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'Smaller, simpler' mantra rings through banking

Apr 24 2015 16:36

London - Deutsche Bank's expected move to sell much of its retail banking business will see it join a growing list of banks choosing to shrink and simplify to survive.

The benefits of size and reach, for years considered the holy grail of global banking, are now seen as being outweighed by the cost and complexity of running businesses across dozens of countries.

Many bank bosses have given up on trying to offer everything to everyone. But as unwinding years of expansion proves difficult, pressure for action has intensified, from politicians who show little patience with institutions they consider too big and complex and investors wanting more return on equity (RoE).

"The underlying economics for banks ... means being all things to all people is too big a burden to sustain," said Bill Michael, head of financial services in Europe at consultancy KPMG. He cited low RoEs, high operational risk and hefty potential costs from regulation.

After missing financial targets and racking up a raft of regulatory fines and problems, Deutsche Bank's board is expected to agree on Friday to sell retail arm Postbank and take a knife to its investment bank.

On the same day, HSBC's bosses responded to investor criticism over a string of misconduct scandals and weak profitability by stressing how far they have shrunk and streamlined the bank in the last four years. HSBC has already sold or shut 77 businesses and could yet dispose of big operations in Brazil or Turkey.

Credit Suisse's incoming CEO Tidjane Thiam is expected to slash trading operations and pull back from other areas, while Barclays chair John McFarlane signalled on his first day on Thursday that he will also wield the knife.

The message is clear: bold action is on the cards to create leaner and simpler models, even after big cuts in recent years at Barclays, Credit Suisse, Citigroup, Morgan Stanley , UBS and Royal Bank of Scotland.

'Not a scrap of evidence bigger is better'

Pressure for banks to be cut down in size has built since the global financial crisis, which was preceded by a frenzy of mergers and acquisitions of the kind that briefly made RBS one of the world's biggest banks.

Bank of England chief economist Andy Haldane said in 2009 "there is not a scrap of evidence of economies of scale or scope in banking - of bigger or broader being better".

Politicians worry that large and complex banks can miss problems, struggle to instill a common culture and are just too hard to manage.

Efforts by some national regulators to limit capital outflows have also encouraged lenders to quit countries in which they lack scale.

Investors, too, are questioning the benefits of size as they lose patience with promises that returns will recover. And valuations reflect their preference for simpler firms.

Wells Fargo, which focuses mainly on US retail and commercial banking, is now the world's biggest bank by market value. Its shares trade at 1.6 times book value, compared to an average for US banks of close to book value.

Lloyds focus on UK retail and commercial lending has helped its shares trade at a big premium to rivals, while Deutsche Bank trades at just 0.6 times book value, even after a rally since its plans for an overhaul emerged.

'Systemically important'

The main challenge for bosses is how far to go.

Most banks want to continue offering a range of services - from personal savings accounts to takeover advice for companies and telling rich clients how to invest - but to fewer clients.

Some bankers argue that simplification reverses two decades of globalisation that have benefited trade and finance, and could leave just three truly global banks - HSBC, JPMorgan and Citigroup.

JPMorgan has rejected calls for its breakup, saying scale has always "defined the winner" in banking. It says not having to duplicate audit functions or cybersecurity for the thousands of clients that use more than one part of the bank saves it $18bn a year.

But demands that 30 'systemically important' banks hold more capital, and the more intense regulatory scrutiny they face, also throw into question the benefits of scale.

The list of banks and their capital requirements are judged annually on five criteria, including size, international reach and complexity.

Lloyds is not on the list and Wells Fargo's capital surcharge is 1 percent of risk-weighted assets, well below the 2.5% HSBC and JPMorgan must hoard in case of losses - in both cases an extra $30bn or more of capital.

One carrot from regulators is that surcharges can be reduced if banks simplify, as happened with UBS and Credit Agricole last year.

banking  |  financial services
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