Do Savings Banks differ from traditional Commercial Banks?

Giovanni Manghetti

March 2011

World Savings and Retail Banking Institute - aisbl – European Savings and Retail Banking Group – aisbl Rue Marie-Thérèse, 11 ￭ B-1000 Bruxelles ￭ Tel: + 32 2 211 11 11 ￭ Fax: + 32 2 211 11 99 E-mail: first [email protected] ￭ Website: www.savings-banks.com DO SAVINGS BANKS DIFFER FROM TRADITIONAL COMMERCIAL BANKS?

Giovanni Manghetti, Chairman, Cassa di Risparmio di Volterra (Italy)

Professor Manghetti has been chairman of Cassa di Risparmio di Volterra SpA, Volterra – Italy (regional bank) since 2003 and is an Association Banking System board member. Previously, he was chairman of the Task Force for the Revision of Insurance Core Principles (ICP), which functioned on a mandate from the Technical Committee of the International Association of Insurance Supervisors (IAIS) whose goals included harmonising the Supervision Principles for all world jurisdictions. Task Force members included representatives of the IMF, the World Bank and 13 leading nations. He has also served in the following posts: 2002- 2008, member of the Scientific Technical Committee, Italian Accounting Standards Setter; 2005-2006, World Bank Advisor in Serbia to the local insurance supervisor; 1988-2002, professor of banking at LUISS “Guido Carli” University, Rome; 1996-2002, President–Managing Director of the Italian Insurance Supervisor Authority (ISVAP); 1983-1996, Economic Advisor of the Labour Minister, Foreign Commerce Minister and Finance Minister; 1990-1996, board member of the Italian investment bank MEDIOCREDITO, Rome. Professor Manghetti has published works on insurance and finance.

Nearly two years ago, this article’s title was limited to the question: What are saving bank risks and opportunities for their savers, borrowers, shareholders, and stakeholders, and in the midst of the crisis in general? I concluded savings banks had many opportunities, but only if their banking activity respected supervisory principles.

141 Two years later, now that the financial crisis is over and the nightmare of a systemic default is a simple lesson for the future, I have to answer a second question: Do savings banks now, after their reforms, differ from traditional commercial banks? In my view this question has strategic implications for the future of savings banks.

In the first part of this essay I will present a summary of their common historical identity. Then I will show some essential data regarding European savings banks in the period before the crisis. I will insist that their risks had been very high, in some cases higher than those generated by the crisis. By comparing data before and after the financial crisis, I will also insist that some savings banks’ structural limits and mistakes occurred during the pre-crisis period.

In the second part, I will present my views about some limits of savings banks exposed during the crisis, and some responses by Spain, a country where savings banks are particularly important and consequently more exposed. In my view, their responses can be considered a paradigm, a lesson to follow. Finally, in light of the reforms that transformed many savings banks, I will ask whether the two souls inside savings banks can live together, thus answering the title question.

1. The historical identity of saving banks

It is difficult to summarise the centuries-long history of savings banks in one country, let alone several, but its essence boils down to the nature of savings banks, or what we might call their DNA.

Not only in Italy but in every culture and tradition, the first essential component of a savings bank’s DNA happens also to be part of its name: saving. It means the bank is dedicated to safeguarding the poor’s money and to vindicating their sacrifices. Savings banks started out closely linked to poor classes and have continued to be, involving in the banking system people without the necessary collateral but with intelligence and vision.

As time went on, a second component of the savings bank’s identity emerged: sustainable development. For savings banks, the word “development” is always strictly tied to the word “sustainable”.

142 But what do they mean together? Their history provides the answer: savings banks have lent to local small companies, entrepreneurs and families – above all, by means of residential mortgages and consumer credit – and provided social services (such as pension payments). Everywhere, savings banks have permitted people to buy homes, cars and the essentials for a decent life.

Finally, programmed into savings bank DNA is social responsibility: continuous attention to providing returns to society. All or most dividends and deposits are reinvested in the territory.

The business of retail banking differs across countries, and bank strategies are not necessarily the same. Savings banks have different cultures and traditions, but they share the above values and business approach. They are not merely economically essential; they are a concrete, historical expression of our democracy.

2. Before and after the crisis

Essential data regarding the period from 1997 to 2007 allow us to explore what happened to savings banks during the positive, pre-crisis cycle. In my view it is during periods of boom and easy money that savings banks can risk more.

Traditionally, and generally speaking, some economists have charged that savings banks are less efficient, less profitable and less stable than commercial banks. It is difficult, given the difference in size per region and specialisation, to come to general, consistent and unambiguous conclusions, but some studies1 recently showed no significant difference in savings bank performance compared to that of other banks.

Studies2 at the end of the financial crisis, regarding the period 2007-2009, partially confirm this conclusion (Table 1), or at the least, in my view, do not contradict it.

1 Rym Ayadi, Reinhard H. Schmidt, Santiago Carbò Valverde with Emrah Arbak and Francisco Rodriguez Fernandez, Investigating Diversity in the Banking Sector in Europe, Tables 3.3, 3.4, 3.5, Centre for European Policy Studies, Brussels, 2009. 2 SNL, Financial Banking (Europe), quoted in ESTABILIDAD FINANCIERA 05/11 N.20, BANCO DE ESPANA. The quoted research presents many limits (references to medians, limited time horizon 2007-2009, absence of any specialisation and, above all, size).

143 Table 1

Stakeholder-based banks* Commercial banks Profitability (%) 2007 2009 2007 2009 ROAA 0.36 0.19 0.69 0.31 ROAE 8.41 3.88 15.95 7.84 Net interest margin 1.55 1.54 1.26 1.38 Cost to income 60.67 59.04 55.08 58.48 Asset quality (%) Impaired & delinquent loans/loans 2.32 4.49 3.85 6.05 Credit costs/Pre-impairment operating profit 20.43 39.67 17.92 49.59

Source: SNL Financial in Estabilidad Financiaera n. 20, Banco de España * The group of stakeholders-based banks includes those entities that are not controlled by shareholders, including entities like the Landesbanken and the French cooperative banks and excluding pure public financing institutes (Istituto de Crèdito Oficial) or national entities (Databank). Note: Includes data for France, Germany, Norway, Spain and United Kingdom. For each variable those entities for which data is available are included, thus the number of entities between each variable may vary.

According to these studies, commercial bank profitability is greater than that of savings banks, but the decreasing tendency is more accentuated in commercial banks than in savings banks; the same can be said for income ratio and its tendency.

Ratios regarding asset quality, which is a measurement of stability, are more reassuring in savings banks, as is savings bank behaviour regarding management fees and benefits, while many investment and financial institutions, as we discovered in the middle of financial crisis, behaved shockingly. Reassurance in this case comes from savings banks refusing a short-term approach to profitability; instead, they are committed to a long-term perspective, especially when it comes to manager remuneration.

However, some savings banks suffered substantial problems and risks during this positive cycle. Savings banks in Germany, Spain and Sweden confirmed their relative dominance in the growing market, while those in Italy, Belgium and Austria suffered dramatically (Table 2).

144 Table 2: ESBG market shares (total assets)

1997 2007 France 194,486 = 6.4% 601,454 = 9% 3,026,370 6,682,335 Italy 271,522 = 16.9% 1,717,487 = 5.1% 602,929 3,331,830 Germany 1,702,815 = 35.7% 2,632,000 = 34.8% 4,774,748 7,562,431 UK 236,093 = 6.1% 494,397 = 4.9% 3,151,807 1,093,134 Spain 278,542 = 33% 9,155,001 = 39% 844,807 2,945,262 Netherlands 23,051 = 3% 70,584 = 3.2 % 769,034 2,195,020 Sweden 76,977 = 19.8% 186,468 = 22% 389,130 845,958 Belgium 76,603 = 11.6% 67,080 = 5.2% 661,487 1,297,788 Austria* 191,751 = 39.4%** 150,351 = 16.9% 486,709 890,747

Source: ESBG, Retail Banking in Europe, The Way Forward, my own calculations. * 1999 **According to the Centre for European Policy Studies (Brussels) publication “Investigating Diversity in the Banking Sector in Europe”, Austria’s 1995 market share was 30.7%.

Now let us examine the role of non-bank deposits (Table 3) in financing savings bank total assets. Most savings banks registered a constant relative decline of direct deposits. Only in Italy, the country whose savings banks suffered the greatest general decline, was the trend positive. For all other countries cited in Table 3, deposits fell. How do we interpret this change in the traditional support of their assets?

In many countries the share is far below 50%. I suppose savings banks became more involved with financial and capital markets to support their increasing assets. If so, it would have been an opportunity for the region. In my view, it was. For financing what?

145 Table 3: Non-bank deposits as share of total ESBG assets

1997 2007 Denmark - 50.0% Germany 44.4% 39.8% Spain 78.9% 63.0% France 81.8% 30.4% Italy 60.2% 73.0% Netherlands 45.9% 38.0% Austria 42.0% 37.0% Portugal 74.0% 44.9% Sweden 32.5% 33.0% UK 54.1% 44.3%

Source: ESBG, quoted.

Let us examine other data regarding their typical activity. What, for example, are savings banks’ market shares of residential mortgage loans and consumer credit? (See Table 4) Complete data are not always available, but where we have the right reports, they show that these market shares are nearly everywhere greater than the general savings bank share of total assets.

Table 4: ESGB market shares, 2007

Consumer credit Residential mortgage loans Germany 28.1% 28.7% (36.8%)* Austria (n.a.) 18% (8.7%)* France 6.6% 15.3% (9%)* Sweden (n.a.) 30% (22%)* UK 14% 8% (4.9%)* Spain 34.47% 57.4% (39.2%)* Netherlands (n.a.) 7.4% (3.2%)*

Source: ESGB, quoted. * Asset market share in parentheses.

146 Table 5: Asset share of five largest credit institutions

EMU (13) 1997 2007 45% 54.7%

Source: ESGB, quoted.

The banking system’s general evolution during the positive cycle reduced the savings banks’ relative importance in the European market, above all where savings banks have not been able to adapt to competition. In some countries, some savings banks disappeared, owing generally to their mistakes, while others joined large financial groups.

According to European supervisory authorities, during the positive cycle savings banks showed the following significant limits: n A structural weakness in governance. Savings banks revealed gaps and an insufficient division of their internal authority (audit, supervising, transparency, control committee, and so on). This weakness is crucial: if it had been eliminated earlier, many negative consequences would have been avoided. The weakness is not mitigated even if we see the same problem in many – too many – commercial banks (but we must admit that in their situation the market is ready to punish them, even if in many cases it does so too late for savers and creditors). n A contradiction between commercial targets in a rising market and social aims – or, technically speaking, between short-term objectives and long-term economic and social goals. n A structural weakness in capital, and consequently in their stability. The positive cycle generated a need to increase capital resources, but for savings banks it was difficult, if not impossible, to attract private investors. So their capital increased less than their assets, with all the implicit risks. n Their activity was concentrated in long-term investments, such as mortgages to families and loans to the real estate sector. n The traditional funding strength – retail deposits – was insufficient to tackle liquidity risks in a market characterised increasingly by liquidity tensions and in banks characterised by a strong need to refinance long-term goals.

147 Of course, during the positive cycle many savings banks in some countries (e.g. Norway, and to a certain degree Italy) were able to compete by respecting the old values while becoming involved with the financial and capital markets. They were successful because the market obliged them to be more cautious in lending and pay more attention to lending principles.

Being modern and efficient institutions was not in contradiction with their social identity. But we cannot ignore that savings banks in some countries, such as Spain, have not been able to respect lending principles in their competition with commercial banks. At the same time, they tried to reach their social targets, which they also failed to do.

3. Spanish savings bank reform

Spanish reform must be studied closely because it is a paradigm for the whole sector of what happened during the positive cycle and of the solution that was found. It was major reform in a country where savings banks had a greater national market share than those almost anywhere else in Europe. It reflected the limits described above. According to Banco De Espana, Spanish savings banks suffered from: n Limited bank size: excessive fragmentation. Average total assets were €29 billion. After reform, the average increased to €76 billion. n Excess capacity: this was measured in terms of branches and staffing levels. Cuts from 10% to 25% in the number of branch offices and from 12% to 18% in their staff are in process. n Write-down of balance sheet losses: they amounted to €52 billion. This explains points a) and b).

Given this situation – excess of losses compared with insufficient capital resources – the only solution was raising capital from the market in such way as to avoid future public intervention. For the moment public funds had to be used in order to avoid immediate default, but their use had to be considered exceptional, una tantum.

Therefore, the reform: n provided some incentive to raise private capital;

148 n transferred any financial activity to a commercial bank (which was compulsory only for entities using public resources); n restructured the sector via 12 mergers involving 38 savings banks and reducing their total number from 45 to 17.

After Italy’s public bank reform (the Amato privatisation and Ciampi laws), this can be considered the greatest restructuring process in Europe (Table 6 and Box 1 show the European situation).

4. What is the difference between post-crisis savings banks and traditional commercial banks?

As to their social vocation, new savings banks are distinct from their social entities (which are in some countries called foundations), or they dedicate part of their profits to social purposes.

Looking at the common denominator of many European reforms, can we conclude that savings banks, in many countries, have been transformed into commercial entities? Yes, but only insofar as savings banks have the opportunity to raise external market capital. So I must refine the question: Is savings bank activity – not their legal status or governing bodies or profit-sharing – really the same as what we see in traditional commercial banks? Are savings banks and traditional commercial banks indistinct when it comes to their management? No, because savings banks continue to distinguish themselves: n Nature of their profit: it still essentially derived from a bank’s traditional activity: the margin of interest. Financial gains are secondary if not absent in their income. This does not happen in traditional commercial banks. n Quality of their customers: these continue to be small enterprises and families, while commercial bank activity is connected with big and small companies as well. n Nature of their objectives: savings banks give priority to mid- and long- term targets. Traditional commercial banks continue to give priority to the value of capital ownership, so looking at short-term market targets in terms of dividends.

149 n In many cases savings bank activity continues to be local. n Savings bank ethics: management bonuses depend on neither annual nor quarterly income. They are transparent and reasonable, thus society accepts them.

5. New opportunities for savings banks?

People continue to move away from big commercial banks and toward local banks, refusing to be considered mere numbers and distrustful of big banks. Increasingly, customers need a close link with the same bank employee who is able to keep his/her word; they want to share their needs, projects, difficulties and dreams. If local savings bank managers are ready to offer consistent and efficient solutions, savings banks in general will generate satisfying results. People know local bank is always there; they know decisions are made in the region and see the social return on banking policy. Reliability is thus part of the savings bank identity, especially when it’s raining and pouring and a solid umbrella really counts.

I believe this situation offers savings banks an opportunity for further growth – on the condition that, given the new opportunities to raise market capital, they always maintain their identity and avoid listening to Ulysses’s sirens. Let us continue to do what is necessary to be competitive in the open ocean: respect banking principles and the ethics at our roots.

150 Box 1: Italian savings banks: a summary

LEGAL STATUS: On 30 July 1990 law no. 218 (the “Amato” law), along with the relevant implementation decrees, passed. In accordance with this law, savings banks transferred their banking activities to ad-hoc joint-stock banking companies (the new savings banks). Once this transfer had taken place, the original savings banks were converted into foundations of banking origin assuming all the socially-oriented and charitable tasks provided for by the statutes of the savings banks.

Today, the joint-stock savings banks are business enterprises governed by the Civil Code and the banking laws. They operate on an equal footing with all other banks in the credit sector. Approximately 50 of them have kept their names. The rest, upon merging with other banks, changed their names and gave rise to some of the main Italian banking groups.

GOVERNING BODIES: Decision-making bodies of Italian savings banks are based on two alternative models of governance:

n a traditional governance system, regulated by art. 2380 of the Civil Code, which consists of a Board of Administration, appointed by the General Assembly, and a Board of Auditors; the Board of Administration could devolve its power to an Executive Committee and to a CEO; n a dual governance system, since the 2003 reform, which consists of a Supervisory Board and an Executive Board. The Supervisory Board is a unique body: it combines powers that in a typical company are separated. Represents an effective solution to create a separation between shareholders and managing bodies. It concerns the determination of addresses and strategic business goals and verification of their implementation and accounting of the bank. The Executive Board has the main goal to manage the bank aimed at achieving the strategic lines. This model doesn’t frequently use by the Savings banks.

151 REGULATION: The savings banks are regulated by three main codes. The Civil Code, which governs all joint-stock companies; Banking Act 1.9.1993, n. 385 and subsequent amendments, following the European directives on banking, called the “Consolidated Law on Banking”; the Financial Act 24.2.1998, n. 58 and subsequent amendments, following the European directives on the financial market, called the “Consolidated Law on Financial Intermediation”. So, at a glance, the reorganisation of the Italian banking and financial system, focusing on privatisation, merger and de-specialisation, began during the 1990s and was completed in the 2000s. As a result, the financial system is more robust and competitive.

SUPERVISION: Bank of Italy, Treasury Department, Antitrust Authority, Consob (securities and exchange authority).

RESTRICTIONS ON ACTIVITY: Freedom of operation. They operate as universal banks.

PROFIT-SHARING: Legal obligation to allocate part of their profit as reserves and annual dividends are distributed among shareholders.

CAPITAL: Accumulated reserve and capital from the market.

OTHER CHARACTERISTICS: The activity of Italian savings banks is more deeply rooted in the real economy than that of international banks, especially in the development of the region in which they operate. The ownership structure of Italian savings banks organised as joint stock companies includes many long-time private shareholders, who hold equity, become elements of the reorganisation, and provide stability.

For this summary my thanks to ACRI (Italian Savings Banks Association).

152 Table 6: Characteristics of the main group of stakeholder-based banks by country prior to the recent change in regulatory burden (2009) Mutual institution owned by its members. under Member-centric “one the principle of one vote”. member, of public institutions in Assembly the General should not exceed 50% of the voting rights. Foundations of private Foundations nature combining financial activity with social vocation. General The Assembly formed by different stakeholders (including employees, representatives of local and depositors, regional government founding entities bodies, and community interest groups). The The representation groups). Independent foundations. Limited liability banks in which almost 10% of the capital is owned by a foundation. Committee of representatives, the highest body, is comprised of depositors employees, and public appointees. ¼ of the committee is elected by the owners of the primary capital certificates. Independently of their share of total capital. Public law institutions owner. with no private are also regional There banks inside the Savings Banks Group (Landesbank) which present different legal some are joint forms; stock companies while others are public law institutions. Executive Board, The which reports to a Supervisory Board, is composed by 2/3 appointed by the municipality/ies where it is located and 1/3 elected by the employees (thus depositors are not represented in the governing bodies). Local or regional independent banks organized through two-or a federated three-tier structure regional and (local, national institutions). are Local cooperatives with member-centric “one the principle of one vote”. member, Local institutions delegate a great of functions variety (mutual support, debt issuance, representation…) to the Central Network Institution. France GermanyFrance Norway SpainKingdom United Institution typeLegal status cooperative banks savings banks savings banks savings banksGoverning bodies building societies

153 Table 6: Characteristics of the main group of stakeholder-based banks by country prior to the recent change in regulatory burden (2009) Subject to their own legislation (the 1986 Act as Building Societies amended by the 1997 Act). Building Societies Financial Services Authority (FSA). Mortgage loans should represent 75% of total assets. Bank of Spain has power over financial stability aspects (solvency and liquidity). Autonomous Communities set other legal considerations relative to the governance structure and consumer protection issues. Bank of Spain. of operation. Freedom Financial Supervisory Authority. of operation. Freedom Subject to general banking regulation and to savings bank law of the respective German state in which they are located. Financial Federal Services Authority (BAFin) in cooperation with the Bundesbank. cannot hold They equity participations in enterprises outside the Savings Bank risky undertake Group, or operate operations outside their local area. Landesbanks enjoy freedom of operation. Subject to general banking regulation. Bank of France. of operation. Freedom manage different They activities (market investment, finance, etc.) insurance, through specialized subsidiaries. France GermanyFrance Norway SpainKingdom United Institution typeRegulation cooperative banks savings banks savings banks savings banksSupervision building societies Restrictions to activity

154 Table 6: Characteristics of the main group of stakeholder-based banks by country prior to the recent change in regulatory burden (2009) Destined to accumulate reserves and to improve conditions of the financial services supplied to depositors or borrowers and (higher savings rates lower mortgage rates). 85% of their capital comes from retained can issue They earnings. capital through Permanent Interest Bearing Shares 1. Tier (PIBS) – non-core At least half to the rest was reserves, Social devoted to Obra (community projects) and to dividends equity units (quotas and participativas) preference shares. Accumulated reserves. could issue capital They in form of equity units (quotas participativas), which could not exceed 50% of total equity. No one could hold more than 5% of all could issue They preference shares with non-voting rights. equity units in circulation. Distributed among charitable gifts and cash dividends to primary capital certificate holders. Accumulated reserves (ownerless capital) and capital from the market (primary capital certificates). A substantial part is destined to fund social, and other cultural Dividends are purposes. distributed among silent equity units’ holders. Accumulated reserves. can issue a form They of preference shares, known as silent equity, which do not have rights over total assets and which absorb although they losses, can recover this amount in subsequent periods case of positive profits. They have the legal They obligation to allocate part of their profit as The listed reserves. non-voting shares receive an annual dividend determined by the banks’ statutes and legal ceilings. Non-marketable shares held by natural persons (customers), “Principle of solidarity” among entities within which networks, provides access to capital when needed. national body can The issue debt instruments (including subordinated notes and investment certificates). France GermanyFrance Norway SpainKingdom United Institution typeProfit sharing cooperative banks savings banks savings banksCapital savings banks building societies

155 Table 6: Characteristics of the main group of stakeholder-based banks by country prior to the recent change in regulatory burden (2009) , 50% of their funding should come from retail deposits (the remaining 50% can be obtained through wholesale funding). Strong local roots. mergers Inter-regional of the autonomous communities concerned. needed the authorization Gift fund destined to serve social and purposes. cultural By law, they should By law, serve the public interest of the region (principle of regionality) and conduct their business according to sound business principles. should open a They account transaction for every applicant. Mergers or takeovers with institutions outside the Savings Bank Group are prohibited. The group (national The body) is listed on the stock exchange. Local or regional banks have majority ownership of the national body and provide financing for the local banks. France GermanyFrance Norway SpainKingdom United Institution typeOther characteristics cooperative banks savings banks savings banks savings banks building societies Sources: Ayadi et al. (2010, 2009), Ori (2004), Bank of England, Spain, Financial SupervisorySources: Ayadi Authority (Norway) Sparebankforeningen, and Perez et al. (2007). Banco de Espana, Estabilidad Financiera, num. 20.

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