Where are the banks today?

univestWhere are the banks today?

Having explained the history associated with where the banks are today, I would now like to examine the current situation.

Ironically the banks are essentially in the same situation as they were in 1986/87. Then they had spent enormous excesses preparing themselves for the new era of investment and corporate banking, they needed more capital to expand into new business opportunities, and remuneration packages reflected the desire to attract the most prolific profit generators. Today we have the enormous losses of the banking collapse in 2008/2009, enormous sums paid to regulators in the form of fines, large claims for damages including large legal bills, demands for more capital adequacy, and remuneration packages still need to attract profit generators.

There are essentially two ways to increase capital: a) asking investors for more investment, or b) translating profits into capital. The latter is by far the easiest with no impact on existing investment returns. The former puts pressure on profit generation to maintain a good dividend yield, which then places pressures on costs to support the remuneration required by the profit generators.

But are some of these profit generators really worth the cost? How many of these profit generators produced large profits through excessive risk or even market manipulation, have been paid their bonuses and moved on, leaving the bank with credibility problems and fines exceeding the benefit of the profit generator.

Let us look at an extreme example. Interest rate swaps are a sophisticated instrument that should only be sold to qualified professionals. Yet some profit generator convinced someone in the banks that these instruments should be sold to small corporates (SME’s) that would have difficulties even qualifying for a straight-forward interest swap under normal corporate banking rules. The structure of interest rate swaps are so complex that there should be more pages of cautionary notes attached than explanation of the mechanism of the instrument. And the banks would know that base interest rates are not going anywhere fast. So do we assume any interest rate movement is geared towards the bank’s borrowing cost? If so then manipulation of these rates by the banks must also be an issue.

Last year I designed a Documentary Credit solution for a tri-party tolling deal (a raw material supplier provides materials of a given quality to a producer of goods with a third party guarantee buyer of the finished goods thus guaranteeing payment to the raw material producer, i.e. guaranteed cash flow) over three countries. The safest mechanism was a conditional tri-party letter of credit which is only a small step removed from a conventional letter of credit. Although the banker to the third party buyer was completely satisfied with the structure they were not convinced that the financial director of the third party buyer fully understood the structure, and thus would not engage. An interest rate swap is streets ahead in complexity to such an instrument, and I would be very surprised if any of the financial directors of these SME’s remotely understood what they were being sold. Even worse I would doubt that the corporate banker selling this product knew any more about these instruments than the script provided by the investment bank. As swaps are purpose designed for a specific need on a Balance Sheet, who was looking at the SME to define their need, and to ensure their understanding of what was being offered?

I think it is clear that the banks are totally focussed on income generation from wherever it thinks it can be obtained. In too many cases the mavericks are still in control. So how can they generate these much needed profits?

Firstly, and foremost, they cut operating costs. Within investment banks this is most certainly a false economy, but it suits the mavericks. A professional operations director, properly respected by the Board, is the first line of defence to protect the bank from abuse. If we look at the problems over recent years in the likes of UBS, BarCap, SocGen, Deutschebank, JP Morgan Chase, et al, none of these problems could have occurred had a solid operations base been in situ. When I ran operations for various banks there was no possibility that a trading director could override any decisions by me on credit, risk, trading volumes, trade procedure, compliance, discipline, funding, hedging, and systems. My head of settlements, who knew more about the markets than any trader, attended the morning strategy meetings with the traders. If he said that trading could not occur in certain instruments, or specific securities issues, or ticket sizes, this was not a request but an instruction. Trading was not allowed over mobile phones. No dealer could get into the dealing room before 7:30am unless by specific authorisation, and only with a settlement clerk present. Our systems had artificial intelligence monitors on all traders, positions, risk, and credit in real time, monitored by me, head of settlements, and financial controller. Traders did not have autonomous computer systems, yet we always had the most sophisticated trading systems on the street. Our counterparties knew that if they did not confirm a trade with our settlement department during the same trading day then we had the right to void it, so dealers could not hide deals. All funding, own book hedging, and bond borrowing was undertaken by settlements on a book basis to ensure that we were properly covered at minimum cost.

Now the mavericks having taken control of, or suppressed, the operations base, what I see today horrifies me in that there is little or no real control over what many business generation platforms are doing in the name of the bank. They are treated like gods, or at least divas, and anyone who speaks out against what they are doing is destined for unemployment. The senior management have a fixation that if they do not comply with the absurd requests of these people that they will take their ‘skills’ elsewhere (and thus risk their own personal rewards). However, put a senior operations person in place in every bank, and who knows what they are about, make them more powerful than the trading director, and the mavericks have nowhere else to go. Alternatively if they are likely to leave you with a horrible mess to clean up after they depart do you want them in any event?

Having entered investment banking in the mid-1970’s with Citicorp, now CitiGroup, my first job was to find a way of providing Walter Wriston, the Global CEO, with global real-time positions of the bank in all markets. This is before the internet – indeed we created the first global corporate intranet in 1978 to achieve this requirement. With today’s technology this task is not only simple, but should be fundamental if any control is to be placed on banking activities.

What about the banks engaged in corporate business? Again horrific. Many so-called corporate bankers that I have encountered in recent years are no more than information gathers for some faceless people hidden from view in dark places. These faceless people are the arbiters of all activity with corporate clients, yet have never met any of them. Gone are the days when a corporate banker, certainly in the SME arena, can read financials better than the financial director of the company, and actively advise on how the financial position can be improved prior to bank lending. Now it is more akin to lending against security without any consideration as to the quality of the lending instrument – just the level of income that can be achieved. Surely it is in the bank’s interest to have quality people guiding their corporate clients and thus protecting their investment, not merely taking security and destroying people’s lives.

Just as an illustration of how dire the training within banks really is, I went into a large branch of Barclays bank in Holburn in London where their principal client base is likely to be corporate clients. I wanted to send a SWIFT payment in USD. I was told, by their resident corporate banker, that Barclays Bank do not send SWIFT payments. This is a sad reflection on where banking is today, and it needs to change quickly. My next blog will look at the way forward.