big.’ Hans Morris provides a thoughtful vision of the future of banking: ‘Since financial institutions are fundamentally information intermediaries, continually declining information costs affect everything. Banking intermediaries are therefore under continuous pressure to add value. Some people will inevitably fall out; they can’t all compete in essentially similar products. Companies merge when they start to feel marginalised and when they lose their way with their stockholders – look at Bankers Trust, JP Morgan, and DLJ [Donaldson Lufkin & Jenrette]. But the outcome of this consolidation is that we’re going to have better and better competitors.’ His chairman, Sandy Weill, offers a broad vision of the future for financial services: ‘Financial services is at the fulcrum of globalization, especially in the emerging markets. If we have a world where people talk together rather than fight, it’s good for financial services. The three biggest growth industries in the world are technology, health care and financial services!’

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Consolidation has created a serious challenge for the traditional investment banks such as Goldman Sachs. Lucas van Praag of Goldman watches warily the merger trend which has created Citigroup and JPMorgan Chase: ‘Some mergers have worked but others have clearly destroyed value for shareholders. The emergence of universal banks has resulted in some pretty predatory behaviour, particularly in the provision of credit and its pricing, designed to make inroads into traditional investment banking activities. But this business has always been fiercely competitive and our challenge is to continue to provide clients with a demonstrably superior service while operating in a manner that is clearly consistent with our shareholders’ best interests. It’s one we relish.’ His colleague, Bob Steel, concludes: ‘It will be a challenge for us if other large commercial banks become serious competitors!’ John Andrews foresees the challenge a bit further down the road: ‘The challenge will be 10 years from now. We’re benefiting now from a class of leaders who grew up in the old partnership.’ Competitors shake their heads over the possible parallels between the former JPMorgan and Goldman Sachs: two strong cultures being marginalized in a fiercely competitive market. But one of our bankologists, a former Goldman executive, disagrees: ‘Don’t worry about Goldman. They’ve completely transformed themselves; the Goldman Sachs of the 1980s is gone. Today they have three legs: onethird traditional advice and M&A, one-third asset management and hedge funds/prime equity, and one-third sales and trading. They’ve globalized better than the others and are more aggressive in using their own capital. Their top people are the best in the business. The culture starts at the top: a simple leverage model with 500–600 top people, who are very strict on each other, whether you’re a partner or not. Every year they push people out if they don’t perform.’

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The consolidation issue looks different if one sits in Europe. The most concerned are the national banks with limited international options. At Handelsbanken, Lars Grönstedt sees few prospects for sensible cross-border deals: ‘On reflection, maybe you can’t make all the pieces fit together, which will lead to a wave of divestitures of so-called “non-core” businesses.’ In Spain, Roberto Higuera of Banco Popular, which has also eschewed a major cross-border merger, sees selected opportunities in the consolidation process: ‘There are lots of unexploited niches in European banking. We’re working on this and have technology solutions for some of them. Spain can’t be different from other developed markets. There will be more acquisition opportunities for the banks, and more differentiation in ROE and growth among the banks. Global and other banks will co-exist and co-habit. There’s no value creation in cross-border deals. Banco Popular can’t make a higher return in markets like France and the UK. They’re bad for stockholders, but the deals will be done.’ The views of UniCredito’s management on industry consolidation coincide with their own proactive stance on the acquisition process. Roberto Nicastro, their retail head, sets the tone regarding the political reality he faces in Italy: ‘Our crystal ball sees progressive pan-European consolidation, with the pace driven by two factors: the economy and politics. A troubled economy leads to more consolidation. Politics won’t be able to interfere with natural economic processes. It’s not a coincidence that retail banks in a big country are locally-owned. Part of the answer is business-driven, and part is politics. Banks are often perceived as both an enterprise and a social institution.’ Meanwhile the CEO, Alessandro Profumo, looks to a more segmented future for European banking: ‘We see future consolidation by business line – the commercial versus investment banking model. Will it succeed? There’s a potential conflict of interest in the Citigroup model. Maybe US banks will start to see what is

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going on in Europe – or European banks will enter the US. The key is to separate production and distribution in many different areas. There could be synergies, with a factory in fund management, investment banking, consumer credit, IT systems, etc. Only distribution is local. UniCredito has had success in such a factory in the CEE.’ His colleague, Pietro Modiano, expresses the concern of a banker based in a market which may not participate fully in global economic growth: ‘We don’t see the future clearly. As an Italian bank we have to face a period of reduction of the weight of banks as intermediaries. Our importance has been exaggerated, especially in the corporate arena. It hasn’t been beneficial for the system; there’s no bond market, and it’s a risky business for both investors and corporations. Disintermediation has been a fascinating challenge since the 1980s, and we see another round of disintermediation in Italy. There’s a temptation to go abroad. Europe is slow for a fast-moving company. Will we miss an opportunity of going to the US or Asia?’ Among our excellent group, UBS is the sole continental Europeanbased bank with a claim to global status. As such, its views on the consolidation issue are of particular interest. Its chairman, Marcel Ospel, points to an outcome which could be challenging for UBS: ‘For years we’ve expected consolidation in banking in the US and Europe. There’ll come a time when it must take place in European universal banking. The US will spearhead that trend. It doesn’t have to affect us. It’s conceivable that investment banking will move closer to the big balance sheets like Citigroup. It could potentially change the landscape for UBS and other banks. Do we want to accommodate this?’ Wuffli, the CEO, inspects his crystal ball for both the banking and wealth management sectors: ‘In global investment banking, there’ll be a clear convergence of client needs with increasing competition driven by scale, capital, breadth of products, etc. At the end there’ll be perhaps six to eight global firms with market shares of about 8–10% each and access to a large balance sheet. It’s a

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model that will last. Then there’ll be the boutiques and individual advisers with charisma and relationships. In local banking, it depends on the political landscape. In Europe, I can’t conceive what a savings bank client with $100,000 gains if his bank is owned by a foreign institution: big cultural differences, layers of management, etc. Pan-European consolidation for retail is like bancassurance – maybe 10–15% synergies and huge structural and cultural barriers. I don’t see yet a McDonalds in retail banking! For wealth management, globalization and consolidation will be slow. The economies aren’t so powerful as in investment banking. UBS has the biggest market share with approximately 3 per cent. We might grow to perhaps 4%, with a few others trying to replicate this. But now there’s no one else with a global model, although some will try. It will be a two-tier industry: a handful of global wealth managers with perhaps 4–5% each and thousands of others.’ Citigroup’s Win Bischoff agrees that European consolidation is the key unresolved issue: ‘The biggest question is what is going to happen in Europe in terms of consolidation. There’ll be more consolidation in the US, possibly a merger of consumer and investment banking. In Asia, not all the local champions will be gobbled up by foreigners. In Europe, there are very strong domestic banks, but they are small by international standards. So far there have been no big cross-border deals. The universal model is well established. France is one-quarter to one-fifth the size of the US but overall, Europe and the US are the same size. Will there be European competitors as large as Citigroup? HSBC and UBS could be.’ As for HSBC itself, their crystal ball remains focused on the emerging market world. The CEO, Stephen Green, opines that: ‘World economic growth will be more subdued with low inflation. Over half of global growth will come from the emerging markets. The China/India region will be one of the most important factors in our lives for the rest of our careers.’ His CFO, Douglas Flint, draws the consequences: ‘In the next three to five years, revenue will be difficult to grow strongly, except in the emerging markets. Banking is overpopulated; the excess

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capacity will exert pressure on revenues. In the end, there’ll be a shakeout with a superleague of major banks and national or niche institutions.’

More demanding clients Another key theme in our interviewee forecasts is an increasingly sophisticated and demanding client, whether corporate, institutional, high net worth or mass market retail. The investment bankers are most emphatic on this point, but retail bankers as well are aware that this might threaten their highly profitable model. As Hans Morris of Citigroup points out: ‘It’s clear in the US; you have to offer a superior product. You can never rest; if you had the best credit card, competitors will continuously come up with a better one. In equities, past relationships are meaningless. The customer asks: “What have you done for me today?” In emerging markets, it’s a different business model; information is comparatively expensive, so we can use it to greater advantage.’ John Studzinski of HSBC agrees: ‘The clients are more sophisticated today, they are internalizing the business, and more information is leading to commoditization. The notion of value added in financial services has to be very carefully looked at.’ For retail bankers, perfecting delivery services for such a more demanding client base is a key goal. As indicated above, Wells Fargo’s retail head, John Stumpf, noted that the client demands better wiring for his on-line experience. For Banco Popular’s Higuera, the Internet is now a vehicle to improve customer service rather than simply a delivery channel. Björn Olafsson of Handelsbanken sees the Internet as both a threat and opportunity: ‘What will it mean for the customer relationship if the customer doesn’t come into the branch? We have to find another way to communicate with him – perhaps by secure email. Each of our branches has its own website,

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and the customer-facing people in the branch must be able to contact the client directly. We must find a way to replace a meeting face-to-face with a meeting on the internet that the client also perceives as personal!’ Making small but steady improvements in the retail service offering is the response of many excellent bankers. Bill Dalton of HSBC talks about its UK experience: ‘The UK market is a competitive one and will remain so. There are no new critical success factors. Our theme is taken from Formula One racing: “Find half a second” – in other words, make continuous small improvements. You don’t need to reinvent the wheel. We have the clients – we just need to do everything a bit better.’

The importance of asset management Another forecast made by several excellent banks is the strategic importance of growing the asset management business, in particular for the individual market. This hardly a revolutionary discovery given the passion with which many banks bought into the fund management business in the1990s, yet it remains a key strategic goal despite the fallout from the stock market collapse since 2000. As discussed in Chapter 3, Wells Fargo and Fifth Third among our excellent retail banks have targeted the broadening of their product array to include investment products such as mutual funds and annuities. In the affluent and high net worth segments, UBS is the biggest global competitor and intends to increase its market share. For example, Bob Niehaus of Fifth Third foresees: ‘More growth in investment products – a broader product range. Organizationally we will have a common customer with a broader product array. The banker has to make sure we are working across silos. There’ll be more sales in the branches to clients who don’t come into town. It’s easier to do in one office, so everyone knows who is where.’ A number of other banks specifically mentioned asset management as a key factor in the transformation of banking in the intermediate term. Handelsbanken has already acquired SPP, a pension

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fund manager, but Lars Grönstedt feels there is room for further development: ‘In the life insurance business, you can make a strong case for bancassurance in view of the demographics plus a slowdown in GDP growth. It’s time to become counter-cyclical! Some life companies will find it hard to rebuild their financial strength; regulators will start squeezing their capital, and banks can be a safe haven for them.’ Andrea Moneta of UniCredito agrees: ‘It’s increasingly clear that the current official pension scheme (the first pillar) won’t provide enough resources; you need a second and a third. It’s a huge opportunity for banks to provide them. A strong fund management product can play a big role in the transformation of household assets similar [in Italy] to the movement from Government bonds to equities. We should be ready!’ Robert Albertson also sees asset management as a unique growth opportunity: ‘It’s a golden moment for the banking system to change stripes in their business mix. A lot of the money today is in deposits taken from brokers by people leaving the stock markets. It’s a one-time shot to keep those deposits and the relationship as well!’

Credit derivatives as a threat Several of our excellent banks agreed with the conclusions of the 2003 Banana Skins survey profiled in Figure 9.1. Not surprisingly, they are among the more conservative of our excellent institutions! Douglas Flint of HSBC has expressed his concern in the previous chapter about gearing and a nightmare scenario of a downward spiral of liquidity. At Handelsbanken, Lars Grönstedt is equally worried: ‘I’m concerned that the next bubble may be credit derivatives. Growth has been too fast. Risk has been transferred to those who can’t evaluate the credit risk – it’s a disconnect between customer contact and risk positions. If lenders can offload risk, it might encourage borrowers to do bad things.’

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An independent perspective from our bankologists Not surprisingly, our conversations with bank analysts and consultants revealed a somewhat different medium-term outlook. We summarize some of their views below. Arguably the greatest disconnect between the two perspectives lies in the likely pressure on profits. Several of our excellent bankers spoke of price competition in the retail sector and commoditization in some investment banking products. None, however, focused on profit pressure being a feature of the medium-term outlook. In sharp contrast, several independent observers are more pessimistic. In the investment banking world, Sir David Scholey, the former CEO of S.G. Warburg and still active as a Director of UBS and other institutions, speaks of a more difficult environment: ‘Clients are now very sophisticated, and the traditional business is a tough one and not particularly rewarding. Access to markets is the real attraction. Disintermediation will continue and trading expertise will continue to be invaluable. Overall, investment banking as such won’t be excessively profitable, but some will find specialist niches in developed markets; whilst others will prosper in new, emerging markets like China, Russia and India. But for those, you need people with as much geopolitical intelligence as banking expertise.’ Jim Freeman, a consultant and former investment banker in New York, paints a picture of an investment banking sector seeking diversification to compensate for slower earnings growth in traditional businesses: ‘The challenge is to grow. All investment banks have grown vastly in the 1990s; it can’t happen again. You need to find a place to make money. Traditional investment banking will be fairly profitable over time. In equities, the secondary business is only marginally profitable. A lot of people have made major bets in fund management, but that’s a different business. Others lend money to clients; that’s potentially a worrying problem. It’s not inherently a great business, and there’s the problem of loan profile diversification. Merchant banking will continue to grow. Over the medium term, you need diversification, but what to buy? An insurance company? It has to be big enough to have an impact.’

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In the lucrative world of retail banking, the threat is price competition, in particular from a lower cost business model. In our interviews, banks such as Handelsbanken spoke of their concern when confronted with price compression. Their response – emphasizing relationship rather than price – seems to have worked to date, but the threat remains. Vasco Moreno, head of European bank research in the specialist brokerage firm of Fox-Pitt Kelton, is much more pessimistic: ‘Clients are becoming a lot smarter. Now you have a lot of commoditized products and some high ROE ones like the current/checking account. A current account in the UK with zero interest paid produces a very high ROE even at today’s interest rates, with a long maturity value. Private banking produces margins of 20–50% with no capital required. The vast majority of products will become commoditized in the long term; it’s hard to avoid. Regulation also will have a huge impact, spurring change in customer behaviour. There’s a trend to direct banking, and regulators will make it easier. More savvy customers will drive lots more migration based on price. In the long term, banks will have to work three times as hard to generate today’s level of profitability.’ In contrast, observers such as Sam Theodore of Moody’s and Robert Albertson of Sandler O’Neill see little threat to the lucrative retail model. Albertson argues that: ‘Spread business is a good business over the market cycle. The real advantage of banks like Wells is that, when you sleep at night, your assets keep earning money. The investor is still looking to fee income, but high fee income banks don’t perform better! How can we convey the message that a low doubledigit growth business should sell at a higher multiple of earnings!?’ As for cross-border mergers, our European bankologists have reservations but acknowledge deals are highly likely. Stuart Graham at Merrill Lynch expresses a typical view: ‘European banks are the victims of their own success. They’ve outperformed the indices in each of the past four years – a result of the transformation of banking in the 1990s. The overriding issue now is revenue growth. Consolidation will go cross-border, and M&A can be ego-driven. Many CEOs

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must be bored stiff; they haven’t done a deal for years! If one bank does such a deal, others will follow.’ Sam Theodore also underlines the human dimension of the expansion dynamics: ‘Banks are run by people and they want to be seen to be doing something. The looming issue for the excellent banks is to keep an eye on the ball. If you’re a top retail bank that’s well run with a good client base and products, you don’t need to merge. But the investor view is that you’re not perceived to be doing something. Managements have to stay in charge – if not, they start to make mistakes!’ Whatever the strategic arguments for cross-border bank mergers, the statistical record is not overwhelming. On the basis of revenue and cost synergies estimated at the time of the deal in Europe, cost synergies as a percentage of the target bank’s cost base invariably fall in single-digit figures as opposed to the multiples of this amount for in-market deals. One of the main contributors to this result is the understandable desire to retain some form of headquarters function in the acquired bank in order to sustain a sense of local culture and identity. On the revenue side, the figures are even more modest as cross-selling is hampered by different local structures, as well as the lack of innovation in most banking products. We shall put forward our own views on this and other issues in the next and final chapter.

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11 Our Own Reflections and Forecasts

A few days before sitting down to write this last chapter, a banker friend at lunch commented that he found our last book (on investment banking) ‘interesting, but I’d have preferred your own honest thoughts’. So off goes the journalist’s hat, and on with that of the independent bankologist! First, let’s go back to earlier research for perspective. What has changed in the excellent bank profile, and what has not? Much has not changed at all. Customer-centricity is still the gold standard for banks, but many are far behind in the race to exceed, much less meet, customer expectations. Revenue generation is equally central: even more so with the inexorable demand by institutional investors for sustained earnings growth. Risk is synonymous with banking, although different risks preoccupy bankers at different times. Banks are still understandably characterized by their leadership and its perceived achievements, and attracting and retaining the best people remains axiomatic for success. Culture is still a central issue in that every bank has one, but it may be dysfunctional in a competitive environment. The ideal bank culture has changed little over two decades: strong communications across the bank; the breaking-down of product silos to offer improved, comprehensive service; leadership which provides discipline and direction; simple performance benchmarks and individual accountability; and superior people with an emphasis on selling skills. Growth by merger and acquisition is still top of the agenda for most CEOs. Way back in our research in 1988, cross-border mergers 123

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were forecast as the wave of the future, and throughout this period investors have ranked bank management on their relative ability to execute deals successfully. What has changed? First, the traditional culture of a bank as a pleasant place to work. A ‘family culture’, which protected and sustained loyal career employees almost regardless of their ability to generate, directly or indirectly, profits for the bank, is under tremendous strain in markets such as Europe. The pressure on both executives and employees to produce results is intense, whether in a retail institution (Fifth Third) or an investment bank (Goldman Sachs). Second, bankers have become painfully aware of the pitfalls of cross-border expansion. Handelsbanken is a rare bank which relies heavily for growth on opening new retail offices abroad, whereas most banks have been disposing of their networks of overseas units which are unable to meet profit benchmarks. Particularly in retail banking, the challenge of attracting top local talent to run a foreignowned entity has been a major hurdle. Third, in the real world, achieving stockholder value has displaced commitments to serve other constituencies such as the local community, employees and even clients. Stockholder value advocates such as Sir Brian Pitman of Lloyds TSB in the early 1990s maintained that maximizing the price of their stock would automatically bring in its train benefits for these other constituencies, but the case study of Lloyds TSB itself in recent years demonstrates the limitations of such a focus. In practice, therefore, management must continue to nurture all these constituencies but, to keep his job, the top item on the CEO’s agenda is to meet the inexorable demand for stockholder value! Finally, bankers know now what business they are in! In the 1980s, excellent retail bankers wondered about whether they needed to be in the broader business of providing investment advice, while corporate bankers agonized over the threat of securitization. Today they know: Dick Kovacevich’s commitment to a wide range of personal financial services is accepted across the retail world, and in investment banking the success of Citigroup demonstrates the potential of linkages between the balance sheet and investment banking products. So let’s turn to our own views for the future. We start by repeating a point made early in the book: our objective is not to predict the fate of our sample of excellent banks, but rather to use them as the basis for profiling today’s best management practice and a possible guide to

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future behaviour across the banking spectrum. However, any look at the future requires examination of the fairly dismal record of bankers’ predictions in the past. Banking is widely perceived as a ‘follow the leader’ business in which lemmings continue to jump over cliffs as they follow what they believe is best practice. Examples are legion. 1 Lending vast sums of money to emerging markets such as Latin America almost brought down the international banking community in the 1980s, yet subsequent lending to Argentina in recent years, and the massive currency and investment losses of Spanish banks diversifying into the region, have demonstrated once again that country risk exists and that premium yields usually reflect real risk. 2 At the height of the Internet boom in the late 1990s, otherwise intelligent bankers fell over themselves predicting the death of the bank branch and the future of investing heavily in stand-alone direct banks and portals selling a range of non-financial products. With the benefit of hindsight, Internet-based banking has a role to play for a major retail bank, but largely as another delivery channel to supplement a physical branch network. 3 At about the same time, convinced of the need to own the life insurance and fund management product to meet the needs for retirement savings, banks in the USA and Europe invested billions of dollars and euros in buying life insurers and standalone fund managers. The concept had validity, but the timing was appalling: most of these investments were made within months of the historical highs of the global equity markets, and the earnings leverage on the upside was transformed on the downside in a massive destruction of stockholder value. Today, ‘open architecture’, or ‘buying the milk but not the cow’, is the current theme for banks aware that their core strength is their customer base and that they are more likely to succeed as distributors than as product specialists. 4 Finally, in our research in 1999 on bank mergers, the unanimous forecast of our senior interviewees in over 30 banks which had undertaken transforming mergers was that cross-border mergers would become commonplace. Five years later, few such additional fully-fledged mergers have taken place as the realities of national regulation, cultural differences and lack of synergies overcame the

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theoretical rationale for such deals. We discuss below our views on this issue, which for many European banks is central to their future strategies. So what are the major issues for the future?

Managing size and complexity The management of size and complexity has been placed at the top of many banks’ agendas by the success of Citigroup in building a truly universal bank with strength not just in perhaps a hundred national retail markets but also in corporate and investment banking. With management teams highly respected by the investment community, favourable valuation metrics and the willingness to use their balance sheet to win business, banks such as Citigroup and others such as HSBC are positioned to continue their acquisition programme should they so desire. And we have seen from our interview series how competitors (including UBS and Goldman Sachs) are following events with some trepidation. So is there a limit to a bank’s size? Can a bank’s size and complexity be managed efficiently by even the strongest leader and his team? We have seen from our interviews that there are no new magic potions which have been conjured up to address these questions. Citigroup has introduced the same three-dimensional matrix used by banks for decades, with several customer-oriented businesses driving the decision-making process. HSBC and Citigroup employ the same management tools as their smaller rivals: accountability for results, a strong sales and performance-oriented culture, and disciplined and visible leadership. The fact that HSBC and Citigroup (and, arguably, UBS) are the only examples of our excellent banks to appear in each of our books since 1984 is some indication of the ability of large and diverse banks to deal successfully with the problems posed by their growth. They have benefited from leadership which is widely viewed as extraordinary and/or cultures which have averted risk disasters, provided excellent client service and profited from growth opportunities. However, the pressures on such behemoths are intense. Win Bischoff and Marcel Ospel have described the combined power of internal bureaucracy and external regulation to thwart entrepreneurial ambition

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and client service. Reliance on a single individual both to provide leadership and manage large egos is a major risk. Knitting together investment and commercial bankers requires years (if not decades) of disciplined effort, and in several cases the outcome is still in doubt. Several of our interviewees pointed to the inherent conflict in the use of the balance sheet in the interest of the bankers and dealers as opposed to those of the stockholders. If there is a fault line which could undermine the universal banking concept, it could be this one. The issue of size and diversity is the subject of great debate. A Financial Times article in early 2004 summarized the arguments for focus: the failure of financial supermarkets in the 1990s, the absence of correlation between size and profitability, the stock market’s distaste for diversity as evidenced in the trend away from bancassurance mergers, and public pronouncements by some of the largest banks that focus, rather than diversification, is their strategic priority. Yet against this logic can be set equally cogent counter-arguments. The Basle II accord will release even more surplus capital which many banks will be reluctant to return to the stockholders, and management ambition will continue to seek out opportunities for revenue growth that are available and that can be rationalized with their existing portfolios. Our verdict? There are a few success stories, but not many. The magic blend of extraordinary leadership, the right culture and sustained earnings growth from a diversified portfolio of businesses is not easily acquired or sustained. Our interviewees at Citigroup are right: the world will be watching! In our view, keeping strong egos aligned will be the litmus paper test of success in a major universal bank.

Cross-border mergers The frustration of excellent national European banks such as UniCredito and Handelsbanken over the challenge of cross-border mergers is palpable. For those such as Handelsbanken, whose very special culture is a key driver of success, a major overseas investment threatens that very culture. As some of our comments on the JPMorgan dilemma revealed, a strong culture can be a strategic weakness as well as a strength. The track record of such mergers gives little confidence in future deals. The example of Nordea in Scandinavia seems to confirm that

128 Excellence in Banking – Revisited!

the apparent similarity of national cultures is no guarantee of successful collaboration, while the embedded differences between retail markets seriously limit operational synergies. Simply cobbling together acquisitions in different financial businesses across borders, as in the case of the Belgo–French Dexia group, creates an additional set of problems. However, consigning major cross-border deals to the dustbin in the future is probably unrealistic for two reasons. The first is the ambivalent posture of major bank stock investors. On the one hand, they are well aware of the execution risks as well as the limited hypothetical addition to earnings. On the other, they implicitly acknowledge that their earnings expectations imply further growth which in many cases can only be achieved by buying abroad. M&A has become an inevitable component of achieving revenue growth for most banks, and a CEO’s merger skills will continue to be part of the job description. More important, however, is management testosterone, which under the guise of maximizing stockholder value has driven so much consolidation in the banking sector. A management team which has expanded successfully by acquisition is highly unlikely in the real world to be deterred from a deal which is available and could possibly pass muster from the market. In our view, the issue is not whether major cross-border transactions will take place, but rather how they should be evaluated if proposed. Which ones might make sense? One option which gained currency several years ago was a true merger of equals in which the resulting entity would be jointly managed, with a ‘best of both’ philosophy and key jobs handed out evenly to both parties. In our view, while this can work in a single market, in a cross-border context it would be a recipe for stalemate and frustration. A more sensible pairing would be the acquisition of a clearly underperforming bank by a foreign buyer equipped with the depth of skills and processes to add value to the combined entity. This would arguably fit the criterion enunciated by George Shaefer of adding revenue, or possibly of cutting costs. Unfortunately, as indicated above, all the evidence in Europe (so far at least) is that cross-border transactions add only marginal revenue synergies. Single-digit anticipated revenue increments would seem to reflect the similarity of bank product offerings as well as the unique nature of each country’s retail structure.

Our Own Reflections and Forecasts 129

More recently, a number of reported bilateral discussions have taken place in Europe between major banks in the UK, Belgium, the Netherlands, Italy and Germany. One can only guess at the reasons for their failure, but they could include inability to agree on price or management responsibilities, asset quality problems, or simply the inability of the fused institutions to produce significant revenue or cost savings. Another approach is to abandon the complex challenge of merging two major retail networks and focus instead on line of business acquisitions. UniCredito and others have espoused such ‘product factory’ solutions, which could take place in specific product areas such as consumer finance, asset management or global custody operations. Specialists such as BNP Paribas’ Cetelem consumer finance subsidiary have succeeded in such a strategy, although it is difficult for an outsider to evaluate the true economies of such central manufacture. So what is our verdict on major cross-border transactions? First, the combination of a highly regarded management team in the acquirer, the small relative size of the acquisition (and therefore potential dilution for the acquirer), and a friendly welcome from the acquired (and its regulator!) should be an acceptable formula for the investment community even if estimated synergies are nominal. Given the attributes of major potential acquirers (such as Citigroup and HSBC), some such deals could be on the horizon. Second, the line of business model as described above has attractions as a cross-border vehicle outside the core retail market. The challenge will be to find a match where the acquirer truly adds value in terms of expertise, lower costs or other material contribution. Finally, highly regarded mid-sized banks such as Handelsbanken may well swallow their concern for cultural dilution and execution risk if they can convince themselves that the risks are manageable. If the alternative is stagnation in the home market and the overseas acquisition is not massive in relative terms, we would expect some banks to take risks they would otherwise eschew.

The outlook for consolidation in general A host of factors should foster continued merger activity in unconcentrated markets such as the USA: the presence of significant synergies in head office and branch networks, management ambition, and

130 Excellence in Banking – Revisited!

investor pressure to sustain revenue growth. What is particularly fascinating has been the number of mergers of banks (such as JPMorgan and Wachovia) which could have continued on their own but which have chosen to merge with what is seen to be the right partner at the right time. As the consolidation process continues in a given market and the number of eligible partners decreases, the pressure to pair up now rather than later increases. A recent report by Fitch Ratings (Haas, 2003) provides an excellent objective appraisal of the strategic impact of the consolidation process in the USA, from which we quote the following excerpts: ‘In 1984 there were 14,496 commercial banks in the US, of which the top 10 held 22% of the total equity. Today [at the end of 2003] there are 7,833 with 47% of the total equity. Ignoring the ramifications of consolidation on either the industry as a whole or any individual institution is missing the proverbial elephant in the middle of the room. Often acquisitions become the defining action taken by management that ultimately distinguishes the Bank of Americas from the Bank of New England [which failed]. Strategically, there are very few companies that are capable of setting long range acquisition plans and sticking to them. The trend among large regional banks is likely to become “capture or be captured”. Surviving institutions will be: very successful and therefore too expensive to acquire; very weak and therefore unattractive take-over candidates, or privately held.’ Our two US regional commercial banks, Wells Fargo and Fifth Third, neatly fit the first category. In this context, the phrase ‘disciplined entrepreneurship’ comes to mind. We first heard it in our interview in 1988 with John Medlin of Wachovia, one of the most conservative yet successful US banks. One can manage a bank in a very conservative fashion, but on a few occasions a unique opportunity merits taking a significant perceived risk. Arguably HSBC’s decision to acquire Household International was one of these. Making these tough decisions is what can make – or break – the reputation of a CEO. In a world where banking headlines are dominated by the activities of a few hundred major investor-owned institutions, it is easy to ignore the thousands of smaller, local retail banks which play a significant and profitable role in communities across the USA and other markets. As we mentioned in our opening chapter, our excellence

Our Own Reflections and Forecasts 131

sample does not do justice to the success of these institutions. Many of our interviewees concur that their toughest retail competitors are such local savings, co-operative or investor-owned banks which have the relationship of trust with their clients so prized by their larger, ‘out-of-town’ rivals. The roughly 8,000 so-called ‘community’ banks in the USA are well-known if only because of their number, which decreases steadily in the consolidation process but is replenished regularly by the formation of new banks (a unique phenomenon across the banking world). In the form of savings banks, however, they also populate the markets of Spain, Germany and other countries. In Spain, for example, a recent study (Citigroup, 2003) shows how the aggregate market share of Spanish savings banks has finally equalled that of the larger commercial banks after rising steadily over the past decade. Driving the success has been not only the savings banks’ strong local relationships but also superior service quality. Figure 11.1 provides an indication of the level and consistency of the profitability of these banks in the USA since the real estate-driven credit problems of the late 1980s to early 1990s. Underpinning this Federal Deposit Figure 11.1 Thousands of US banks sustain attractive returns over the past decade % 1.5

% 15 Return on equity Scale

1.2

12

0.9

9

0.6

6

Return on assets Scale

3

0.3

0 1966

70

75

80

85

90

Source: Federal Reserve Bank of New York

95

00 02

0

132 Excellence in Banking – Revisited!

Insurance Corporation (FDIC) data is the ability of thousands of US banking institutions to earn a healthy ROE in the 12–15 per cent range with a remarkable degree of consistency.

The profitability of retail banking As far back as our interview series in 1988, the profit outlook for retail banking has been an issue for both investors and bank management. Figure 11.2 demonstrates the ability of banks in the UK, Spain, Sweden and other European markets to earn ROEs on their retail activity of 20–30 per cent year after year, when the cost of capital is a fraction of that return. Should there not be some convergence over time as has been the case in corporate banking, especially with growing transparency, competition, the advent of Internet banking, and so on? The answer, in our view, is customer lethargy. Retail banking services are not sufficiently exciting – or disappointing – to encourage many customers to change key service providers voluntarily. One of the few surveys which measure that lethargy is the 2000 Cruickshank Report in the UK on competition in banking. Table 11.1 summarizes the data gathered from individual UK banks on the average duration of a customer relationship for individual products. While competition Figure 11.2 Superior retail bankinga returns in many European markets 35

31.7 25.9

25

24.5

22.5

20

21.3 20.0 19.2 18.7

15

12.7 12.4 9.3

10

a Generally excludes non-domestic retail Source: DIBC/Company documents, data for 2002

Commerzbank

Credit Suisse

Fortis

KBC

SocGen

Swedbank

Svenska Handelsbanken

BSCH

Abbey National

SE Banken

0

Credit Lyonnais

5 BBVA

% Return on equity

30

Our Own Reflections and Forecasts 133

Table 11.1 Customer lethargy and relative competition in the UK Concentration (HHI)

Cost reflective pricing?

Current a/c Credit cards

High Fairly high

No Varies

Personal loans Mortgages

Low

Savings

Acceptable

Fairly high

Extent of shopping around?

Median time Effective product held competition? (years)

Low Low but Increasing Probably no Low

11.1 8.1

Probably yes Low but increasing N/A Low

7.5

N/A

9.9

No Moving in that direction Not clear Moving in that direction Some recent improvement

N/A ⫽ not applicable Note: HHI is a measure of market concentration Source: Cruickshank Report on Competition in UK Banking, 2000

is strong in some products (such as credit cards and home mortgages), the fact that retail customers change their core current account relationship only every 11 years on average enables banks to win significant revenues, directly or indirectly, from that key relationship. In sum, despite the appeal of lower cost providers such as Internet banks, we would be surprised to see significant attrition of retail bank margins over the foreseeable future.

The outlook for risk management One of the interesting findings from our interview series has been the acknowledgement by many universal and investment bankers that they are prepared to assume more risk in absolute terms. In part this is simply a desire to maximize their revenue stream, but it also reflects competitive pressure. At the same time they are acutely conscious of reputational risk in the current corporate governance environment. Does this portend increased losses, whether credit, market or operational? Are, for example, credit derivatives an accident waiting to happen? Should, for example, a major investment bank (such as Goldman Sachs) be investing heavily in power plants? We tend to agree with our interviewees from the rating agencies and other relative optimists. Risk management techniques have

134 Excellence in Banking – Revisited!

indeed been transformed in the past two decades. Credit and other derivatives, as Alan Greenspan and others have pointed out, are tools which can be used for good or ill. In the latter category they permit a given risk position to be highly leveraged, but the blame for unexpected losses should fall on the user of the instrument rather than the investment itself. Credit derivatives themselves have transformed the business of risk taking in banking. Yet one clear conclusion is that they have allowed banks – at least in theory – to transfer risk to others who are (one hopes) able to understand and manage it. Figure 11.3, taken from a Fitch Ratings study, demonstrates that insurers and other non-banks have been net takers of risk. As several of our interviewees have pointed out, the most serious risks are those which arise despite the application of sophisticated risk management techniques. The ‘hundred year flood’ will thus continue to plague banks, and their earning power and balance sheets must be sufficiently robust to accommodate these unanticipated Figure 11.3 The impact by sector of the use of credit derivatives (notional amounts) (USDbn) 1,500 1,200 900 600 300 0 –300 –600 –900 –1,200 –1,500 –1,800 Global banks Sold

Insurance Bought

Net

CDO = Collateralized Debt Obligation Source: Fitch Ratings

Financial guaranty Cash CDO

Our Own Reflections and Forecasts 135

losses. Arguably an even greater concern is the possible systemic risk from the failure of one of a diminishing number of massive universal banks. In conclusion, actual loss experience may increase as the universal banks put on more risk, but the most serious concern is likely to be the human error from pushing the risk envelope too far. For bankologists such as Sam Theodore of Moody’s, this is yet another argument in favour of retail banks!

Changing the culture Culture change is a strategic target for many banks, but the evidence of durable success is limited. As McKinsey’s Colin Price has pointed out, the change management techniques are well known, and our sample of excellent banks includes several who have created a highly successful client-centred culture over a period of decades. But how long does it take to ensure durable change? With the average tenure of a CEO, according to Price, falling to 3.6 years in 2003, how likely is it that the CEO will be around long enough to drive the necessary change? In our view, more research needs to be done to answer these questions. As Price maintains, a strong leader using the standard change management techniques can improve performance in a few years, but how durable is that change? Evidence from excellent retail banks such as Handelsbanken and Banco Popular Español indicates that cultural change is not a one-off process but evolves over time, and a very long period of time at that! And once the culture is in place, as at Goldman Sachs, monumental efforts must be made to sustain it. So we cannot be too optimistic about the ability of most banks to achieve durable cultural change in the span of one – or even more than one – CEO’s tenure. As our friend comparing his institution with that of Citigroup, observed on page 82, the forces of silo-ism, personal agendas and bureaucracy are sufficiently strong to thwart most change management efforts. To conclude on the issue of cultural change, it might be useful to scan some quotations from Jan Wallander’s story of transforming Handelsbanken (2003). ‘In the case of Handelsbanken it took in reality about five years for us to more or less reach the goal; for some functions it took considerably longer.

136 Excellence in Banking – Revisited!

The reason why was not only the opposition we met; it was also because the process had to be carried out step by step.’ (p. 41) ‘A large organisation leads a life of its own. It is like a heavy goods train thundering through the night. What has to be stopped is the work of the head office departments. In our case we did as follows: the departments were forbidden to send out any more memos to the branch offices apart from those that were necessary for the daily work and reports to the authorities.’ (p. 49) ‘The natural desire for company leaders to assert themselves is continuously encouraged by the media and what is, sometimes reverently, called “the market”. But to have a rise in the share price as the main aim can obviously lead to destructive behaviours which, in the long run, may have disastrous consequences.’ (p. 61) ‘Managing Directors are and should be people with a strong need to assert their authority. The easiest way of asserting themselves is to lead the company that grows the most and is some sense the largest. The media and the professional and short-term players that dominate the share market also work in symbiosis.’ (p. 59) ‘It is easy to construct attractive-looking mathematical arguments showing the advantages of large-scale operations, but it is more difficult to illustrate their disadvantages. They are symbolized by words like rigidity, slowness, bureaucracy, lack of transparency and so on. Vaguer, but none the less real in their effects.’ (p. 87) Those of us who have worked in and around large banks may recognize some of these phenomena! So what is the ‘take-away’ – to use the current expression in a busy world – from this research? It’s people! From the top leadership down to the client-facing people in the branch or call centre, this is the distinguishing feature of our excellent banks. It’s not location, although it is certainly easier to build a business in a growth market such as Spain or California than a Rust Belt state such as Ohio. The example of Fifth Third is a classic story of a determined, disciplined, sales-oriented top management winning market share in a very average market. And UBS has leveraged its offshore wealth management and domestic investment banking skills to become the largest global fund manager and a serious competitor in the global investment banking world.

Our Own Reflections and Forecasts 137

Neither is it the overall business profile. Bankologists strain to categorize financial institutions and draw conclusions about their peer group performance. Thus we have had super-regionals, bancassurers, pan-Europeans, globals, monoline investment banks, and now universal banks. (We ourselves struggle to categorize Citigroup!) These distinctions may be relevant, but the boundaries keep changing, partly because markets change, but also because remarkable human beings are in charge and exploit opportunities. Ten years ago Goldman Sachs may have primarily been an adviser to its corporate and institutional clients, but ten years from now it may be a leading producer and trader of electric power and other commodities as well as a major fund manager. Banking isn’t really ‘different’. It’s a service business, whether the clients are major corporates or the mass market. As one of our interviewees pointed out, other service businesses such as the tourism industry do a pretty good job of client service. What is ‘different’ is that many bank employees, up to and including the top management, are uncomfortable in a service or selling role. The McKinsey studies of cultural change in banks seem to confirm that many bankers seem to regard client contact and selling as ‘not my job’ and prefer to administer or process transactions. The process of converting bankers from administrators to a sales and service role is not a painless one. The old ‘family feeling’ has gone, and in its place is a ranking in order of revenue or profit generation. From Fifth Third and Handelsbanken to Goldman Sachs, the bottom tier is managed out in one way or another. The pressure to perform can be acute, and job satisfaction probably comes more from being part of a leading bank rather than the former comfort of lifetime employment and nice people to work alongside. The other issues we have explored in our earlier excellence books remain on management’s agenda, but the lessons of experience, the processes and the technologies are available. Banks still need technology, although they are now able to buy much of it in from outsourcing or technology partners. Risk management is a daily challenge, but the VAR models and other risk controls are in place across the banking system. Costs must be controlled, and the lessons from our excellent banks including Fifth Third, Goldman and Handelsbanken are that the starting point for cost management is

138 Excellence in Banking – Revisited!

revenue generation. After that one needs to evaluate the costs which need to be cut (ideally, variable ones). And if one wants to change the culture, there is a host of tested methodologies to use. All of this brings us back to our favourite ‘people’ topic of leadership. Is banking the Rust Belt of leadership? We can’t generalize, but what we can say is that the leaders of our excellent banks – and their predecessors – have truly shaped outstanding institutions. One does not need to subscribe to the ‘great man’ theory to acknowledge the role played by a single individual in building a culture of performance and selling. Can one imagine Citigroup today without Sandy Weill? Or Wells Fargo without Dick Kovacevich? Or Jan Wallander and his worthy successors in Handelsbanken? Going forward, it seems to us that the challenge for bankologists is look beyond the PowerPoint presentations and promises of future ROE expansion to the people behind them. Does management have the ‘bench depth’ and experience to manage a major merger or acquisition? Do top management as well as employees well down the chain sing from the same songbook? Is there clear accountability for performance? The answers to these and similar questions are not likely to be gleaned from chats with the CEO and his CFO, but perhaps from the competition, outside analysts, or employees well down the chain of command. The final word, of course, is leadership succession. Will the new leader carry on the work of his predecessor? Or will he have his own agenda, which might be a better one but will require massive cultural and other change which could take years to work through? This is simply another reason for watching Citigroup and others who are setting the pace in excellent banking!

Appendix 1: Profiles of the Excellent Banks Banco Popular Español The third largest Spanish bank with a disciplined focus on retail and commercial clients, Banco Popular Español (BPE) has achieved a financial and market record which is the envy of its peers both in Spain and other markets. Its domestic market share has expanded steadily in recent years to 10 per cent of loans and 8 per cent of deposits in the banking sector. Led since the 1970s by Luis and Javier Valls, its current co-chairmen, the bank has grown in its domestic market largely by organic means supplemented by acquisitions of smaller regional banks which retain their local identity. In 2003, Popular made its first significant expansion abroad into the neighbouring market of Portugal by acquiring BNC, a mortgage bank with over 100 branches across the country. The ‘Banco Popular model’ of retail/SME customer focus may well be exported to other national markets. It features the design of product packages designed for over 400 affinity groups among BPE’s five million retail and SME clients. In recent months the strategic focus has moved from the SME sector to the mass retail market, where the bank intends to focus on cards and mortgage products. In the high net worth sector, its Popular Banca Privada affiliate will attack a market which is relatively new for the group. While BPE’s market share in traditional retail products has grown impressively, its share of mutual funds has remained at a relatively low 3 per cent of the banking sector. Sustained by a disciplined, sales-oriented culture, BPE has become a role model for achieving a superior ROE by growing revenues significantly more than costs, winning market share in core traditional retail products, minimizing non-performing loans and eschewing the corporate/investment banking sector. Its ROE has exceeded 25 per cent in each of the last four years, supported by a remarkable cost/ income ratio of only 35 per cent and a lean ratio of non-performing to total loans of 0.83 per cent in 2003. This financial record has been reflected in superior market valuation parameters. BPE’s price/book ratio at year-end 2003 was 3.3, 139

140 Appendix 1

Table A.1 Key performance metrics 1999–2003

ROE Cost/Income Ratio Earnings per Share Price/Book Ratio

1999

2000

2001

2002

2003

25.9% 41.9

27.2% 39.1

27.7% 37.2

27.5% 35.7

25.6% 34.5

1.97

2.26

2.60

2.92

3.21

3.9

3.9

3.5

3.3

3.3

Source: Company documents

among the highest of any major bank in the markets we follow. During that year, the bank’s market capitalization increased by 27 per cent. Table A.1 provides key performance metrics for the period 1999–2003. BPE’s medium-term plan for the 2004–6 period calls for a 50 per cent increase in business volumes, a continuation of the recent growth trend. Market observers are concerned with the threat to the bank’s growth from its larger domestic competitors, who have refocused on the Spanish market after their problems in Latin America. The bank’s ability to build market share in Portugal will also be a key barometer of success in exporting its unique model.

Citigroup Citigroup is the world’s largest banking institution with a market capitalization of roughly US$250 billion and an equity base exceeding $100 billion, roughly 260,000 employees and a presence in over 100 national markets. Its diversity is equally remarkable, with a strong retail presence in the USA and other target markets, a leading position in the global investment banking sector, and rough geographic balance between North America and other dynamic markets such as Asia. Outside North America, the group has an impressive 50 million customers. The institution was formed in 1998 from a merger of equals between the former Citibank and the Travelers Group, headed by Sandy Weill. Following a period of co-CEO leadership, Weill was made sole CEO and, with his team, transformed the group into a

Profiles of the Excellent Banks 141

more disciplined, cost-effective and cohesive entity. His team’s major strategic achievement has been to build on the investment banking capabilities contributed by the Travelers Group to create an integrated global corporate and investment bank which has won considerable market share from its rivals. Figure A.1 outlines the geographic and product contribution of Citigroup’s component businesses. The Global Consumer Bank, which groups retail, consumer finance and cards, accounted in 2003 for 55 per cent of income from continuing operations. Its strategy to build market share has been achieved in recent years as Citigroup continues to acquire globally and leverages its strength in products such as credit cards. Global Corporate and Investment Banking, which provided 31 per cent of earnings in 2003, has built an enviable competitive position, winning market share across the product and geographic spectrum by leveraging its balance sheet effectively to win investment banking mandates. Thus Citigroup for the past few years has been the leader in global debt and equity issuance with a market share in excess of 10 per cent, while it ranks an impressive number two in global completed M&A with an 18 per cent market share in 2003. The balance of 14 per cent is provided by the global fund management, life insurance and private client operations. Citigroup aggressively manages its portfolio of businesses, divesting itself in particular of low profit, low growth units and acquiring entities which in aggregate have boosted single-digit organic earnings growth to double-digit increases. Management is known for its ability to take out costs, drive accountability across the organization, and on balance increase revenues faster than costs with the result that it generally has a higher profit margin, or operating leverage, than many of its competitors. A new matrix structure composed of four major product groups and the international operations ensures that products are managed on a global basis. The group’s financial targets are to achieve double-digit annual earnings growth and an ROE superior to that of its peers. In 2003, reported ROE was 19.8 per cent and pre-tax earnings rose 28 per cent over the 2002 level. Looking to the future, the Citigroup model is challenging traditional competitors in both retail and investment banking. By winning market share across the board, achieving a superior ROE and sustaining double-digit growth, Citigroup and its focused management

142

Figure A.1 Citigroup income by product and geography 2003 Product Contributions 4% 10%

55% 31%

Global Consumer

Global Corporate & Investment Banking

Global Investment Management

Private Client Services

2003 Geographic Contributions 4%

4%

8%

10%

10%

64%

North America Asia

Mexico

Europe, Middle East and Africa Japan

Latin America

Note: Excludes corporates/other and proprietary investment activities Source: Company documents

Profiles of the Excellent Banks 143

have achieved a loyal following in the investment community. The challenge is to sustain this momentum, which historically has been associated with Sandy Weill, who stepped down as CEO in 2003 but remains Chairman and is widely assumed to retain significant influence on strategy.

Fifth Third Bancorp Fifth Third Bancorp has become a role model for a highly decentralized, sales-oriented retail bank which has regularly generated doubledigit annual earnings growth to sustain a superior ROE as well as valuation multiple. Based in Cincinnati, Ohio, Fifth Third is a regional bank with $91 billion in assets at end-2003 and a branch network of 960 units in eight states, primarily in the Midwestern USA. Led since 1990 by its CEO, George Schaefer, Fifth Third has grown both organically and by acquisition – roughly 50 banks, including the $22 billion Old Kent Bank – during his tenure. Its culture is revenue-driven, with demanding targets and significant incentives paid for performance. Market shares range from 28 per cent of banking assets in its home market of Cincinnati to 10 per cent in Western Michigan and Chicago, as well as lower shares in other markets. A strong competitive advantage against larger competitors using a matrix organization is the bank’s reporting structure, under which all lines of business in one of the bank’s 17 regions report to the CEO of that region. Figure A.2 profiles the revenue contribution in 2002 from the bank’s key business lines. Outside its retail branch network, which contributes almost half of total revenues, Fifth Third Investment Advisors, with around $200 billion of funds under custody, generates another 10 per cent of total revenues. Its payments processing affiliate, Fifth Third Processing Solutions, is the oldest and largest US electronic funds transfer processor as well as sixth largest merchant processor. Some 197,000 merchants and 1,500 financial institutions rely on this unit for their electronic processing. In commercial banking, which accounts for 30 per cent of revenues, the in-house lending limit of $25 million reflects strong risk diversification, and 96 per cent of loans are made to borrowers within the bank’s geographic footprint. The bank’s revenue-driven business model has produced a superior ROA (return on assets) exceeding 2 per cent in recent years as well as an ROE in 2003 of 20.4 per cent. Even more important for the bank’s

144 Appendix 1

Figure A.2 Fifth Third 2003 revenue contributions by business lines 10%

11%

49%

30%

Retail Electronic Payment

Commercial Investment Advisers

Source: Company documents

acquisition strategy, Fifth Third’s valuation parameters are among the highest in US banking: its price/book ratio on year-end 2003 book of $15.04 per share is a remarkable 3.7. A significant event in recent years has been an agreement with the bank’s regulators stemming from a charge in 2002 for certain aged and in transit treasury items found internally to be impaired. The agreement with Fifth Third’s regulators calls for a moratorium on acquisitions which, at the time of writing, was still in force, but management expects it to be lifted in the near future.

Goldman Sachs While retaining its traditional leadership position in global M&A and global equity underwriting, Goldman Sachs has diversified in recent years into other growth businesses as well as reducing the volatility dimension of its earnings stream. Having expanded massively during the 1990s boom from roughly 5,000 staff to 25,000 at the market peak, the firm’s employment at end 2003 had fallen to under 20,000.

Profiles of the Excellent Banks 145

The seminal event in the firm’s 130-year history was the IPO in 1999, which provided liquidity for its partners and created currency for acquisitions to grow the business. While many observers had predicted that the break-up of the partnership would destroy Goldman’s unique client and performance-oriented culture, the firm has re-created a partnership concept with an internal profit sharing plan for about 300 of its key executives which replicates in many respects the old partnership model. Roughly 60 per cent of the stock is owned by current and past employees. The pie chart of contribution to net revenues shown in Figure A.3 reflects a transformation in earnings sources driven by market forces as well as a proactive strategy of diversification. The firm’s revenue contribution from advisory services (Investment Banking), its core traditional business, has fallen to only 17 per cent of the total in 2003. Depressed capital markets since the peak in 2000, coupled with competition from newcomers such as Citigroup, has thus reduced its contribution to third after FICC (fixed income and commodities) with 35 per cent and equities with 27 per cent.

Figure A.3 Goldman Sachs 2003 contributions to net revenues 17%

18%

65% Investment Banking

Trading & Principal Investments

Asset Management & Securities Services Source: Company documents

146 Appendix 1

Successful proprietary trading in FICC, coupled with customerrelated fixed income transactions, has more than offset the drop in advisory since the market peak. Goldman is prepared to take significant amounts of market risk in its trading books, and recently it has been more willing to use its balance sheet to support customerrelated market transactions. Equally important has been diversification into fund management (12 per cent) and securities services (6 per cent), such as serving the prime brokerage needs of hedge fund clients. Acquisitions and organic growth have lifted third party fund management to $373 billion in assets under management at end 2003. Less successful has been a major investment in New York Stock Exchange specialist Spear, Leeds & Kellogg. Private equity has also made a significant, albeit volatile, contribution to earnings, with the alliance based on a $1.3 billion investment in the Japanese bank Sumitomo Mitsui enabling Goldman to make $4.3 billion in commitments underwritten by the Japanese bank. During the recent market downturn, Goldman has effectively controlled its cost base; compensation expenses have fallen to 46 per cent of total revenues in 2003 from 48 per cent in 2002. As a result of this cost management program and the support of new earnings sources, Goldman’s ROE based on net tangible equity has risen to 19.9 per cent in 2003, only fractionally below the firm’s 20 per cent target. Going forward, the group has two main challenges. It must retain as much as possible of what is regarded in the business as the gold standard in firm culture, and it must meet the competition of larger universal players prepared to win business on the basis of balance sheet leverage. Thus Goldman’s equity capital of about $22 billion is about one-fifth of that of Citigroup, which holds the number two position under Goldman in M&A.

HSBC Holdings plc A truly global bank with roughly 8,000 offices in 80 countries around the world, HSBC has steadily diversified its product and geographic profile by organic growth and acquisition to create the world’s second largest bank by market capitalization. From its formation as a British colonial bank in Hong Kong in 1865, HSBC has used major acquisitions since the 1980s to diversify

147

Figure A.4 HSBC contributions to 2003 pre-tax profit by customer group and by geography

4% 28% 31%

15% 22% Personal Financial Services Commercial Banking

Consumer Finance

Private Banking

Corporate/Investment Banking 1%

29%

34%

10%

26% Europe

Hong Kong

Rest of Asia/Africa

South America North America

Source: Company documents

148 Appendix 1

away from its Asian roots. The sequence started with the USA (Marine Midland, a regional bank) in the 1980s, then Midland Bank in the UK in the 1990s (along with a shift of corporate headquarters to the UK), CCF in France in 2000, Republic NY and Safra also in 1999, Bital in Mexico in 2002 and, most recently, Household International, a consumer finance company in the USA which doubled the group’s North American exposure. Despite this massive expansion, the group’s culture still retains its core value of collective management, based originally on the trust and strong communication of an international cadre of British expatriates but now extended across a variety of national cultures. HSBC has also been a deposit-focused group, preferring to build liquidity before adding earning assets, although the Household purchase has modified this focus. Another core value is conservatism, reflecting perhaps the group’s origins in the volatile Asian environment. Thus its target Tier 1 ratio is a relatively high 8.25 per cent. Figure A.4 profiles the group’s geographic and product diversity in 2003, reflecting the Household acquisition. The Household acquisition for $14 billion thus substantially increases the North American contribution to a level in line with that of Hong Kong and Europe, as well as boosting aggregate personal financial services (including consumer finance) above those of corporate/investment and commercial banking. In contrast, organic growth has slowed in recent years; for 2003, net interest income excluding acquisitions increased only marginally. Cross-selling Household products to HSBC clients, in particular in the emerging markets in which HSBC has strength, is thus a key strategy. Another major strategic initiative is the effort to build organically a global investment banking capability to compete with that of Citigroup, HSBC’s closest rival for global leadership. HSBC’s financial record in recent years reflects its conservative stance: ROE has varied between a low of 10 per cent during 2001, when Argentinian losses hit the profit and loss, and 17 per cent in the boom year of 2000. Equally important is a relatively high price/earnings ratio which supports the bank’s acquisition programme. A five-year target set in 1998 of doubling shareholder value by the end of 2003 achieved its objective, and HSBC stock also outperformed its benchmark peer group of nine banks.

Profiles of the Excellent Banks 149

Svenska Handelsbanken Sweden’s largest banking institution, Svenska Handelsbanken, has regularly led its Nordic peers in generating a superior return on capital through its unique decentralized retail model. Throughout the past three decades, Handelsbanken’s ROE (14.9 per cent in 2003) has achieved the bank’s strategic goal of outperforming the weighted average of its quoted Nordic competitors. Established in 1871, Handelsbanken under the leadership of its then CEO in the 1970s, Jan Wallander, evolved a culture and structure which focused key decisions on the retail branch and its management. Similar in many respects to a franchising operation, the branch manager determines which products will be sold to which customers, including the largest corporates. Each of the over 400 domestic branches has its own website. Thus the corporate centre in many respects responds to the needs of the branches rather than issues orders as is the case for a traditional large bank. In its home market, through organic growth and the acquisition of a mortgage bank and a mutual occupational pension provider, Handelsbanken leads its competitors with 27 per cent of the overall lending market, 30 per cent of mortgage finance, 20 per cent of life insurance and 29 per cent of the mutual fund market. Its Handelsbanken Markets division is responsible for international banking outside the bank’s Nordic and UK business, as well as capital market activities. The latter is largely driven by the retail distribution of structured products rather than traditional investment banking activities. The pension and insurance business has been depressed by equity market conditions in recent years, but management believes that the long-term potential of meeting pension needs in Sweden is exceptionally attractive. Figure A.5 demonstrates the dominant role played by the branch system as a contributor to operating profits. With its growth potential limited in the Swedish market, Handelsbanken’s international strategy assumes critical importance. Largely by organic growth – unique among European banks – Handelsbanken has now become the fourth or fifth largest bank in each of the other three Nordic markets, and in the UK its small branch network now contributes 2 per cent of group profits. In these

150 Appendix 1

Figure A.5 Svenska Handelsbanken operating profit by business areaa 1% 1% 4% 9%

85% Branch Offices

Markets

Pensions/Insurance

Asset Management Other

a

As of June 2003 Source: Company documents

markets it follows the same strategy as in Sweden: delegating substantial responsibility to local branch management for the full range of products and customers. Handelsbanken’s business model has delivered superior returns through focus on the metric of the cost/income ratio, essentially ensuring that revenue growth exceeds that of costs. With revenue growth in Sweden slowing to the low single digits, this focus is essential to sustaining acceptable earnings growth. It also permits the bank to be selective in its lending strategy. Thus in 2003 the cost/income ratio was a remarkably low 46 per cent (well below its Swedish peers) and loan loss provisions once again less than 10 basis points of the loan portfolio. Handelsbanken’s decentralized culture is also reflected in the fact that its largest single stockholder is its own staff in the form of the Oktagonen Foundation, which manages a profit-sharing system for

Profiles of the Excellent Banks 151

all employees that pays out when, as has been the case in every year except 1973, the bank’s ROE exceeds its relative target compared to peer banks. Each employee receives the same amount, and disbursements are made on retirement.

UBS AG Formed in 1998 from the merger of two of the three largest Swiss banks, UBS AG has grown from its Swiss base to become the world’s largest wealth manager as well as one of the top global investment banks. With total equity at year-end 2003 of US$28 billion equivalent, the group is the largest financial institution in Switzerland with major operations in London and New York, as well as about 50 other countries. Led by the chairman, Marcel Ospel, and his team from the former Swiss Bank Corporation, UBS has grown organically and through the acquisition of about 10 firms since the early 1990s. Peter Wuffli, the CEO, sees creating a single culture with a client focus as his major goal. The formative merger was the fusion with the former Union Bank of Switzerland, which created substantial cost savings in the Swiss market as well as shaping one of the leading global investment banking entities. In 1998, following losses incurred by the former UBS, the Chairman resigned and major changes took place in the group’s risk management structure. Of the subsequent acquisitions made by the group, the purchase of the US broker Paine Webber, with 14 per cent of the US market, has been the most significant. Figure A.6 provides the 2003 contribution by management unit to earnings before tax and extraordinary items and excluding a negative contribution from the corporate centre. Investment Banking and Securities, with 43 per cent of 2003 pretax contribution, represents the largest single contributor to group results. UBS has built on its strength in the European market, where it was ranked number three in equities trading and four in equity issuance in 2003. Expansion has targeted the key US market, where UBS has also achieved a number three ranking in equity trading. Expansion in the US investment banking market has taken the form largely of the recruitment of established professionals and teams. Overall, in 2003 UBS climbed to a number four ranking in Freeman & Co.’s measure of global investment banking fees earned. Investment

152 Appendix 1

Figure A.6 UBS 2003 contribution by business group

47%

49%

4% Wealth Management & Business Banking Global Asset Management Investment Bank Notes: Before tax and excluding significant financial events. Before allocation of the Corporate Centre which is (13 per cent) against the total of the above businesses Source: Company documents

banking earnings are also projected to provide a growing share of overall earnings. UBS is the largest wealth manager in the world with SF2.2 trillion in managed assets at year-end 2003. The major components of this business are its traditional Swiss private banking activity with over 3,000 client advisers, the former Paine Webber brokerage/private client unit in the USA, the institutional arm of UBS Global Asset Management, and a growing ‘onshore’ private banking activity in Europe outside Switzerland. In the Swiss retail and corporate banking markets, UBS is the largest Swiss bank with at least 25 per cent of most market segments. The 1997 merger created economies which have significantly increased the profitability of this core unit. The bank targets an after-tax ROE of 15–20 per cent before goodwill amortization and extraordinary items. After reaching a historic high during the boom year of 2000 when ROE topped 20 per cent, net income fell in 2001 and 2002 but recovered in 2003, when ROE

Profiles of the Excellent Banks 153

rose above the target range to 20.9 per cent. UBS has been prepared to accept short-term losses to build market position. Thus the former Paine Webber only moved into positive earnings (after goodwill amortization) in 2003, while the European Wealth Management initiative is still a drain on current earnings. Private equity has been dropped as a core business after losses suffered in recent years.

UniCredito Italiano Formed in 1998 from the merger of a major corporate bank (Credito Italiano) and several regional savings banks in the wealthy provinces of Northern Italy, UniCredito has become the desired business model for its Italian peers as well as the country’s largest bank by market capitalization and capital base. Following several years of managing the merged bank on a federal basis, as of January 2003 the management team headed by Alessandro Profumo created three domestic operating units on a line of business basis and integrated its central functions. Figure A.7 Figure A.7 UniCredito divisional contribution to net income 18%

34% 8%

40% Retail

Corporate

New Europe (CEE)

Private & Asset Management Notes: As of September 2003; rebased to exclude losses (14 per cent) from other items Source: Company documents

154 Appendix 1

profiles the relative contribution to net income for the first nine months of 2003 of these units as well as its New Europe unit operating in CEE. The major earnings contributor currently is the group’s Corporate Division with 40 per cent of total income (after deducting nonoperating items). The sale of derivatives to UniCredito’s SME client base has accounted for a major portion of the group’s revenue growth in recent years. In the Retail Division, the bank’s branch network of 2,750 units located primarily in northern Italy is supplemented by its consumer finance unit Clarima. The Private Banking and Asset Management division, which includes the Pioneer fund management unit with e114 billion of assets under management, also contains UniCredito’s force of 1,600 financial advisers. In CEE, management moved quickly after the 1998 merger to enter this emerging market with the acquisition of the leading Polish retail bank Pekao, which has been subsequently joined by a number of smaller acquisitions in the CEE. Based on its core market area of Northern Italy, UniCredito now holds 8 per cent of the retail deposit and lending markets in the country as well as 12 per cent of retail mortgage loans. With significant expansion via the acquisition route in Italy forestalled by regulatory action for the foreseeable future, management has targeted overseas markets to supplement domestic growth. UniCredito is now the second largest foreign bank in CEE and aims to become the largest in terms of assets. Management is also actively considering expansion into other European markets where it believes its business model can add value. For the period 2003–6, UniCredito has embarked on an aggressive strategic plan which calls for an 11.5 per cent annual increase in group operating profit (well above recent revenue growth) and an increase in ROE from 17 per cent in 2003 to 21 per cent in 2006. Driving this expansion in the face of rising competition from its peers and uncertain economic growth is the implementation of a customer-focused strategy designed to win market share through revenue growth.

Wells Fargo & Company The fourth largest US bank in terms of assets and market capitalization, Wells Fargo is a role model for consistent growth based on its

Profiles of the Excellent Banks 155

strength in retail banking across its base in the Western and Midwestern USA. Its strategy is to combine the strengths of the community bank with its status as the most ‘super-regional’ of the US banks. Wells also has received the accolade of being the only AAArated bank in the USA. The current bank was formed from the merger in 1998 of two major regional banks, Norwest in Minneapolis and Wells Fargo in San Francisco. Led by the former Norwest CEO, Richard Kovacevich, the bank passed through a complex period of cultural and systems change and has subsequently acquired over 60 smaller banks and other financial institutions. Wells Fargo’s strategy is keyed to cross-selling a wide range of financial products through over 3,000 ‘stores’ or branches, which have deep roots in communities across its geographic footprint of over 20 states. Its strategic target is to achieve ‘100 per cent of every customer’s business’ through a sales-oriented culture based on team Figure A.8 Wells Fargo earnings contribution by line of business

6%

4%

9% 35%

14%

17% Community Banking

15% Investments & Insurance

Specialized Lending

Wholesale Banking Consumer Finance Commercial Real Estate Residential Mortgage & Home Equity Note: Percentages are based on normalized historical averages and near future years’ expectations. Source: Company documents

156 Appendix 1

collaboration, specific revenue targets and an emphasis on retail investment products such as annuities and mutual funds. Wells’ cross-selling ratio of over four products per customer is the highest of any large US bank, and management targets a remarkable eight products for the longer term. Figure A.8 provides a breakdown of earnings contributions based on historical and projected data. The bank’s retail businesses account for about 80 per cent of total earnings. It is the largest home mortgage originator in the USA, a business which is balanced over the interest rate cycle by its mortgage service function, which is itself the second largest in the country. Its consumer finance business, Wells Fargo Financial, has achieved 22 per cent annual growth in receivables since 1999. A major strategic focus is the sale of retail investment products through its own sales force of 1,100 financial consultants and 6,200 independent financial advisers. While the bank is strong in SME and small corporate banking, it has shrunk its large corporate business in recent years so that wholesale banking accounts for a relatively small 9 per cent of total earnings. A major acquisition has been the Acordia insurance agency, the largest bank-owned agency in the USA with 150 offices and 4,500 insurance professionals. Wells is also the largest US lender to the commercial real estate sector as well as the leading competitor in asset-based lending. International business is largely conducted through a joint venture with HSBC. Management’s key financial target is to grow earnings at a doubledigit annual rate through organic expansion and acquisitions. Since 1993, the bank and its predecessors have experienced a 13 per cent compound annual growth in earnings per share. Return on equity in 2003 was 19.4 per cent, supported by a relatively high net margin in excess of 5 per cent (against a US big bank average of less than 4 per cent). Management views the group as a diversified financial institution, rather than a bank, and is therefore able to exploit opportunities across the full spectrum of retail and commercial financial services.

Appendix 2: The Business Principles of Goldman Sachs

1 Our clients’ interests always come first. Our experience shows that if we serve our clients well, our own success will follow. 2 Our assets are our people, capital and reputation. If any of these is ever diminished, the last is the most difficult to restore. We are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us. Our continued success depends upon unswerving adherence to this standard. 3 Our goal is to provide superior returns to our shareholders. Profitability is critical to achieving superior returns, building our capital, and attracting and keeping our best people. Significant employee stock ownership aligns the interests of our employees and our shareholders. 4 We take great pride in the professional quality of our work. We have an uncompromising determination to achieve excellence in everything we undertake. Though we may be involved in a wide variety and heavy volume of activity, we would, if it came to a choice, rather be best than biggest. 5 We stress creativity and imagination in everything we do. While recognizing that the old way may still be the best way, we constantly strive to find a better solution to a client’s problems. We pride ourselves on having pioneered many of the practices and techniques that have become standard in the industry. 6 We make an unusual effort to identify and recruit the very best person for every job. Although our activities are measured in billions of dollars, we select our people one by one. In a service business, we know that without the best people, we cannot be the best firm. 7 We offer our people the opportunity to move ahead more rapidly than is possible at most other places. Advancement depends on merit and we have yet to find the limits to the responsibility our best people are able to assume. For us to be successful, our men and women must reflect the diversity of the communities and

157

158 Appendix 2

8

9

10

11

12

13

14

cultures in which we operate. That means we must attract, retain and motivate people from many backgrounds and perspectives. Being diverse is not optional; it is what we must be. We stress teamwork in everything we do. While individual creativity is always encouraged, we have found that team effort produces the best results. We have no room for those who put their personal interests ahead of the interests of the firm and its clients. The dedication of our people to the firm and the intense effort they give their jobs are greater than one finds in most organizations. We think that this is an important part of our success. We consider our size an asset that we try hard to preserve. We want to be big enough to undertake the largest project that any of our clients could contemplate, yet small enough to maintain loyalty, the intimacy and the esprit de corps that we all treasure and that contribute greatly to our success. We constantly strive to anticipate the rapidly changing needs of our clients and to develop new services to meet those needs. We know that the world of finance will not stand still and that complacency can lead to extinction. We regularly receive confidential information as part of our normal client relationships. To breach a confidence or to use confidential information improperly or carelessly would be unthinkable. Our business is highly competitive, and we aggressively seek to expand our client relationships. However, we must always be fair competitors and must never denigrate other firms. Integrity and honesty are at the heart of our business. We expect our people to maintain high ethical standards in everything they do, both in their work for the firm and in their personal lives. Source: Annual Reports

Bibliography Barney, J.B. (1986) ‘Organisational Culture: Can it be a Source of Competitive Advantage?’ Academy of Management Review, 11(3). Christiansen, Clayton (1999) What is an Organisation’s Culture?, Harvard Business School case study, 9-399-104. Citigroup Capital Markets (2003) Spanish Retail Banking – Banks vs. Cajas, 11 November (London). Cruickshank (2000) Competition in UK Banking (London: HMSO). Davis, Steven I. (1985) Excellence in Banking (London: Macmillan – now Palgrave Macmillan). Davis, Steven I. (1989) Managing Change in the Excellent Banks (London: Macmillan – now Palgrave Macmillan). Davis, Steven I. (1997) Leadership in Financial Services: Lessons for the future (London: Macmillan – now Palgrave Macmillan). Davis, Steven I. (2000) Bank Mergers: Lessons for the Future (London: Macmillan). Davis, Steven I. (2003) Investment Banking: Addressing the Management Issues (London: Macmillan – now Palgrave Macmillan). Davis, Steven I. et al. (1994) Global Investment Banking: Which New Players will Make the Team? (New York: Salomon Brothers). DIBC (2003) Cross Pillar Mergers outside Canada: The Lessons for Public Policy, submission to Department of Finance, Ottawa. The Economist (2003a) Investment Banks 2003: A Survey of Awareness and Perceptions (London). The Economist (2003b) Tough at the Top – A Survey of Corporate Leadership, 25 October. Financial Times (2004a) The Myth of the Megabank, 6 January, p. 17. Financial Times (2004b) World’s Most Respected Leaders: Views from 20 Countries, Special report, 20 January. Haas, Sharon (2003) Evaluating US Bank Mergers and Acquisitions: Mergers, Consumer Fortunes are Keys to US Banks’ 2004 Outlook (New York: Fitch Ratings). McKinsey & Co. (2003) ‘Bank/insurance mergers’ McKinsey Quarterly, 2. Mercer Oliver Wyman (2003, 2004) State of the Financial Services Industry (New York). Schein, Edgar (1988) Organisational Culture and Leadership (San Francisco, Jossey-Bass). Wallander, Jan (2003) Decentralisation – Why and how to make it Work: The Handelsbanken Story (Stockholm: SNS Forum). Waterman, R. and Peters, T. (1982) In Search of Excellence; Lessons from America’s best-run companies (New York: Random House).

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Index Abbey National 100 Ackermann, Josef 18 Acordia insurance agency 156 acquisitions see mergers and acquisitions affinity marketing 64 Albertson, Robert 59, 90, 92, 100, 118, 120 Andrews, John 39, 56–7, 81, 112 Arnold, Neal 54 artefacts 36 asset management 117–18 assumptions 36, 37 see also culture ‘Banana Skins’ survey 97–9, 118 Banco Nacional de Credito Immobiliaro (BNC) 65, 139 Banco Popular Español (BPE) 3, 4, 5, 8, 9, 69, 105 business model 29 culture 47, 49, 135 execution 87–9 and the future 113, 116 leadership 56 profile 139–40 revenue growth 64–5, 71–2 Bankers Trust 7, 8–9, 10–11, 38, 100 acquisition by Deutsche Bank 14–16, 97 innovation 68–9 bankologists 1 and the future 119–21 Barney, J.B. 35 Basle II accord 100, 107, 127 Bischoff, Sir Win 23, 45, 78, 79, 115, 126 Bital 148 BNP Paribas 129 Brittain, A1 38 business models 21–33 Butler, Pat 82 Callahan, Pat CCF 148

46, 91

Centre for the Study of Financial Innovation (CSFI) ‘Banana Skins’ survey 97–9, 118 Ceska Sporitelna 85–6 Cetelem 129 change 57 in banking sector 7–11 culture change 36–7, 135–8 Chase Manhattan 12–14 Christiansen, C. 36 Citibank 38, 140 Citigroup 3, 4, 5, 8, 11, 69 business model 18, 22–3 culture 38, 44–5 execution 89 and the future 111, 115, 116 growth in assets and employees 76 leadership 55 managing size and complexity 77–8, 126 profile 140–3 revenue growth 66–7 risk management 105 client wheel 47–8 clients see customers/clients commercial banking see retail banking Commerzbank 71 commitment, customer 60, 62, 63 community banks 130–2 competition customer lethargy and 132–3 price competition 120 complexity, managing 75–83, 126–7 consolidation see mergers and acquisitions consumer finance 71 co-ordination 33 corporate banking 33, 81 cost/income ratios 87–9 cost management 59, 86–90, 96, 137–8 country risk 125 credit derivatives 98, 99, 118, 134

161

162 Index

credit risk 105, 106 Credit Suisse Group 8, 10–11, 18–19, 37–8, 71 Credito Italiano 153 cross-border mergers 110, 113–16, 123–4, 125–6 and the future 120–1, 127–9 cross-selling 60–73 Cruickshank Report 132–3 culture 35–49, 57, 123, 124 changing 36–7, 135–8 customer orientation 35, 37, 123 customer service 33, 85, 92–3, 94, 96 customers/clients commitment 60, 62, 63 lethargy 132–3 more demanding 116–17

profile 143–4 revenue growth 65–6 risk management 106–7 Financial Times 127 leadership survey 51–2 First Boston 18–19 First Union 17–18 Fitch Ratings 130, 134 Flint, Douglas 24, 41, 71, 90, 103–4, 115–16, 118 Francke, Lennart 28–9, 48, 87, 106 Freeman, Jim 15, 119 fund managers 125 future banks’ perceptions of 109–21 major issues 126–38

Economist, The 57–8 customer preference survey 93, 94 electronic banking 86 Ellerton, Chris 19, 77, 100 emerging markets 115–16, 125 Enron 11, 102 European banks 110, 113–15, 120–1 excellent banks changing profile 9–10, 123–4 fortunes of earlier samples 7–19 sample 1–6 excess value creation 9–10 execution 85–96

global universal banks 2, 3, 4, 93 see also Citigroup; HSBC; UBS Goldman Sachs 3, 4, 5, 8, 16, 137 business model 26–7 business principles (values) 38–9, 157–8 culture 38–40, 135 execution 95–6 and the future 112 leadership 56–7 managing size and complexity 80–1 profile 144–6 risk management 104–5 Graham, Stuart 120–1 Green, Stephen 23–4, 40–1, 54–5, 75, 78–9, 115 offshoring 91 risk 103 Greenspan, Alan 134 Grönstedt, Lars 28, 52–3, 61, 72, 113, 118 Gubert, Walter 14 Gulliver, Stuart 25, 41

Federal Deposit Insurance Corporation (FDIC) 131–2 Fifth Third 3, 4, 8, 9, 130, 136 business model 32–3 culture 45 execution 89, 95 and the future 110–11, 117 leadership 53–4

Haas, S. 130 Handelsbanken see Svenska Handelsbanken Higuera, Roberto 29, 56, 64–5, 87–9, 109, 113, 116 Household International 71, 100, 130, 148 Hoyt, Dave 32, 46, 80, 93, 103

Dalton, Bill 24–5, 42, 67, 79, 117 Davis, S.I. 3, 12, 15, 55 derivatives 68–9, 134 credit derivatives 98, 99, 118, 134 Deutsche Bank 8, 11, 15, 38, 97 Dexia group 128 DIBC 70, 71 disciplined entrepreneurship 130 disintermediation 12 Druskin, Bob 89

Index 163

HSBC 3, 4, 5, 8, 11, 156 acquisition of Household International 71, 100, 130, 148 business model 23–5 culture 38, 40–2 execution 90, 91 and the future 115–16, 117 growth in assets and employees 76 leadership 54–5 managing size and complexity 78–9, 126 profile 146–8 revenue growth 69, 71 risk management 100, 103–4 ING Direct 86 innovation 60–73 institutional investors 59–60 insurance/banking mergers 70–1, 125 Internet 86, 91, 116–17, 125 investment banking 2, 3, 4, 33, 119, 124 consolidation 8–9, 12–16 see also Goldman Sachs Jeker, Robert 37–8 joint ventures 91 JPMorgan 7, 8–9, 12–14, 38, 68–9, 112, 127 Kovacevich, Richard (Dick) 53, 57, 89, 92–3, 124, 138, 155 business model 31–2 consolidation 110 cross-selling 60–3 risk management 102–3 Lascelles, David 98–9 leadership 37, 51–8, 123, 135, 138 Legal & General 17, 70–1 Leonard, John 102 leveraged lending 97 life insurers 125 line of business acquisitions 129 liquidity 103–4 Lloyds TSB 124 locally-based, smaller banks 2–3, 130–2 Long Term Capital Management 100

Luengo, José Luis 49 Lutes, Brian 54, 66, 95, 107, 111 Marine Midland 148 Mathias, Peter 81 McKinsey & Co. 36, 137 Medlin, John 17–18, 130 Mercer Oliver Wyman 9–10 mergers and acquisitions 7–9, 11–19 banks’ views on future for 109–16 cross-border see cross-border mergers outlook for 129–32 sustaining revenue growth 60–73 Midland Bank 148 Modiano, Pietro 31, 43–4, 69, 114 Moneta, Andrea 43, 53, 68, 72, 118 monoline investment banks 2, 3, 4 see also Goldman Sachs Moreno, Vasco 120 Morgan (JP) Bank 7, 8–9, 12–14, 38, 68–9, 112, 127 Morgan Stanley 16 Morris, Hans 23, 44, 66–7, 89, 116 future of banking 111 matrix structure 78 risk management 105 Munro, Allan 13 National Westminster 7, 8, 10, 16–17, 38, 70–1 Nicastro, Roberto 30–1, 43, 72, 113 Niehaus, Bob 45, 54, 65–6, 106, 117 non-performing loans 100–1 Nordea 82–3, 127–8 Nordström, Lars G. 82–3 Norwest Bank 155 O’Connor (derivatives firm) 104 offshoring 91 Oktagonen Foundation 150–1 Olafsson, Björn G. 91, 116–17 Old Kent Bank 65, 143 open architecture 125 organizational structure 77–8, 96, 126 Ospel, Marcel 42–3, 51, 52, 89, 93, 126, 151 consolidation 114 management size and complexity 79 risk management 104, 107

164 Index

outsourcing 91 overcapacity 7–8 overseas expansion 60–73, 124 packaging (bundling) retail products 64, 68 Paine Webber 151, 152, 153 Parmalat 11 Paulson, Hank 56–7 Pekao 154 people 136–8 attracting and retaining the best people 93–6 and their culture 35–49 Pioneer 43–4 Pitman, Sir Brian 124 PNC Financial 8, 11 positioning 21 Prescott, Charles 77, 101 Price, Colin 36–7, 49, 58, 135 price/book value 3–5 price competition 120 profitability 119 of retail banking 132–3 Profumo, Alessandro 30, 52, 53, 80, 113–14, 153 prospective return on equity (ROE) 3–5 RAROC (risk-adjusted return on capital) 97 rating agency ratings 2 recruitment and retention 93–6 regional commercial banks 2, 3, 4 see also Banco Popular Español; Fifth Third; Svenska Handelsbanken; UniCredito Italiano; Wells Fargo Republic NY 148 reputational risk 103, 105, 106 retail banking 2, 3, 4, 33, 82, 107, 120, 124 consolidation 16–19 profitability 132–3 regional commercial banks see regional commercial banks small, local retail banks 2–3, 130–2 retention of staff 93–6 return on equity (ROE) 132 prospective 3–5

revenue growth 59–73, 123, 128 risk management 10–11, 97–107, 123, 137 outlook for 133–5 rogue traders 98–9 Rohner, Marcel 67–8, 92, 104 Rowe, Bill 106 Royal Bank of Scotland 17, 71, 100 Rudloff, Hans-Jurg 81 S.G. Warburg 7, 8–9, 16 Safra 148 Sanford, Charlie 15 savings banks 131 Schaefer, George 85, 89, 93–5, 106, 128, 143 business model 33 culture 45 future of banking industry 110–11 leadership 53–4 revenue growth 65 Schein, Edgar 36 Scholey, Sir David 16, 119 senior credit officer 97 service businesses 137 see also customer service ‘silos’, organizational 37, 46 size, managing 75–83, 126–7 small, local retail banks 2–3, 130–2 Soifer, Ray 14, 15–16, 77, 99 Spain 131 Spear, Leeds & Kellogg 146 specialist investment banks 2, 3, 4 see also Goldman Sachs SPP 117–18 Stack, Jack 85–6 Statius-Muller, Robert 102 Steel, Robert (Bob) 27, 39, 80, 95, 97, 105, 112 stockholder value 2, 9, 11–19, 124 Stott, Andrew 75–7, 99 strategic positioning 21 Studzinski, John 25, 41–2, 55, 78, 103, 116 Stumpf, John 32, 45–6, 90–1, 110, 116 Sumitomo Mitsui 146 Svenska Handelsbanken (SHB) 3, 4, 5, 8, 9, 69 business model 28–9 culture 47–8, 49, 127

Index 165

Svenska Handelsbanken (SHB) – continued culture change 135–6 execution 87, 91 and the future 113, 116–17, 117–18, 118 leadership 52–3 profile 149–51 revenue growth 61, 64, 71–2, 124 risk management 106 Swiss Bank Corporation (SBC) 7, 8, 10, 11, 151 Taylor Nelson Sofres (TNS) customer commitment survey 60, 62, 63 technology 86, 90–1, 96, 137 see also Internet tenure of leaders 57, 135 Theodore, Sam 15, 90, 101, 120, 121, 135 Toronto Dominion 8, 10–11, 38 Travelers Group 140, 141 UBS 3, 4, 8, 11, 69, 105, 136 business model 25–6 culture 42–3 execution 89, 92, 93 and the future 114–15, 117 growth in assets and employees 76 leadership 52 managing size and complexity 79 profile 151–3 revenue growth 67–8 risk management 104 UniCredito Italiano 3, 4, 5, 8, 70, 129 business model 30–1 culture 43–4 and the future 113–14, 118 leadership 53 managing size and complexity 80 profile 153–4 revenue growth 68, 69, 71, 72 Union Bank of Switzerland (pre-merger) 7, 8–9, 10, 11, 38, 104, 151

United Kingdom (UK) 132–3 United States (USA) consolidation 110–12, 129–32 non-performing loans 100–1 universal banks 2, 3, 4, 93 see also Citigroup; HSBC; UBS Valls, Javier 139 Valls, Luis 29, 47, 49, 51, 56, 139 values 36, 37, 57 Goldman Sachs 38–9, 157–8 see also culture van Praag, Lucas 26, 39–40, 56, 80, 104–5, 112 Wachovia 7, 8, 17–18, 130 Wallander, Jan 28, 47, 52, 135–6, 138, 149 Warburg (S.G.) Bank 7, 8–9, 16 Weill, Sandy 22, 35, 52, 138, 140–1, 143 culture 44 future for financial services 111 leadership 55 risk management 105 Wells Fargo 3, 4, 5, 8, 69, 130 business model 31–2 culture 45–6 execution 89, 90–1, 92–3 and the future 110, 116, 117 leadership 53 managing size and complexity 80 profile 154–6 revenue growth 60–3 risk management 102–3 Wells Fargo San Francisco 155 wholesale banking 82 Winterthur 19, 71 Worldcom 11 Wuffli, Peter 25–6, 42, 52, 68, 79, 114–15, 151 Zeitlin, Jide 26–7, 39, 57, 80–1, 95–6, 104 Zell, Michael 47–8, 64