Thinking big A survey of international banking May 20th 2006

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Thinking big Also in this section Calmer waters After decades of wrenching change, Ameri- can banks are now mastering new business models. Page 3 The risk-takers Investment banks are a race apart. Page 4 One Basel leads to another The dicult business of drawing up new international banking rules. Page 6 What single market? But western European banks are beginning to do more cross-border business. Page 7 Gone shopping Austrian banks have led the way in eastern Europe. Page 9 A land of limited opportunities Russian banks worth having are few and far between. Page 10 Banks the world over are scrambling to become larger, whether by organic growth or by mergers and acquisitions, says Robert Cottrell. High living But how much does size matter? Brazil’s banks charge startling rates to private customers. Page 11 ORROWING and lending has become most everywhere, big banks have been B a fairly well-understood line of busi- getting bigger through mergers and acqui- Naturally gifted ness, and a fairly well-managed one most sitions as well as through organic growth. Overprotected it may be, but India’s banking of the time in most of the world. It is the Is there a natural limit to this process of sector is going from strength to strength. banks themselves that are volatile, shifting bank-eat-bank? Could the biggest bank of Page 12 shapes and strategies as furiously as their tomorrow be two or three or even ten regulators will allow them in their eorts times the size of a Citibank or an HSBC to- Proceed with caution to win markets and market share. In China day, and if not, why not? And who bene- they are escaping state captivity by selling ts? It is not always the surviving bank’s Financial services in China are set for huge shares to foreigners and stockmarket in- shareholders. One-half of recent bank growth, but there is no easy way in. Page 14 vestors. In Russia they are running wild, mergers around the world have destroyed with balance sheets growing by 30-40% a shareholder value, says Philippe De Back in business year. In Japan three new megabanks Backer, a partner in Bain & Co, a consulting Japan’s banks have restructured and consoli- have eaten 11 old banks and are now di- rm. In America it is medium-sized banks dated. Now they must nd new ways of gesting them. In central Europe foreigners that are prized most highly by the stock- making money. Page 16 have bought or built 80% of the top local markets, partly because investors expect banks since the fall of communism. them to be bought dearly by the big banks. A funny sort of privatisation In America the ten biggest commercial One argument commonly used in fa- The future of Japan’s postal savings bank banks control 49% of the country’s bank- vour of mergers, in banking as in many remains a mystery. Page 17 ing assets, up from 29% a decade ago. They other industries, is the pursuit of econo- are pausing for breath now, after a long mies of scale in areas such as procurement, The limits to size merger binge encouraged by the deregula- systems, operations, research and market- tion of interstate banking and the removal ing. But the gains from that in the mass pro- When banks go wrong, the biggest come o of barriers between banks, insurance com- duction of nancial services, though not worst. But that doesn’t stop the scramble for panies and securities rms. Non-nancial necessarily illusory, can be elusive. There growth. Page 18 companies are not meant to own banks, is a sizeable literature of academic papers but even that is now being tested by Amer- claiming that economies of scale can be Acknowledgments and sources are at ica’s biggest retailer, Wal-Mart, which exhausted by the time a bank reaches a rel- www.economist.com/surveys wants a restricted banking licence. atively modest size. A study of European This survey of commercial banking banks in the 1990s, published by the Euro- An audio interview with the author is at around the world is much preoccupied by pean Investment Bank, put the gure for www.economist.com/audio questions of size and of ownership. Al- savings banks as low as 600m ($760m) in1 2 A survey of international banking The Economist May 20th 2006

2 assets. More recent studies suggest far bank holding companies that are building higher thresholds, up to $25 billion. them clearly believe so. A decade of deals 2 Big banks might even dispute that there A third reason for banks to pursue Top ten bank mergers and acquisitions since 1995 is a limit at all. But at some point disecono- growth through mergers and acquisitions Deal value mies of scale will also start creeping in. is one that is never used as an argument at Target Acquirer/year $bn Management will nd it harder and harder the time, but is universally recognised as a UFJ Holdings Mitsubishi Tokyo 59.1 to aggregate and summarise everything factor. It is managerial ambition (which in- Financial Group/2005 that is going on in the bank, opening the cludes managerial error). Chief executives Bank One JPMorgan Chase/2004 56.9 way to the duplication of expense, the ne- want the gratication of running a bigger FleetBoston Bank of America/2003 47.7 glect of concealed risks and the failure of company, or they fear that their own com- Financial internal controls. Something of that last pany will be taken over unless they grab BankAmerica NationsBank/1998 43.1 problem aicted the world’s biggest bank another one rst. Citicorp Travelers Group/1998 36.3 holding company, Citigroup, in 2002-05, Managers can argue that the business MBNA Bank of America/2005 35.2 when it was rocked by a string of compli- environment is changing rapidly and that NatWest Royal Bank of 32.4 ance problems. America’s Federal Reserve banks must seize the new market opportu- Scotland/1999 reacted by telling Citigroup to suspend nities created by new technology or na- Wells Fargo Norwest/1998 31.7 large acquisitions, but lifted the order in tional deregulation or economic globalisa- JPMorgan Chase Manhattan/2000 29.5 April this year when it judged that the tion. Thus there is much talk in Europe Sakura Bank Sumitomo Bank/2000 25.8 company had got better controls in place. now of a fresh wave of cross-border merg- Source: Dealogic Another argument commonly made ers and acquisitions within the 25 coun- for mergers is based on economies of tries of the European Union, encouraged scope, the proposition that related lines of by the single European currency, the deep- mance. One is the ability to place strategic business under the same ownership or ening Single European Market and the en- bets on future markets, such as China, management can share resources and largement of the EU into central and east- without putting the whole bank at risk. create opportunities for one another. The ern Europe. Shareholders may be the more Another is regulatory capture, or the abil- basic economy of scope common to al- easily persuaded because a takeover tends ity of the regulatee to inuence the regula- most all banks is the taking of deposits on to look good at the time. The buyer books tor. The bigger the bank, the more likely its one hand and the making of loans on the the new revenues immediately and cuts home-country regulators and legislators other. The bank gets to re-use its deposi- some overlapping costs. The acquisition will be to take its interests into account tors’ money protably. The skills and in- premium goes straight to goodwill. It is when drafting new rules, and the more formation useful on one side of the busi- only later that you nd out whether the likely they will be to judge it too big to ness tend to be useful on the other side too. businesses are a good long-term t. fail in the event of a crisis. But does the same hold good when a re- And perhaps growth-hungry CEOs are tail bank is paired with, say, a corporate wiser than their students and their critics Wait for it bank, an investment-banking division, a know. The very big banks created in Amer- Not, of course, that banks these days fold credit-card processor, an asset-manage- ica over the past ten years have not been as often as they used to, which is another ment operation, private banking (for rich stellar stockmarket performers recently, reason why strong banks go shopping. people), an insurance business or a foreign but they may just be taking time to bed Weak banks no longer fall into their laps, at branch network? These businesses all down and knit their management and least in Europe and America. Banks fail less overlap with one another to some degree, computer systems more closely together. often, partly because external conditions but so do lots of other businesses. The Their future results may transform the cur- have been kinder. Developed economies fashion for industrial conglomerates came rent wisdom about economies of scale. around the world have become more sta- and went 30 years ago. Will nancial con- Bigness may also have benets not eas- ble over the past 20-30 years, save for Ja- glomerates be any more enduring? The ily captured in studies of nancial perfor- pan in the 1990s. Big shocks in the nancial markets have become rarer and better managed. Recent medium-sized shocks, How the mighty have grown 1 such as the downgrading of General Mo- World’s top ten banks by assets*, $bn tors’ credit rating last year, have been rela- 2004 1995 1985 tively easily absorbed. The nancial mar- kets have moved, you might say, from UBS 1,533 Deutsche Bank 503 Citicorp 167 being a source of shocks to being shock ab- Citigroup 1,484 Sanwa Bank 501 Dai-Ichi Kangyo Bank 158 sorbers too. Mizuho Financial Group 1,296 Sumitomo Bank 500 Fuji Bank 142 Such stability may engender its own in- HSBC Holdings 1,277 Dai-Ichi Kangyo Bank 499 Sumitomo Bank 135 stability if it encourages everyone to take Crédit Agricole 1,243 Fuji Bank 487 Mitsubishi Bank 133 on more risk in the belief that disasters are BNP Paribas 1,234 Sakura Bank 478 Banque Nationale de Paris 123 less likely to happen. But give credit, until JPMorgan Chase 1,157 Mitsubishi Bank 475 Sanwa Bank 123 then, where credit is due. Benign economic Deutsche Bank 1,144 Norinchukin Bank 430 Crédit Agricole 123 conditions have encouraged stable banks, Royal Bank of Scotland 1,119 Crédit Agricole 386 BankAmerica 115 and vice versa. Bankers and regulators in Bank of America 1,110 ICBC† 374 Crédit Lyonnais 111 much of the world have arrived together at

† a pretty good model of how commercial Source: The Banker *Mitsubishi-UFJ Financial Group was formed in October 2005 with assets of $1.71trn Industrial & Commercial Bank of China banks ought to be run. Pressured by the de-1 The Economist May 20th 2006 A survey of international banking 3

2 mands of the capital markets for eciency its risk-modelling methods will make into a generally less risky business. and predictability, they have also been banks even harder to understand than This survey broadly agrees on both pretty good about sticking to the rules and they are already. Ask a banker to explain points. It considers the state of compe- so avoiding catastrophic mistakes. risk management or credit derivatives or tition and consolidation in the developed A version of that modern banking capital allocation to you, and the algebra markets of America, Europe and Japan. It model is enshrined in a new set of rules, will soon be spilling o the blackboard. looks at the big emerging markets of running to about 700 pages, that tell banks The opacity of banks may count against China, India and Russia, where the global how they should weigh their risks, and them with investors. Mercer Oliver Wy- winners and losers of the future may be how much capital they should keep on man, a strategic and risk-management decided. (China alone may account for hand in case things go wrong. Big banks in consultancy, says that publicly listed - over 25% of new global demand for nan- most developed banking markets will be nancial-services companies around the cial services in the coming ve years, says adopting the new rules, known as Basel 2, world were valued last year at an average Alain LeCouedic, a partner at Boston Con- starting with the European Union next of 14 times their prots, against a multiple sulting Group.) It pauses to consider the in- year. But America is hesitating. Some crit- of 18 for non-nancial companies. But the tricacies of Basel 2, the virtues of pure in- ics there think that the Basel 2 rules are at discount has been shrinking, suggesting vestment banks and the cost of a Brazilian once too lax and too complicated; others both that investors have got more optimis- overdraft before drawing a conclusion think they discriminate too much between tic about relative growth prospects for - which can be briey summarised here: big and small banks. nancial services, and that they think bank- better banks tend to get bigger, but bigger One safe prediction is that Basel 2 and ers have got better at banking, turning it banks are not necessarily better. 7 Calmer waters

After decades of wrenching change, American banks are now mastering new business models

HE introduction to this survey sug- or 20 years ago. JPMorgan Chase, Amer- small local ones with assets of less than $1 Tgested two basic reasons why banks ica’s third-biggest bank by market capital- billion. No bank has failed since June 2004, merge. The rst was the hope of increasing isation, is the product of mergers among an historic record, says the Federal Deposit shareholder value through economies of 550 banks and other nancial institutions, Insurance Corporation (FDIC), which in- scale or scope. The second was to gratify including 20 in the past 15 years. sures deposits at banks and savings associ- managers who wanted to build an empire, Only now, after 30 years of bone-shak- ations. One reason is that 2005 was the or wanted to avoid being taken over in an- ing structural change, during which the to- fth consecutive year of record prots for other bank’s empire-building. In the tal number of bank holding companies American banks. Last year they made $134 America of the past decade or so bank and thrifts (or mortgage companies) has billion, 9.6% more than they did in 2004. managers were more than usually free to halved, has the pace of consolidation Return on equity, or prot as a percentage pursue empire-building ambitions be- slowed. More banks are being created to of capitalthe key measure of a bank’s cause there was so little certainty where take the place of some of those eaten up in protability for its shareholdersfell the industry was heading. Claims that mergers and acquisitions. The total num- slightly, but remained close to 60-year they would increase shareholder value ber of banks seems to be stabilising at highs. It was down mainly because banks were hard for outsiders to dispute. around 8,000, more than 90% of them were making so much money that they The strategic bets were being placed by could aord to plough capital back into guesswork because four big structural their balance sheets, boosting their capital- changes threatened to make earlier mod- Holding their own 3 to-asset ratios to the highest levels seen els of commercial banking obsolete: rst, US banks’ non-financial debt and market share since 1939. the growth of the capital markets, gather- Ratio of Commercial banks’ The capital markets have proved a con- ing pace through the 1980s; second, the ar- non-financial-sector share of non-financial- tainable threat. They did take market share rival over the same period of powerful debt to GDP sector debt, % away from the banks: between 1974 and new information technologies; third, the 2.0 40 1994, the proportion of non-nancial debt deregulation of interstate banking by the 1.8 35 advanced by America’s commercial banks Riegle-Neal act of 1994; and fourth, the re- declined from 30% to just over 20% (see moval of barriers between banks, insur- 1.6 30 chart 3). But since then the banks’ share has ance companies and securities companies 1.4 25 held steady. And because American bor- by the Gramm-Leach-Bliley act of 1999, al- rowing and lending was increasing lowing the formation of diversied nan- 1.2 20 sharply over that period, the amount of cial groups. These changes produced a credit provided by the banks kept growing wave of big mergers among American 1.0 15 in absolute terms at roughly the same banks from the mid-1990s onward. The speed as the economy as a whole, even 1952 60 70 80 90 2002 bigger the bank today, the more likely it is while their market share was shrinking. to be wildly dierent from what it was ten Source: FDIC The growth of capital markets also1 4 A survey of international banking The Economist May 20th 2006

Investment banks are a The risk-takers race apart

HE bigger the commercial bank, the vid Viniar, the rm’s chief nancial o- Given the much bigger market capitalisa- Tbigger the investment-banking opera- cer, said the conditions in most main tion of the largest commercial banks, the tion it is likely to have under its wing, un- nancial markets were the best in 25 overlap of business lines and the propen- derwriting stocks and bonds, advising on years. But as to exactly what it was that sity of commercial banks to merge in mergers and acquisitions, and trading in Goldman did so protably, nobody could search of new economies of scale and securities and commodities both on the be sure. More than half the rm’s reve- scope, is it only a matter of time before bank’s own account and on those of nues were accounted for by a single line, the big commercial banks start buying up other institutions. This is where the bank labelled FICC, for trading in xed in- the investment banks too? does its main business with big corpora- come, currencies and commodities. Not necessarily. One reason is that the tions, which have moved more and more Goldman and the other big invest- commercial banks are trying to reduce of their borrowing to the capital markets ment banks have worked furiously hard the volatility of their earnings, not in- over the past two or three decades. Citi- to ensure that their risks are as eciently crease it. Another is that the pure invest- group had the biggest investment-bank- hedged and as nely priced as manage- ment banks are packed with very highly ing revenues last year of any institution ment and mathematics will allow. Risk- paid, headstrong individuals who would save for the biggest of the pure invest- taking is their core business, the thing that be hard if not impossible to accommo- ment banks, Goldman Sachs. they get paid forunlike retail banks, date within any other company’s culture. The pure American investment banks whose core business is distribution. The average pay and benets at Goldman are a well-matched and well-consoli- But if you make a 39% return on equity for all employees, right down to drivers dated bunch. There are ve in the top tier: when everything goes right, what if and doormen, in the rst three months of Goldman, Morgan Stanley, Merrill Lynch, things go wrong, and a hedge fund or two this year alone worked out at $220,000 Lehman Brothers and Bear Stearns. All blows up in your face? Such worries help per head, more than twice what a big began this year with record or near-record account for the relatively lowly valuation commercial bank pays its average em- prots. Goldman Sachs reported a 39% re- of the pure investment banks in the stock- ployee for an entire year. To graft a Gold- turn on equity in the rst quarter, the oth- market. Early this year they were priced man or a Lehman on to a commercial- ers from 19% to 27%. around 11 or 12 times earnings and 2.5 bank culture would threaten chaos. By Goldman’s reckoning, it was a times book value, not far out of line with Which is not to say that, sooner or later, quarter when everything came right. Da- much less protable commercial banks. somebody might not try it.

2 created new opportunities for the com- where. Investment in branches may get tered institution which is a bank in all but mercial banks. They could securitise and less attractive if the yield curve stays at, name. Small banks fear that a Wal-Mart sell o loans, taking arrangement fees reducing the prot a bank can make by bank would put them out of business. Big without tying up capital. By 2001 roughly lending its depositors’ money on to long- banks fear losing big companies’ pay- 18% of their non-interest income came term borrowers. Even so, any American ments business if Wal-Mart gets its way from selling and servicing securitised as- bank with branches to sell has been nd- and other rms follow suit. sets. With the collapse of the wall between ing a queue of willing buyers. The big banks are right to worry about commercial banking and underwriting in Wal-Mart. The small banks may be overdo- the late 1990s, commercial banks could The next lot of worries ing it. Most Americans already have a plunge into investment-banking markets. There are still fears that new competitors choice of banks, big and small, within Predictions in the 1990s that banks will eat the banks’ lunch. The use of mo- driving distance. They might use a small would lose their retail customers to in- bile telephones for payments might open local bank because they value the proxim- ternet-based competitors were also wide the way for telephone companies to com- ity, the personal service and the local of the mark. Branch networks have proved pete with banks in holding balances and roots, and are unlikely to turn to Wal-Mart to be indispensable as the place where cus- running payments systems. But that for those qualities. In any case, Wal-Mart tomers go to open accounts and where would be a big departure for the phone should have the chance to compete. The they can most easily be charmed into buy- companies. They would need to take on historic separation in America between ing more services. In America the number and manage much more nancial risk, and banking and commerce reected the fear of branches grew by 2.5% last year, and accept new regulatory burdens. That may that an industrial company would drain banks have also been spending heavily to yet happen; but more likely, they will turn the money from any bank allowed to fall improve existing branches. The biggest in- to banks to do the job. under its sway, and manipulate its lend- ternet-only deposit-taker in America, ING Another current worry among Ameri- ing. But that is what regulators are there to Direct, positions itself explicitly as an can banks is the eort by Wal-Mart, the prevent. And if securities houses and in- add-on service for people who already world’s biggest retailer, to get a licence for surance companies are free to tie up with have a conventional bank account else- an industrial loan company, a state-char- banks, as they have been since 1999, it is1 The Economist May 20th 2006 A survey of international banking 5

2 hard to see why supermarkets or anybody else should be treated less favourably. A third worry for American banks is the attening of the yield curve, which is an- other way of saying that short-term inter- est rates have risen almost to the level of long-term ones. That makes it much harder for banks to extract a prot from their basic strategy of borrowing short from their depositors and lending long to companies and housebuyers. Worse still, a at or inverted yield curve often presages a recession. That would mean demand for loans would grow more slowly, existing borrowers would have less money for re- The big banks have learnt to love their ated by charging more to lend money than payments, and assets used as loan collat- retail customers, all the more so because they pay to borrow it. The bigger the bank, eral might fall in value. Banks would have their big corporate borrowers have moved the more fee income it usually has. At Citi- to make more provisions against their so much of their borrowing to the capital bank, fee income amounts to almost half loans, cutting into prots. markets. Between 1984 and 2004 commer- of all revenues; for a one-branch savings cial and industrial lending shrank from bank, the gure will be tiny. That ought to Not like the bad old days 38% to 18% of American banks’ loan books. be working to the big banks’ advantage. Yet these are tries when compared with Over the same period, residential mort- The dierence between the average cost of business conditions of 15-20 years ago. The gage lending rose from 12% to 31%. a bank’s funds and the average return on sky above the banks may not be a perfect Retail banking customers, including its loans and investments is low by historic blue, but the clouds are smaller and the small businesses, provide just over half of standards, and getting lower. visibility is better. commercial banks’ revenues. Getting and A puzzle here is that the size of a bank, Each of the big banks at the top of the holding a customer’s demand deposit ac- and the diversity of its income, impresses industry has its own distinctive mix of count is only the start of a long campaign the stockmarkets less than you might ex- businesses; all have moved some distance to sell other products and services, ranging pect. Roughly speaking, the bigger and the from the traditional banking strategy of from asset management and credit cards to more complicated the bank, the smaller holding assets on the balance sheet. They mortgages and safe-deposit boxes. Wells the premium over book value which it securitise loans and sell them on in the Fargo, widely considered to be among the commands in the stockmarket. Citigroup capital markets, or syndicate them to other best of America’s big retail banks, pushed and JPMorgan Chase have underper- banks, blurring the distinction between up the average number of products it sells formed the Dow Jones Industrial Index bank as lender and bank as trader. Ken each customer from 4.6 at the end of 2004 over the past ve years. Bank of America Lewis, chairman and chief executive of to 4.8 at the end of 2005, and in the longer has outperformed it, but still trades at a Bank of America, says that he and his col- term hopes to sell each of them at least 30% discount to the sum of its parts, says leagues are marrying our huge distribu- eight. Online banking has become a new one expert. tion network for originating loans with ca- and more protable way for the banks to One reason may be that the nancial pable capital-markets distribution, or, to serve their existing customers, rather than engineering which produced these very put it more simplysaying ‘yes’ to more a threat to their existence. big banks is taking time to bed down, and customers, and getting those loans that By selling products for which they can that in a few more years the economies of would not otherwise t our risk para- charge fees, rather than merely making scale and of scope will come through. meters into the hands of investors who ac- loans and holding them, banks can reduce There are patchwork quilts of inherited cept that risk at an appropriate yield. their reliance on interest income, gener- and incompatible computer systems to in- In the past decade big commercial tegrate; huge workforces to rationalise and banks have also become buyers and sell- motivate; and research to be done on ers of derivatives, such as credit-default Increasingly handsome 4 which products and services will cross-sell swaps and interest-rate swaps, sometimes US commercial banks’ return on equity, % to which new customers. in terrifying volumes, both for prot and to 16 hedge their other assets and liabilities. The Why investors hold back billions and trillions involved in deriva- 12 But even then, two basic problems will re- tives trading are liable to worry outsiders, main. One is that investors tend to shun though the banks claim to be in control of 8 opacity, and big diversied nancial insti- the situation. True, the net position of a 4 tutions will always be intrinsically hard to bank in the derivatives market may not be + understand. A second problem is that non- a very big number by the standards of its 0 interest earnings, especially those from – balance-sheet totals at any one time. The 4 trading, are seen by investors as more vola- real danger here is that, given the volume tile than interest earnings, and, as a general of gross trading over time, any managerial 8 rule, the more volatile the earnings, the or operational failing could very quickly 1934 50 60 70 80 90 2004 lower the valuation of the company. Source: FDIC snowball into a much bigger problem. JPMorgan Chase’s chief executive, James1 6 A survey of international banking The Economist May 20th 2006

2 Dimon, hopes he can bring down the vola- years than JPMorgan will be ready to do Ci- to experiment with buying one. tility of trading earnings. That would be tigroup, although, he insisted in his next But far more likely, in the near term at quite a trick to pull o. breath, it’s not likely that either one will least, is that America’s big banks will aim It is hard to imagine further mega-deals happen. to go on growing by buying small and me- that would make the biggest American Alternatively, you might think that dium-sized banks, extending their branch banks even biggerbut then the same was JPMorgan Chase would be better balanced networks and capturing more of the retail true ten years ago. And besides, as of April, with a global retail network, in which case customers that they have learnt to serve so Citigroup has been back in the game. Its a merger with HSBC would be the possible protably. In the meantime, they can be chairman, Charles Prince, bantered at a big-bang solution. Or that the pure invest- fairly sure that nobody else is going to take conference in February that we are more ment banks are relatively cheap, and that them over against their will. To that extent, likely to be ready to do JPMorgan in a few sooner or later a commercial bank is going they have won their strategic bets. 7 One Basel leads to another

The dicult business of drawing up new international banking rules

S BANKS get bigger, they also become ters in America and subsidiaries in Europe, Basel 2 invites banks to choose be- Asmarter. That, at any rate, is the theory and vice versa, can only guess how they tween two approaches when calculating underpinning a new set of rules on risks will reconcile European and American reg- credit risk and capital allocation. The sim- and capital for banks around the world, ulatory requirements when the EU works pler method, the so-called standardised formally called the International Conver- to Basel 2 rules and America does not. approach, is designed for smaller banks gence of Capital Measures and Capital The Basel rules have their origin in the with less sophisticated risk-modelling and Standards and informally Basel 2. The failure of Germany’s Herstatt Bank in 1974. risk-management systems. It requires code has been drafted by the Basel Com- Herstatt defaulted on contracts with banks banks to use the risk assessments provided mittee on Banking Supervision, an o- overseas, highlighting the need for more by accredited credit-rating agencies when shoot of the Bank for International Settle- international co-operation among bank- giving a risk weighting to their loans and ments (BIS), which supports and co-ordin- ing regulators. The Basel Committee pub- investments. ates the work of leading central banks lished its rst Basel Capital Accord, now Bigger banks with more sophisticated around the world. It is a gentlemen’s agree- known as Basel 1, in 1988. risk-modelling and risk-management sys- ment among leading regulators which all Recognising that some loans and in- tems can opt for what Basel 2 calls the in- countries with international banks are en- vestments were less risky than others, the ternal ratings-based approach, or IRB. The couraged to adopt, but which relies on na- Basel rules weighted them accordingly. IRB allows a bank to use its own internal tional law for its implementation. For example, all loans to companies were historic data to calculate the riskiness of its One striking feature of Basel 2 is its assigned a weighting of 100%, but loans to loans and investments. To do this calcula- principle that banks should have the op- banks in rich Western countries had a risk tion, the bank needs to be able to estimate tion to decide for themselves where they weighting of just 20%. A bank which had the probability of default within one year think their big and their little risks lie, and $8m in capital and lent $100m to compa- for each borrower; the bank’s potential ex- then to allocate their capital accordingly, nies was at the limit of its lending capacity posure at a default; the bank’s potential subject to national regulators’ rules and if it observed the minimum capital re- loss from a default; and, in the absence of a national laws. Another feature is that it quirement of 8% recommended by the Ba- default, when the borrower will repay. will probably allow many big banks to re- sel Committee. But a bank which lent only In addition to these risks of default, Ba- duce the capital needed for their current to other banks could lend $500m before sel 2 requires banks to provide capital balance sheet, in some cases quite sharply. reaching its limit. against what it calls operational risk, Europeans, by and large, are keen to get meaning the risk of losses from crashing on with it. The European Union has passed A bigger, better rule book computer systems, natural disasters or legislation to implement Basel 2 next year. These Basel 1 rules soon came to be seen as rogue traders. But here calculation shades Americans, by contrast, are worried on much too crude in the way they weighted into guesswork. three counts. First, they think the rules are risks, with one category for all corporate In allowing banks to do more of their too slack, allowing banks to reduce capital loans, another for all sovereign loans and own risk assessment under IRB, the Basel too far. Second, they reckon that American so on. Work on a new and more exible rules rely on national regulators to ensure banks will not be able to implement the framework, Basel 2, started in 1996, and a that banks are up to the job and are doing it rules reliably without at least another four draft was published in June 2004. The new diligently. That is a tall order, at least ini- years’ practice, if ever. Third, they fear that code was designed for internationally ac- tially. National regulators also need to the rules will give the biggest banks too tive banks. In America, this may mean look out for problems which may not be much of an advantage over small banks. only ten to 20 banks. In the European Un- easily caught by assessment of default risk Those worries have persuaded Amer- ion all banks will have to implement Basel alone. A bank with a very large portfolio of ica to adopt Basel 2 later and more gradu- 2, so that they can be treated equally, as xed-interest securities and derivatives, ally. International banks with headquar- European law requires. for example, would lose a bundle if inter-1 The Economist May 20th 2006 A survey of international banking 7

2 est rates went the wrong way. transition period. No American bank will The Basel 2 rules count on market dis- Beauty parade 5 be allowed to use Basel 2 as a reason for re- cipline to do some of the work of keeping Large banks’ capital ratios and profitability ducing its risk capital by a total of more banks in line. Banks must publish details 2002, as % of total assets than 5% before 2009, 10% by 2010 and 15% of their assets and liabilities and of the Equity capital Pre-tax profits by 2011. Small banks will get a new set of models they use to calculate credit and op- Country 2002 2002 2000-02 rules more exible than those of Basel 1 erational risk. As George Kaufman, profes- United States 6.34 1.66 1.67 but much less complicated than those of sor of nance at Loyola University in Chi- Spain 5.07 0.93 1.15 Basel 2, including more categories of risk, cago, has pointed out, this is not really Australia 4.91 1.49 1.61 more use of external credit ratings and market discipline, but transparency and Italy 4.68 0.48 0.81 more scope for using collateral and guar- disclosure. If regulators wanted to increase Britain 4.49 1.11 1.34 antees to reduce risk weightings. market discipline, they could do so by Canada 4.32 0.61 0.3 American regulators will also reserve abolishing deposit insurance, which France 3.94 0.58 0.72 the right to keep a basic minimum equity would make depositors think more about Japan 3.15 0.04 -0.25 capital ratio for all banks, currently set at their choice of bank, or by requiring all Germany 2.63 0.05 0.29 4% of assets regardless of risk weighting, banks to issue publicly traded subordi- and they will go on prodding banks to Switzerland 2.18 0.08 0.49 nated debt. keep their capital levels well above any America’s hesitations over Basel 2 were Source: FDIC statutory minimum. Most banks do that al- increased by a study last year of how its ready in order to impress customers and banks might calculate current risks and duce large reductions in risk-based capital shareholders as well as regulators. The ar- capital requirements using Basel 2 rules. requirements, implying a far lower stan- gument here is that capital signals the On average, the banks thought that apply- dard of capital adequacy than we have in trustworthiness of a bank. Having lots of it ing Basel 2 rules would allow them to de- the US today. on the balance sheet keeps down the crease their regulatory capital by 15%. They A third concern among America’s thou- bank’s cost of funds. Certainly, interna- reached that conclusion using calculations sands of small banks has been that Basel 2 tional comparisons suggest that high capi- of risk falling well short of the level of reli- would give big banks an unfair advantage. tal ratios have done no harm to American ability that will be necessary to allow su- Big banks using the IRB approach would banks’ prots in recent years (see chart 5). pervisors to accept those estimates for risk- be updating their risk calculations second America returned to strict capital re- based capital purposes, said John Dugan, by second, laying o assets that tied up a quirements for all banks in 1984, after Con- America’s Comptroller of the Currency, lot of capital and adding ones that tied up tinental Illinois, the country’s seventh-big- whose job includes bank regulation. Dif- much less. Small banks without the same gest bank, lost half its funds overnight. ferent banks gave weightings ranging from information systems, and without the Until then, the biggest banks had not been 5% to 80% for seemingly identical risks. same scale and diversity of assets in which subject to any minimum capital require- And even if banks manage to standar- to trade, might end up with a concentra- ment, in the belief that they could be dise their calculations, the Basel 2 rules tion of the worst-priced risks without even trusted to manage their own balance will still be a cause for concern, according knowing it. sheets. Times have changed, and banks to Donald Powell, the FDIC’s chairman. Its To allow more time to deal with these too. But Americans can be forgiven if they formulas for regulatory capital, he told the concerns, America plans to implement Ba- worry that banks, at any rate, have not Senate, are inherently calibrated to pro- sel 2 only from 2008, and with a three-year changed enough. 7 What single market?

But western European banks are at last beginning to do more cross-border business

VEN in Frankfurt the bankers have a Like American banks, European banks the size of the market for private-sector Espring in their step. A cyclical recovery have beneted from benign external econ- debt securities and half the capitalisation in the German economy and in German omic conditions. Unlike American banks, of the country’s equity markets. banks’ protability has been under way they have held their ground pretty well The European Central Bank calculates since mid-2005. Deutsche Bank, Ger- against the capital markets as providers of that the cost of bank borrowing has been many’s biggest, reported a return on equ- nance to big corporate borrowers. Ac- very close indeed to that of market-based ity of 25% last year, up from 16% in 2004, cording to gures compiled by the IMF, the debt over the past ve years, and often helped by a very good year in its big invest- total assets of European banks amounted slightly below it. Last year non-nancial ment-banking operations. Merrill Lynch, to $28 trillion in 2004, two-and-a-half corporations in Europe increased their an American investment bank, predicts an times the total value of the market in priv- bank borrowings more than twice as fast average 18% return on equity for big pub- ate-sector debt securities, and three times as they did their issues of debt securities. licly listed European banks this year. If so, the capitalisation of Europe’s stockmark- Analysing past data for bank lending and that will mark the ninth straight year of ets. In America, by contrast, the sum of private debt issues in the euro zone, two strong protability for the industry. bank assets was $8.5 trillion, roughly half economists, Fiorella De Fiore of the ECB1 8 A survey of international banking The Economist May 20th 2006

thusiastically than they have merged or halting in most and even reversing in Home and abroad 6 branched or sold services across borders. some, such as France and Poland. Value of mergers and acquisitions among This is not to say that the single market One reason banks may be looking European banks, ¤bn and other EU legislation has had little ef- abroad more now is that consolidation in European domestic fect. It has encouraged and forced wide- their home markets has started to reach Cross-border outside Europe ranging deregulation of banking and other natural limits. Between 1990 and 2004 the European cross-border nancial services and removed interest- market share of the top ve banks rose 120 rate controls, capital controls and barriers from 26% to 54% in Italy; from 35% to 46% in 100 between banking and insurance and Spain; from 52% to 66% in France; from 66% 80 stockbroking. This deregulation helped to 82% in Britain; and from 78% to 89% in bring about a huge expansion in the ratio the Netherlands, according to Boston Con- 60 of banking assets, says Mr Dermine. In the sulting Group. Germany is something of 40 Netherlands, the ratio of banking assets to an outlier, with the top ve banks holding GDP 20 more than tripled between 1981 and just 22% of the market, but much of that 2003. In Britain, a centre for international market is in the hands of public-sector and 0 banking, it almost quadrupled. co-operative banks immune to private 1996 97 98 99 2000 01 02 03 04 05 In the ve years after Europe launched takeover. The concentration of some types Source: PricewaterhouseCoopers its common currency in 1999, the value of of retail banking is much higher still. nancial-industry mergers within the EU Across all EU countries, the top three mort- 2 and Harald Uhlig of Humboldt University was roughly equal to that within America, gage banks in each country have, on aver- in Berlin, concluded that banks do propor- at 500 billion against 580 billion, even age, two-thirds of the market there. tionately more lending to companies in without much in the way of cross-border Europe because it is harder for the public at acquisitions. Given the smaller size of Eu- Open Sesame large to get reliable information about the rope’s markets, that implies a wave of Another reason for banks to look abroad creditworthiness of borrowers. The impli- European consolidation at least equal to may be that even protectionist govern- cation is not so much that banks are better the American one provoked by the ments in Europe are losing the political at their job in Europe, rather that capital Gramm-Leach-Bliley act of 1999, which will, or the legal certainty, needed to de- markets are less ecient. An alternative ar- brought down barriers between banking fend national banking sectors. When the gument might be that European banks and insurance and securities companies. European Commission asked banks early have been underpricing their corporate Now there are signs that big cross-bor- last year why they did not attempt more loans, but that view is contradicted, at least der bank mergers in Europe may be getting cross-border acquisitions, one of the most for recent years, by low rates of defaults easier, or at least more attractive. The past common replies was that they expected and provisions. three years have seen three of Europe’s big- political interference in takeover bids. And Helped by consolidation within Eu- gest such deals to date, and the rst to take indeed, when two foreign banks, Banco rope and by acquisitions in America, Eu- place between big banks from big coun- Bilbao Vizcaya Argentaria (BBVA) of Spain rope’s banks have gone on getting bigger tries. Oddly, this has come just as the po- and ABN Amro of the Netherlands, over the past 10-15 years, in some ways litical momentum behind European inte- launched bids last year for two Italian more strikingly so than their American gration has been slowing in all countries, banks, Banco Nazionale del Lavoro and counterparts. The biggest American bank, Banca Antonveneta, the Bank of Italy tried Citigroup, has capital equivalent to about to frustrate them by promoting rival do- 1% of America’s GDP. The biggest Dutch Love thy neighbour 7 mestic bids. But under pressure from the bank, ING, is at 6.5% of Dutch GDP. The Top ten European cross-border bank mergers European Union and from business lob- biggest Swiss banks, UBS and Credit and acquisitions since 1995 bies, it gave up and its governor resigned. Suisse, each have capital equivalent to Deal value The banks went to foreigners. ABN got An- Target Acquirer/year $bn about 13% of Swiss GDP. As Jean Dermine, tonveneta. BNL was bought this year by HVB Group UniCredit/2005 22.3 professor of banking and nance at another foreign bank, BNP Paribas of INSEAD Abbey National Banco Santander 16.8 BBVA France’s business school, points Central Hispano/2004 France, after had dropped out. out, the bail-out of Crédit Lyonnais cost BNP Paribas’s chief executive, Baudoin Générale de Fortis Group/1998 12.7 French taxpayers twice the bank’s pub- Banque Prot, said later that his bank had swooped lished capital in 1991. Not that any big Banca Nazionale BNP Paribas/2006 11.0 into the bid battle because it believed that European bank is going to repeat that spec- del Lavoro cross-border consolidation among Euro- tacle, but the biggest European banks now Crédit Commercial HSBC Holdings/2000 10.7 pean banks was under way, there were really are too big to fail. de France limited partners and the barriers to suc- However, Europe’s banks have not got Banca ABN AMRO/2005 7.2 cess were high. He was pleased to have bigger in quite the way that has long been Antonveneta taken BNP Paribas into a relatively exclu- predicted. Despite all the laws and rules Bank Austria HVB Group/2000 6.7 sive club of banks with retail networks in enacted since the mid-1980s to give the Merita Nordbanken/1997 4.7 more than one European country. European Union a single market in goods Banque Bruxelles ING/1997 4.7 Mr Prot’s words were not without and services, including banking and - Lambert irony, because even now it would take a nance, banks have obstinately gone on get- Unidanmark Nordic Baltic very bold foreigner to think of launching a Holding/2000 4.6 ting bigger within their home countries. hostile bid for any big French bank. Even They have merged at home much more en- Source: Dealogic so, the Italian drama must have had some1 The Economist May 20th 2006 A survey of international banking 9

2 demonstration eect across Europe in ad- to nd a home bias among households dition to its impact on Italy. The chances of when it comes to placing their savings. successful political interference must now They want to be sure they can get attention be lower than they were, so long as banks when something goes wrong. But a foreign are big and bold enough to face up bank with a well-run local branch can pro- squarely and publicly to governments. vide this better than a local bank with an The segmentation of European bank- awful call centre half way round the globe. ing cuts deepest where the banks are most The more that local banks are hollowed visible, in their retail operations. The capi- out by outsourcing and oshoring of cus- tal markets, trading in debt issues, equities tomer services and back-oce work to and credit derivatives, have become well low-wage countries in Asia and eastern integrated since the launch of the common Europe, the weaker the economic argu- currency, partly because so much of the ments against cross-border mergers will running has been made there by Ameri- become. A foreign rm may have trouble can investment banks operating out of stang call centres with people who can London with a Europe-wide mandate. Big speak Danish or Slovak: some things will loans cross borders easily too, because big have to stay local. But once a mortgage borrowers shop around and because loan or a credit card has been sold, the eco- banks syndicate (ie, divide up) the loans to ease some of the banks’ fears. British nomics of servicing it will be the same among themselves. The European market critics mocked Santander’s ambitions, but wherever it originated. in syndicated loans expanded by 35% last the Spanish bank has done well with the So what will happen if banks, per- year, almost twice the global growth rate. deal. Last year it cut Abbey’s costs by suaded at last that cross-border mergers Retail banking has been conned much £224m, equivalent to almost 10% of reve- work, all pile into the market at once? more within national borders, mainly be- nues. Trading prots rose by almost one- Prices, already high, will rise further, as cause governments have insisted on regu- half. Santander expects more productivity they have done in eastern Europe (see lating it heavily, ostensibly to protect small gains from integrating computer systems. box). That will be good for shareholders in savers. Banks have worried whether they The truth which Europe may now be in target banks, but perhaps worrying for the would appeal to foreign customers, and the process of discovering, or admitting to banking system as a whole, especially if whether foreign tax laws or foreign regula- itself, is that there are very few national banks overpay with capital taken o their tors would trip them up. dierences in what people want from their balance sheets thanks to Basel 2. Europe’s The rst of the recent big cross-border banks. Everyone wants safety, reliability, leaders have spent years talking up the bids, by Banco Santander of Spain for Ab- convenience, courtesy, clarity and, subject need for banking integration. Success may bey National of Britain, may have helped to all this, a good return. It is also common yet see them trying to talk it down again. 7

Austrian banks have led the way Gone shopping in eastern Europe

INCE the collapse of communism, for- tria, which merged in 1997 (only to be We are operating in markets with as- S eign banks have bought up roughly bought in 2000 by HVB of Germany, set growth of 40%, sometimes 50%, a 80% of all the banking business in the which last year was bought by UniCredit year, says Herbert Stepic, chief executive new central European member countries of Italy). A third Austrian bank, Erste, of Raieisen International Bank, and of the European Union. With hindsight, joined the fray with its purchase in 2000 when you apply this to the valuation those that bought early now look very of Ceska Sporitelna, a Czech bank. model it is not so hard to understand why clever. The markets are still relatively As the Balkan wars subsided, more banks are purchased at these price lev- small, but growth rates are high, and so countries became bankable. Raieisen els. Others are less sure. If you pay ve are prot margins. bought into Bosnia in 2000, Serbia in times book value, that requires extremely The surprise is who got in rst. Ger- 2001 and Albania in 2004. But by now high expectations about key criteria, many was the region’s biggest trading other foreign banks were in the race, chas- says Wilhelm Nuese, a director of Com- partner, but German banks were busy at ing a dwindling number of prospects, merzbank. There must be a business home with the shocks and costs of uni- and prices spiralled upwards. Last year model in place, economic growth, cus- cation. They left central Europe to their Raieisen paid more than four times tomer growth, prot growth. In Ukraine smaller Austrian neighbours. Raieisen, a book value for a bank in Ukraine, Bank you would need [economic] growth of co-operative banking group, went into Aval; and Erste paid 5.8 times book value 7-8% a year for the next 12 years , and Hungary in 1987 and was in seven more for a Romanian savings bank, Banca present growth averages less than 4% an- countries by 1998. Hard on Raieisen’s Comerciala Romania, beating o ve nuallyAre these prices reasonable? If heels came Creditanstalt and Bank Aus- other bidders. you ask me, they are not, says Mr Nuese. 10 A survey of international banking The Economist May 20th 2006

A land of limited opportunities

Russian banks worth having are few and far between

F A big bank in America were growing at need more money from outside investors. Ithe same speed as the whole Russian Given the shallowness of the country’s do- Rising star 8 banking system in recent years, the inspec- mestic capital markets, that means raising Sberbank’s share price v MSCI* emerging- tors would be all over it. The Russian sys- most of it from foreign investors, by selling market banks, Jan 2000=100, $ terms tem’s total assets in nominal terms ex- them equity or subordinated debt. Or, in- 5,000 panded by 37% last year, corporate lending deed, entire banks. Sberbank was up 31%, retail deposits were up 39% This year Austria’s Raieisen Interna- MSCI emerging- 4,000 market banks and consumer lending almost doubled for tional Bank, which has been operating in 3,000 the third year in succession. The story in Russia since 1996, paid $550m for Impex- Russia is one of real growth and real poten- bank, a Russian bank specialising in retail 2,000 tial. By any conventional measure, Russia banking and consumer nance. This deal 1,000 is way underbanked, says George Car- gives Raieisen 190 new branches across dona, a former HSBC executive who re- the country, plus 350 consumer-nance 0 cently joined the board of MDM, a Russian outlets in supermarkets and shopping cen- 2000 01 02 03 04 05 06 private bank. Even Sberbank, Russia’s tres. Nicholas Tesseyman, deputy director *Morgan Stanley Source: Thomson Datastream Capital International huge but slow-moving state-owned sav- of the Moscow oce of the European Bank ings bank, has roughly tripled its total as- for Reconstruction and Development, calls sets and increased its loans to customers the Impex deal the rst signicant acqui- banks are tiny, or dormant, or are pocket sixfold in the past ve years. sition by a foreign player in the banking institutions serving the needs of at most In many ways such growth is good. sectorUp until now they have been tiny one or two controlling shareholders. Any After struggling through the chaotic 1990s deals, acquisitions of shell banks or green- self-respecting business group wants a li- and touching bottom with a big currency eld projects. This is something that may censed bank as its corporate treasury, be- devaluation and a debt default in 1998, the break the mould. cause under Russian law it is much more whole Russian economy now has to make tax-ecient for companies to lend or bor- up for lost time. Russia’s banking assets at Banks everywhere, and nothing to buy row money via a bank than directly. the end of 2004 were equivalent to 45% of Foreigners who want to buy a Russian Discard the dormant, the captive and GDP, compared with a range of 55-120% in bank may think that they have plenty from the pocket banks, and the picture changes Poland, Hungary, the Czech Republic and which to choose. The central bank re- dramatically. There are very few banks in the Baltic states. The mortgage market in corded 1,199 licensed banks at the end of Russia serving a wide range of customers. Russia is in its infancy, with outstanding January 2006one for every $550m of The state-controlled savings bank, Sber- loans worth perhaps $2 billion in total. It GDP, compared with one for every $1.4 bil- bank, accounted for 26% of all the assets could be ten times that amount by 2010, lion in America. But that raw number is and liabilities in the country’s banking sys- says Natalya Orlova, an economist with misleading. All but 100 or so of Russia’s tem at the end of 2005, including 54% of all Alfa Bank in Moscow. retail deposits. The second- and third-rank- In other ways, such growth is worrying. ing banks, Vneshtorgbank and Gazprom- It tends to mean that credit quality is fall- bank, are also state-controlled. Together ing. Banks are lending more and more to with Sberbank, they accounted for about borrowers that they know less and less two-fths of total assets. The four biggest well. Fast growth also puts pressure on privately owned Russian banks, Alfa Bank, banks to keep up their capital ratios. Until MDM, Rosbank and UralSib, have about recently Russian banks could nd the capi- 8% of the market between them. There are tal they needed mainly from retained pro- 42 foreign-owned banks which between ts. But now, according to Fitch Ratings, a them have about 7% of the market, with credit-rating agency, prots are no longer Raieisen and Citibank the most visible. quite enough to do the trick. The banking Most of the remaining top 100 are very system’s regulatory capital (measured as a small banks with regional or industrial share of total assets) declined by almost niches, a handful of corporate customers three percentage points between the rst and big ideas. quarter of 2004 and the third quarter of Almost every Russian bank that you 2005. It remained comfortably above the meet will tell you that its ambition is to be 10% capital ratio xed by the central bank, in the top 30 or 40 Russian banks, and to but some institutions were getting close to develop retail business, and to expand into that level and had to rein in new lending. the regions, says Mr Tesseyman, who To go on getting bigger, Russian banks meets plenty of them. These are admirable1 The Economist May 20th 2006 A survey of international banking 11

2 aims, but clearly they are not going to be higher than most commercial banks. sian population will behave in a similar achievable by all banks. The alternative Other Russian banks want to follow if the way, but that assumption is tendentious, ambitionand perhaps the real aim of ev- markets hold up. Analysts say that Ros- to say the least. ery private bank in Russia bar one or bank may go this year, and that Vneshtorg- Nor is the Russian government’s be- twois to sell out to foreigners at a fancy bank and Gazprombank, both state-con- haviour all that easy to predict. In principle price. Now that Impex has sold for almost trolled, may list minority stakes next year. it welcomes free enterprise and foreign di- three times book value, sellers of the big- Buyers will have to proceed with cau- rect investors. In practice it hates any loss ger private banks are going to be arguing tion. Russian assets are no longer cheap, of administrative control over industries it for four times or more. and Russian banks are moving targets. considers of strategic value. One issue Loan portfolios are growing fast, but there holding up Russia’s bid to join the World How about a listing? are not nearly enough data to model the Trade Organisation has been the govern- For larger private banks, fancy prices may risks, and such few as are available have ment’s refusal to ease restrictions on for- also be available through the stockmarket. been collected during an economic boom. eign bank branches. Sberbank has enjoyed a long run as the Credit quality may look very dierent Russia’s protectionism would be more only listed Russian bank stock with any li- when a downturn hits. At best, says Rich- defensible if there were already so much quidity. Its shares have been much in de- ard Hainsworth, who runs a bank credit- scale and diversity and competition with- mand, tripling last year (see chart 8, previ- rating agency called RusRating, we can in the banking industry that the entry of ous page). That left Sberbank trading at 20 look at the experience of other countries, more big foreign players would make little times historic earnings this year, much we can make the assumption that the Rus- dierence. But Russia is not even half way1

Brazil’s banks charge startling High living rates to private customers

HE prot of $5.5 billion reais reported well under control now and might even Tfor 2005 by the biggest private bank in A world of difference 9 drop below 5% this year. That made the Brazil, Banco Bradesco, was the highest Brazil’s banking spread, non-earmarked credit, % central bank’s benchmark interest rate of ever made by a Latin American bank. It 15.75% in April no bargain, but no excuse 60 implied a return on equity of 32%, making Individuals for three-gure overdraft rates either. Are Bradesco twice as protable as the aver- 50 the banks colluding? age European or American commercial Joao Manoel Pinho de Mello, a profes- 40 bank, and more protable than a Wall Total sor at Pontifícia Universidade Católica in Street investment bank in a good year. 30 Rio de Janeiro, says it may look like collu- Bradesco’s 80% growth in prots was all sion, but he suggests a market-based rea- 20 the more impressive in a year when the Corporate son, adverse selection, as one reason why Brazilian economy grew by only 2.3%. 10 personal rates have stayed so high. Bor- Bradesco attributed the good result rowers prone to default, he says, may be mainly to cost control and loan growth. 0 disproportionately sensitive to changes 2001 02 0304 05 Loans to clients rose during 2005 from in interest rates. A bank will not rush to 34% to 39% of total assets, leaving less Source: Banco Central do Brasil undercut its competitors if an oer of money parked in government securities. cheaper overdrafts merely brings it a But the leap in prots for Bradesco and Nor, in Brazil, is there an obvious lack larger share of deadbeat customers. other Brazilian banks will reinforce long- of competition. Five banks share just over And, to be fair, there are cheaper ways running grumbles in Brazil that banks half the market, a similar ratio to that in for Brazilians to borrow. Workers can get there, as in many other Latin America much of western Europe. Yet some lend- much lower interest rates through em- countries, charge far too much for their ing rates are eye-watering. A monthly sur- ployer-sponsored schemes, with repay- loans, especially to private borrowers. vey of interest rates compiled by a ments deducted from their wages. Banks’ net interest margins in the region Brazilian trade union, Anefac, found that Borrowing of this sort has been increas- are about half as high again as in the rest the average monthly interest rate on a ing much faster than direct personal lend- of the developing world. Many analysts bank overdraft in February was 8.19%, ing in recent years. have asked why, and drawn a blank from equivalent to a compound annual rate of But even taking these cheaper loans most of the usual suspects. Banks in Latin 157%. If you borrow on a credit card, you into account, the banks’ average spread America do not dier markedly from pay 10.24% a month or 222% a year. on a personal loan earlier this year was those elsewhere in the developing world Brazil has a history of high ination, 44%, about three times that on a corporate in terms of their size, or the volatility of which used to mean that interest rates loan. If banks in Brazil are serious about their macroeconomic environment, or in were vertiginous, and so were banks’ building up their retail business, this the tax burden they bear. margins. But ination is supposed to be needs to come down. 12 A survey of international banking The Economist May 20th 2006

2 there. The nancial system functions bet- of ownership just makes life dicult. They provement in the quality of bank regula- ter than it used to, but not nearly well very quickly get to their limits for any one tion, so the main result may be to increase enough.There is no long-term rouble debt borrower, at which point they have to stop the moral hazard both that banks will use to speak of. Short-term lending rates are lending or circumvent the law. If Russia their depositors’ money rashly and that high. Many regional banks in eect have had more big banks, the needs of its big depositors will have less reason to choose monopolies in local markets, thanks to of- companies would be better served and strong banks over weak ones. cial backing, the IMF said last year. Assets their risks more widely spread. The best thing for Russia’s banking sys- are highly concentrated on a few large bor- The nancial system, like the rest of the tem would be a break-up and privatisation rowers and related lending is common, re- economy, has become more robust since of Sberbank, but the country’s botched ecting the structure of an economy the shambles of 1998. There is far more sales of industrial companies in the 1990s where a handful of business groups repre- money around. The government is rich. have made that option unthinkable. So, sents close to half of GDP. The administration runs more eectively. too, has Russia’s political course. It has be- That concentration of ownership But a mini-panic swept some banks com- come a far more statist country since Vladi- makes Russia a paradise for investment paratively recently, in mid-2004, and it is mir Putin took power in 2000. If a sale of bankers chasing big-ticket clients: the not hard to imagine something on that minority stakes in Vneshtorgbank and country has perhaps 20 companies with a scale being repeated. Two private banks Gazprombank does indeed go ahead, it net income above $1 billion, against four or suered runs. One of them, Gutabank, sus- will suggest that Russia thinks market dis- ve in India. A proposed share issue for a pended operations. A state-owned bank, cipline can help raise the transparency and Russian state-owned oil company, Ros- Vneshtorgbank, subsequently took it over eciency even of state-controlled banks. neft, could be the biggest ever initial public at a token price. That is a good thing. The bad thing is that oering from an emerging market. Interna- The 2004 panic was encouraged by a these state-owned banks look set to stay as tional investment banks are racing to in- lack of public condence in banking regu- top dogs of the banking system. If private crease their presence in Russia. Late last lation and in banking stability. In a bid to and foreign banks somehow manage to year Deutsche Bank paid a reported allay fears about the second, the govern- eat substantially into the dominant posi- $420m for 60% of UFG, a Moscow invest- ment began to introduce deposit insurance tions of Sberbank, Vneshtorgbank and ment bank, after buying 40% in 2003. But last year. But the insurance provision has Gazprombank, the state, on present form, for the commercial banks, concentration not been accompanied by an obvious im- will help them bite back. 7 Naturally gifted

Overprotected it may be, but India’s banking sector is going from strength to strength

HATEVER it takes to be good at bank- 1992. They have munched into the market lated, but also because the new Indian Wing, India has it by the bucketload at share of the remaining state-owned banks, banks have been dauntingly good at sell- every level. Look at the number of Indian as you would expect. Less predictably, ing themselves and at keeping down their expatriates holding down whizz-kid jobs they have nibbled away at the market costs. The biggest of them, ICICI Bank, at investment banks in London and New share of foreign banks toopartly because managed a return on assets and a prot per York, at least until they are lured back by in- the foreigners have been more tightly regu- employee last year almost identical with vestment banks in India itself. Look at the that of Standard Chartered, the biggest of growing proportion of back-oce work the foreign banks. At the same time, its de- that foreign banks are moving to India by Private passion 10 posit base, and its loan portfolio, grew oshoring and outsourcing. It is not only Indian bank assets by type of bank, % of total much faster. the basic payments and call-centre chores Nationalised banks New private sector* The foreign banks have every right to that get moved to India these days. Late State Bank of India Foreign banks feel mildly annoyed with the Indian gov- last year JPMorgan Chase said it planned Old private sector ernment, which has kept them on a leash to move one-third of the processing of its 100 much shorter than that of their Indian foreign-exchange trades and of its credit competitors. For all the reform and deregu- derivative contracts, having already 80 lation across much of the Indian economy moved some of its nancial research and since the nancial crisis of 1990-91, the analysis. By 2007 it expects to have 9,000 60 government still has no plans to let for- employees in India, up from 5,000 now, eigners buy Indian banks (except as dis- one-quarter of them working for its invest- 40 tress sales) until at least 2009, and there is ment-banking division. Deutsche Bank, no certainty that it will happen even then. 20 UBS and others are making similar moves. In the meantime the 31 foreign banks ac- Look, too, at the bold growth strategies 0 tive in the market are guaranteed the right of the new private banks that have our- 1995 2000 05 10† to open no more than 12 branches a year *Founded after 1994 ished since India began relaxing the state’s † between them. near-monopoly on the banking system in Source: Boston Consulting Group Forecast The foreigners have been consoled by1 The Economist May 20th 2006 A survey of international banking 13

2 the formidable growth of the banking market as whole. Total assets have dou- bled in the past ve years. Consumer lend- ing alone has been growing by an average of 40% in each of the past ve years, enough to keep the foreign banks’ assets and prots growing handsomely despite a slight loss of market share. By restricting the expansion of foreign banks, and so limiting the competition to provide banking services to Indian cus- tomers, the government has kept business costs unnecessarily high. Even so, to judge from the development of the banking sec- tor, this is one of those rare occasions when it is tempting to claim that a touch of protectionism has had its benets. It gave the Indian private banks the space to learn how to grow, and to gain condence as One big winner from the growth of re- ance sheet, against 1.65% for ICICI Bank they went. The biggest of them, ICICI and tail lending has been ICICI Bank, the big- and 3.84% for the banking system as a HDFC, burst forth with mass-market low- gest of the new private banks. Founded as whole. But those are low gures for fast- cost national business models that pitted a state development bank in 1955, it growing banks, all the more so in a bank- them directly against the big state-owned formed a commercial banking subsidiary ing system where three-quarters of the as- banks, perhaps forcing competition on in 1994. The development and the com- sets are still in the hands of government- them more eectively than any foreign mercial bank made separate oerings of controlled institutions that are vulnerable banks might have done. their shares, then merged again in 2002. to ineciency and political interference. Retail banking currently accounts for However good Indian bankers are at their The wonders of competition about two-thirds of the balance sheet. We jobs, their loan books could still show up As a result, competition induced by the were the rst to identify the changes in the some nasty surprises if and when the new private-sector banks has clearly re- economy, we could ride the curve, says economy turns down. energised the Indian banking sector as a Vishakha Mulye, ICICI Bank’s chief nan- whole, in the words of Rakesh Mohan, cial ocer. A perfect moment for reform deputy governor of the Reserve Bank of In the past four years, ICICI Bank has For the moment the economy is buoyant, India, the central bank. In the ve years to also been busy expanding internationally. to the point at which India has displaced 2004, operating costs at India’s public-sec- It has branches or subsidiaries in 12 coun- even China as the favourite big story tor banks fell from 66% to 45% of revenues. tries, aiming its services mainly at Indian among foreign investors. Now would be a Return on assets, a measure of protabil- communities overseas but sometimes perfect moment for the government to ity, rose from 0.57% to 0.89%. Non-per- nding that they attract a much wider cli- push India’s banking reforms further, by forming loans fell from 14% of the loan entele. Last year ICICI Bank launched a di- selling down state shareholdings and by book to 5.5%. All this was done with a rela- rect-banking service in Britain, oering a encouraging further consolidation. The tively modest contribution of state funds, deposit rate half a percentage point above banking system would evolve from a large less than 1% of GDP in all, to recapitalise that of its main rivals, which the bank said number of small banks to a small number the public-sector banks, oset by invest- was made possible by the low cost of op- of large banks. A rst step in that direction ment gains, as minority stakes in public- erating the service from India. Demand would be some arranged mergers among sector banks were sold on the stockmarket was so strong that it swamped ICICI the country’s 28 public-sector banks, end- and the shares rose in value. Bank’s computers. ing up with three or four banks big enough As in so much of Asia, the fastest Hard on ICICI Bank’s heels comes to thrive independently or to fetch a fancy growth was in consumer lending. That HDFC Bank, India’s second-largest private price from Indian or foreign buyers. will remain one of the most buoyant mar- bank, which was spun o from a govern- The main opposition to further consoli- kets in India, thanks to favourable demo- ment-owned mortgage institution of the dation even along these lines comes from graphics, changing cultural and consump- same name in 1994. HDFC Bank thinks of India’s trade unions and their political al- tion patterns, higher purchasing power itself as being a touch more selective than lies who fear that it would cause job losses. and the spread of nancial services out- ICICI Bank. When the market is growing, But much of that fear may be misplaced, side the big cities. Fitch Ratings calculates you can say, ‘I will grab market share and I says Janmejaya Sinha, a vice-president of that retail lending as a share of all bank will gure out along the way how to make Boston Consulting Group, at least as re- lending in India has risen from 11% to 24% money from it,’ or you can say, ‘I can pick gards branch closures. The problem in In- in the past ve years. But relative to GDP it and choose, and still grow,’ and we have dia is one of too few bank branches, not remains fairly low by world standards, at opted for the second, says Paresh Suk- too many, especially outside the big cities. 10%, against 13% in China, 50-60% in thankar, HDFC Bank’s country head of With a stable of big, strong domestic smaller Asian economies such as Malaysia credit and market risk. HDFC reported net banks, India could be much more relaxed and Singapore, and 80-100% in rich coun- non-performing loans equal to just 0.24% about lowering the remaining barriers to tries such as Britain and America. of the loan book in its last published bal- foreign entry. That would benet the econ-1 14 A survey of international banking The Economist May 20th 2006

2 omy through increased competition. It markets and then across the world. seas, they still have to resolve the reputa- would also be good for Indian banks, or at That may sound far-fetched. But as ba- tion issue. Customers in Europe or Amer- least for those that rose to the challenge. It sic banking becomes more of a commod- ica might hesitate to rely on a bank (and a would let them prove to themselves that ity business, the winners will be the banks banking regulator) in Mumbai to preserve they are every bit as good as the best for- that can do it most cheaply. India has the their savings. But such things can change. eign competition, and they would be less necessary skills at the keenest prices. For- After all, Western consumers once mocked likely to be denied market entry by other eign banks can move only so many of their the idea of Japan as a carmaker, yet Japan countries on reciprocity grounds. The operations there, but Indian banks have all soon proved them wrong. India might pull stage would then be set for decades of of them there already, at costs far below o the same trick in nancial services. But growth in which Indian banks would be- their developed-country rivals’. rst its government has to get out of the come powerful players, rst in other Asian If Indian banks want to expand over- way and give the bankers a chance. 7 Proceed with caution

Financial services in China are set for huge growth, but there is no easy way in

IGGER may sometimes be better in come will be a clean-up at the fourth bank, dards, but in some ways they have started B banking, but ownership matters too. the Agricultural Bank of China, which is to look like bargains already. The govern- Whatever the size of a bank, it will usually said to have the lowest credit quality, the ment began by selling shares to direct in- perform worse in government hands, be- least ecient operations and the lowest vestors at about 1.2 times book value. cause governments are generally less moti- degree of transparency of any of the four. When 12% of Ccb was oated in Hong vated than private shareholders are, and The bill there may be the highest of the lot. Kong last year, investors on the stockmark- less good than market forces are at collect- et were willing to pay almost twice book ing and digesting information. Besides, Early birds value. That implied big paper gains for the they have lots of other things to do. There If China’s banks had dug themselves into direct investors in Ccb and left some in are bound to be conicts of interest and some scarily deep holes, foreign investors China grumbling that the banks had been lapses of concentration. The bigger the proved remarkably keen to jump in along- sold too cheaply. state-owned bank, the bigger the mistakes side them and help them dig their way out Not so. It was the arrival of direct inves- it is liable to make. again. From the moment the government tors that raised the perceived value of the China has paid dearly for the mistakes began talking of selling stakes in CCB and banks. The foreigners were expected to im- of four big new commercial banks which BOC, a queue of foreigners formed to buy. prove the management and the corporate the government carved out of the old com- The same happened when it added ICBC governance of the banks to the benet of munist banking system in 1994-95. Bewil- to the list in 2005. all shareholders. The readiness of big insti- dered by the rush to capitalism, the big So far China has collected more than tutions to risk their capital was taken as a state banks were soon making two bad $20 billion for stakes in banks some of sign that there were no more huge horrors loans for every three good ones. The gov- which would have been unsellable at any left lurking in the banks’ loan portfolios. ernment set about cleaning them up in ear- price seven years earlier. These were big Their presence was essential to getting the nest in 1999, taking loans equivalent to 17% and risky investments by anybody’s stan- public listings moving at all. 1 of GDP o their books. When that failed to change the banks’ ways, the government was forced to take a Piling in 11 new and more radical tack. In 2003 it said it Top ten recent foreign investments in Chinese banks would recapitalise two of the four, the Deal value Bank of China (BOC) and the China Con- Date Target (% purchased) Acquirer (nationality) $m struction Bank (Ccb), using $45 billion Aug 2005 Bank of China (10.0) Royal Bank of Scotland (Britain), 3,100 from state reserves. Then it would bring in Merrill Lynch (US), Li Ka-shing (Hong Kong) outside investors, who might know how Jun 2005 China Construction Bank Corp (9.0) Bank of America (US) 3,000 to change the banks in ways that the gov- Dec 2005 Guangdong Development Bank* (85.0) Citigroup (US) and others 3,000 ernment did not, and it would oat minor- Jan 2006 Industrial & Commercial Bank of China (7.0) Goldman Sachs (US) 2,580 ity stakes in the banks on the Hong Kong Jun 2005 China Construction Bank Corp (5.1) Temasek Holdings (Singapore) 2,466 stockmarket, in the hope that market disci- Aug 2004 Bank of Communications (19.9) HSBC Holdings (Britain) 1,745 pline could also play its part. Sep 2005 Bank of China (5.0) Temasek Holdings (Singapore) 1,550 Last year a similar plan was announced Jan 2006 Industrial & Commercial Allianz (Germany) 1,000 for a third bank, the Industrial and Com- Bank of China (2.5) ICBC mercial Bank of China ( ). This restruc- Mar 2006 China CITIC Bank (19.9) CITIC (Hong Kong) 714 turing may cost up to $80 billion, says Sep 2005 Bank of China (1.6) UBS (Switzerland) 500 Richard Podpiera, an economist with the International Monetary Fund. Last to Source: Dealogic *Subject to regulatory approval The Economist May 20th 2006 A survey of international banking 15

2 As for the foreigners, they have got a foothold in a huge market just as the con- Watch it grow 12 ventional wisdom has been shifting in its China’s financial-services industry, $bn favour. For any nancial institution with Banking Insurance Fund management global pretensions, the perceived risk no Balance sheet totals Premiums Assets under management longer lies with getting into China, it lies 12,500 150 400 Deposit Non-life with daring to stay out. 10,000 Loan Life 300 The calculations on both sides may 100 7,500 have worked out well in the short term, 200 but that leaves two big questions open for 5,000 50 the long term. The rst is whether the cur- 2,500 100 rent optimism about future growth in Chi- nese nancial services is well founded. 0 0 0 The second is whether, even in a growth 2000 2004 2010* 2000 2004 2010* 2000 2004 2010* Source: Bain & Company *Forecast market, these big state banks are the best choice for foreign investors. On the rst of those points, the answer south, a deal that will require China’s lead- rowing and lending than they are already, is a yes that gets more condent the lon- ers to waive their rule that foreigners can- which is to say, not much good at all. That ger the view that you take. Goldman Sachs not own more than 25% of any bank. matters less as long as a rising tide of forecasts that the number of people in HSBC has also chosen to put its eggs in growth and modernisation in China is lift- China with incomes over $3,000 a year smaller baskets. In 2004 it paid $1.75 bil- ing all ships. But with a 60% market share, will rise tenfold between 2005 and 2015. lion for a 19.9% share in Bank of Communi- six layers of management between head China’s government, though it has proved cations (BoCom), which is China’s fth- oce and branch level, huge sta numbers itself capable of huge policy errors in the biggest bank but which has only one- and very little experience of lending on past, is getting steadily more condent eighth the number of branches and sta of strict commercial criteria, the state banks about allowing market forces to help ICBC, the biggest state bank. In addition, will nd it hard to grow, let alone to mod- shape the economy, including, at long last, HSBC is building up a branch network that ernise, as fast as their smaller rivals. the nancial-services sector. If things go currently stretches to 12 main branches tolerably well, say the consultants at Bain, and eight sub-branches. It also has stakes When the capital markets wake up total banking assets in China in 2010 will in a municipal bank, the Bank of Shanghai, They are already losing good business to be twice what they were in 2004. The mar- and in an insurance company, Ping An. smaller joint-stock banks. They will lose ket for insurance will almost triple, and as- If HSBC, one of the world’s biggest more good business when (and if) China sets under management will increase six- banks, with all the advantages that its Chi- eases its restrictions on foreign banks by fold (see chart 12). nese roots bring it in terms of geography, next year, in line with its commitments to There could be hiccups, or worse, along language and culture, sees BoCom as the the World Trade Organisation. And they the way, however. David Marshall, re- right size of partner, are other foreign in- will lose more business still when China at gional head of nancial institutions for vestors over-reaching themselves by pair- last gets round to modernising and open- Fitch Ratings, says that a sharp slowdown ing up with banks ve times BoCom’s size? ing up its capital markets. The lack of de- in China’s economic growth could lead to The short answer is that the foreigners velopment in this area in the past decade losses of 10% of bank loan books. A seri- will probably not have a huge impact on has left the banking sector with a near-mo- ous recession could well mean a banking the state banks, whatever the early buzz. At nopoly on corporate lending. Banking as- crisis in which credit losses overwhelmed most they can seed the Chinese banks sets are very high by international stan- the banks’ still-slender capital bases. with a few good ideas and a few good peo- dards, at 210% of GDP in 2004. More ple, and hope that these take root and competition is needed from the capital The downside risk ourish. They can also make a fuss if they markets if China wants to build a modern As to whether the big state banks oer the see things going badly wrong inside the market economy. best way for foreign banks to capture this banks. And that may be enough for them. The capital markets need time and formidable growth, the evidence is more After all, they want other things out of the money to get on their feet, just as the bank- equivocal. The biggest contra-indicator is relationship too. ing sector did. The majority of China’s 130 that HSBC and Citigroup, two big foreign They get access to the state banks’ huge or so securities companies were left tech- banks which know China well and which branch networks as distribution channels nically insolvent after a decade of ill-man- have huge experience of building up for- for their products. They can guide the de- aged speculation. But the capital markets’ eign operations, have chosen other routes velopment of narrow but protable lines turn must come. When they start to attract into the market. of new business such as credit cards. They money away from the banks, what now Citigroup paid $70m for a 4.6% stake in get, or so they hope, a closer relationship looks like a high-growth, high-margin China’s eighth-biggest bank, Shanghai Pu- with the government that will help them banking industry will look much more like dong Development Bank, in 2002. It is now obtain other licences in the future, for ex- low-growth and low-margin, at least for in the process of raising that stake to 19.9%. ample in insurance and in brokerage. So average and below-average performers. So It is also leading a consortium of foreigners any further capital gain on their invest- the strategic investors who paid 1.2 times oering to pay $3 billion for 85% of Guang- ment will be a bonus. book value to get into the big and slow- dong Development Bank, another me- The state banks, in short, may never get moving state banks probably got the price dium-sized bank from China’s prosperous much better at their basic business of bor- about right. Later buyers, beware. 7 16 A survey of international banking The Economist May 20th 2006

Back in business

Japan’s banks have restructured and consolidated. Now they must nd new ways of making money

OR a society so given to miniaturism, supply, not demand. David Atkinson, an FJapan is powerfully attached to gigan- analyst with Goldman Sachs in Tokyo, cal- tism in banking. In a study of the banking culates that the big banks have only 2,700 crisis and economic slump that gutted Ja- branches between them in the whole of Ja- pan in the 1990s, Akihiro Kanaya and Da- pan. One carmaker alone, Toyota, has al- vid Woo, economists with the Interna- most twice as many dealerships. Divide tional Monetary Fund, say that part of the the sales sta of Japan’s major banks by cause was the persistent focus of banks the customer base, says Mr Atkinson, and on market share. The banks pursued there are only enough sta for at most 55 growth for growth’s sake, making new minutes of personal contact with each cus- loans at the peak of property and stock- tomer each year, allowing for about two market bubbles in 1989-90 when that transactions of modest complexity. By meant taking on riskier and riskier cus- contrast, the average customer of an Amer- tomers at lower and lower margins. ican retail bank expects to conduct two or When those loans went bad, the weak- three branch transactions per month. est banks collapsed, but only after they Newer, nimbler banks have been seiz- had made another lot of bad loans in the ing the opportunity. They include Shinsei hope of growing their way out of trouble, Bank, re-born from the Long Term Credit postponing a banking recovery by another Bank of Japan, which collapsed in 1998 half-decade. From a high point in 1986, and was bought two years later by foreign when they accounted for a quarter of the investors. Its retail banking business has Japanese stockmarket’s capitalisation, to a attracted 1.6m customers from a standing low point in 2003, when they spoke for start in 2001. A survey by the Nihon Keizai less than 3% of it, the banks have had a gru- Shimbun newspaper ranked Shinsei the elling ride. Their lending contracted by best bank in Japan for customer service one-third, and familiar names disap- last year, followed by Sony Bank, an in- peared in a wave of mergers and bail-outs. ternet bank launched by the Sony group Eleven of the country’s biggest commer- ve years ago. cial and development banks, some of them among the largest in the world, con- The biggest network of them all solidated into three megabanks. The big Japanese banks had even less in- Industrial Bank of Japan, Dai-Ichi Kan- centive to develop retail networks while gyo Bank and Fuji Bank were among the the state-owned post oce savings bank big names subsumed into Mizuho in 2000; oered a cheap alternative. But the savings Sumitomo Bank and Sakura Bank fused ability remains low by international stan- bank, by some measures the biggest nan- into Sumitomo Mitsui in 2001; and in Janu- dards, and their strategic direction is un- cial institution in the world, is now due to ary this year Bank of Tokyo-Mitsubishi clear. They are run by a generation of be privatised. Its long-term future is not yet and UFJ, both the product of earlier merg- managers who got where they are today clear (see box, next page). It scarcely mat- ers, completed a merger which once again by managing shrinkage, not growth. ters, however, whether Japan’s big banks gave Japan the biggest bank in the world Not only do the banks have to grow expect the privatised postal savings bank by total assets: Mitsubishi-UFJ Financial again, they have to grow in new directions to be a Godzilla-sized competitor in 12 Group, or MUFG, with a balance-sheet to- if they want to boost their prots to inter- years’ time, or whether they foresee its tal of $1.7 trillion, slightly more than that of national standards. They now have to do dwindling from a major to a minor com- America’s Citigroup. well as retail banks, a line of business in petitor. Either possibility ought to be fo- That has made MUFG cock of the walk, which they have been relatively weak but cusing their minds on the need to ahead of Mizuho with $1.46 trillion in total which is the least volatile and most prot- strengthen their own retail business. So assets and Sumitomo Mitsui Financial able area of banking in most rich coun- too should the prospect of rising short- Group with $900 billion. These banks are tries. Whereas HSBC gets more than 60% of term interest rates, after years of zero rates. even bigger than the biggest banks of the its prots from retail banking and Citi- Even allowing for a rise in deposit rates as pre-crisis days. But are they any better? group more than 70%, the gure for Mi- well, banks should be able to get a better The stockmarket certainly seems pretty zuho is about 42%, for SMFG 15% and for return from loans than they have been do- keen on them. Bank shares have multi- MUFG 16%, says Naoko Nemoto, an ana- ing in recent years. plied in value since the low point struck lyst with Standard & Poor’s. There are signs that the big Japanese three years ago. But the big banks’ prot- The blockage in Japan looks like one of banks have indeed been looking ahead to1 The Economist May 20th 2006 A survey of international banking 17

2 such things. Moving, as often, in convoy, to be valued in the stockmarket at any- throwing money around elsewhere. The they have been buying into nance com- thing like the size of its global rivals, retail politics are touchy, too. Japan’s pre-1945 panies which operate credit cards and expansion is the only large-scale option empire casts a long shadow. Relations which lend money at high interest rates to readily available to it, and to its rivals too. with China have become more fractious people with poor credit histories. This And perhaps then, with more proven during Junichiro Koizumi’s term as prime may yield some short-term prots, but the retail expertise at home, Japanese banks minister, partly because his visits to the Ya- banks would be eccentric to put too much will become a touch more visible abroad, sukuni war shrine in Tokyo have caused long-term emphasis on this limited market where after the retrenchment of the past angry protests in China, and partly be- when they have so many better-heeled decade they are at present hardly visible at cause Japan is seen as an ally of China’s customers of their own to whom they all. Which is not to say they are entirely ab- great new rival, America. could be selling loans. Very probably they sent, but that their business is mainly in - Even if the political climate improves have that in mind, and they are buying - nancing Japanese investments and Japan- and when Japan’s banks have paid o the nance companies to help them under- related trade. As India’s economy boomed government, they need to have a banking stand better how the process works. Fine, last year, lending there by Japanese banks model worth exporting, whether to China though they might acquire the same tripled to $4.3 billion. But China in particu- or anywhere else. Such things can be built knowledge more cheaply by hiring a con- lar must present a frustrating spectacle. Its from unlikely beginnings. Think how use- sulting rm or buying a book. banking system has opened to foreign in- less British banks were at retail in the Building up a branch network can be vestment, the potential is immense, West- 1960s, and how much better they are now. an expensive and time-consuming pro- ern banks are piling inyet Japanese banks Japan has formidable traditions of mass cess. Mr Atkinson thinks that in the long are standing on the sidelines. production and of personal service. Put term MUFG could reasonably aim for The timing has been bad for them, be- them together, and a great retail banking 1,500 branches, or two-thirds more than it cause they mostly still need to repay system could be built on that foundation has at present. It sounds a lot, but what money which the government lent them equal to the corporate banking system of other option does MUFG have? It has huge during the banking crisis. Until they have which the Japanese were justly proud for assets but relatively low prots. If it wants nished doing that, they can hardly start most of the 20th century. 7

The future of Japan’s postal A funny sort of privatisation savings bank remains a mystery

MALL savers across Japan can hunt also served the state as a captive buyer of ce branches; and the mail-delivery sys- S down a bank branch, or they can let government bonds and as a direct cash- tem. But they will remain under a single the postman come to them, collect their cow for other government agencies and state holding company until 2017. Then, money and put it in the postal savings programmes, keeping some spending out as the law currently stands, the govern- bank. Until next year they also have the of the hands of the parliament and mak- ment will have to divest itself entirely of benet of an unconditional government ing the government budget for each year the savings bank and the insurance busi- guarantee on deposits. During the bank- look much better than it was. ness, though there is nothing to stop it re- ing crisis of the 1990s savers shifted their purchasing them immediately if it has money to Japan Post en masse, causing its A step in the right direction changed its mind about the sale by then. deposits to double. A rst partial reform in 2001 ended the di- If that sounds a funny sort of privatisa- Now the commercial banks are back rect use of the postal savings system for tion, it is all the funnier because seem- to normal, and the government is moving policy lending by the government. But ingly nobody, unless this is a very to privatise the postal savings bank. But the savings bank remained a very big well-kept ocial secret, knows how the nobody knows yet whether this will buyer of Japanese government bonds, savings bank is going to operate from create a giant new competitor for the holding about 30% of the entire stock, and 2007 onwards, even while it is still under banks, or whether it will give them new of bonds issued by the same government state management. It could be left to markets to cannibalise. agencies which the savings bank used to dwindle as a minimum service for people In broad economic terms, the postal fund directly. All the same, the process with no alternative, or it could be man- savings bank has done Japan question- has introduced more transparency and aged energetically as a rival to the banks. able good. It was a safe harbour for savers discipline, and has helped to prepare the The only thing on which there is general in the 1990s and so perhaps averted an way for further reform: the privatisation agreement is that nothing should be done even bigger panic. But if it had not been of the whole post oce, which is due to to frighten away depositors. If they pulled there, perhaps the Japanese banks would begin next year. out their money in a rush, that would have got into retail banking earlier and The four main components of the post force the savings bank to raise money by diversied their business, making their oce will be put into separate compa- selling securities, including its huge gov- lending less concentrated and the crash nies: the savings bank; a life-insurance ernment bond positions, sending the less severe. The postal savings bank has business; the network of 25,000 post-of- bond markets crashing. 18 A survey of international banking The Economist May 20th 2006

The limits to size

When banks go wrong, the biggest come o worst. But that doesn’t stop the scramble for growth

O SAY that bankers are getting better at banks are right about economies of scale, cap the size of any bank as a share of GDP. Tbanking is to say that they are getting and if management and information sys- The gure would dier from country to better at information technology, and tems can keep pace, then why should country, depending on the appetite for higher mathematics, and retailing, and banks not go on consolidating until only public spending, the place of nancial ser- marketing, as well as at hiring and manag- three or four or ve of them are left, with vices in the economy and the desire to ac- ing people who are specialists in those three-quarters of the market between commodate national champions. The cap things. Risk management, the rock on them, in a given country, or a given conti- for America might be 1% of GDP for any which any contemporary bank rests, nent, or indeed the world? one bank’s capital, beyond which it might scarcely existed as a profession outside the The problem is that banks do go wrong grow organically but not by acquisition. insurance industry until the 1970s. from time to time, and whenever that hap- That would be no more intrusive than the The ruthless scrutiny of capital markets pens, size turns out to be their worst fea- current American rule stopping any one and regulators has been good for banking ture. The bigger a troubled bank, the less bank gaining more than a 10% market but hard on bankers. It means that the credible a government’s claim that it will share of deposits by acquisition, a limit al- modern banker, even (and especially) the not intervene, the harder to manage the ready touched by Bank of America. biggest boss of the biggest bank, must be a failure, and the bigger the nal bill to tax- But that last factor aside, there is no ob- details man. The bank is a vast machine, payers. Even without a crisis, a bank is get- vious limit to consolidation currently in and he is its chief engineer. ting too big for comfort if regulators start sight, only supply and demand. In Febru- Ken Lewis, boss of Bank of America, making their rules around it. That sties ary Charles Prince, Citigroup’s chairman, downplays even his importance as a strat- new competition and provides room for oered his view of the future: Nobody egist. The things that make Bank of Amer- risk to grow. So even if economies of scale wants to sell. Everybody wants to buy ica special, he says, are franchise, or mar- were innite, bigger banks would not al- something. Any bank holding company of ket position; execution, or operational ways be better banks. size is in the acquisition mode, not the sell- eciency; and track record. Beyond that, One answer might be for countries to ing mode. It’s just as simple as that. 7 he told an investor conference in February, we believe strongly that there are no un- Future surveys ique strategies in nancial services. Oer to readers Reprints of this survey are available at a price of Nor unique products, to judge from a £2.50 plus postage and packing. Countries and regions letter to shareholders written earlier this A minimum order of ve copies is required. Pakistan July 8th year by James Dimon, JPMorgan Chase’s France October 28th boss. The bank’s job was to deliver the Corporate oer Business, nance and economics and ideas right bundle of products at the right price, Customisation options on corporate orders of 500 Business in India June 3rd he said. Where the products are ‘manu- or more are available. Please contact us to discuss Logistics June 17th factured’ is of little interest to customers, your requirements. Climate change September 9th he said. That is a fair claim to make so long Send all orders to: The world economy September 16th as the product proves reliable. If it goes The Rights and Syndication Department Talent October 7th even a tiny bit wrong, then where and 26 Red Lion Square Telecoms October 14th how it is manufactured suddenly starts to London WC1r 4HQ matter very much indeed. Tel +44 (0)20 7576 8000 This survey began by asking whether, Fax +44 (0)20 7576 8492 as banks grew and as banking systems e-mail: [email protected] consolidated, there was a natural limit to Previous surveys and a list of forthcoming their size. The short answer is that no bank surveys can be found online can be too big, so long as there is enough www.economist.com/surveys free competition to keep it on its toes. If