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High Financier: Sir Siegmund Warburg and the Art of Relationship Banking Transcript High Financier: Sir Siegmund Warburg and the Art of Relationship Banking Transcript Date: Wednesday, 2 June 2010 - 12:00AM Location: Museum of London High Financier: Sir Siegmund Warburg and the Art of Relationship Banking Professor Kenneth Costa Gresham Professor of Commerce 02/06/2010 1. Introduction Good evening. Thank you for coming to this last lecture in my series. It is a particular honour to be sharing the platform with Niall Ferguson. Niall is not just a distinguished historian. He is the official biographer of Sir Siegmund Warburg, whose enduring contribution to finance and how that can inform the debate about banking in the current turmoil is my starting point tonight. Warburgs were brave enough to employ me - theology is not the first recruitment ground for bankers! - and I spent a good part of my working life at the bank he founded. My personal experience will therefore colour what I have to say. But I believe that offers us some valuable pointers as to the future of banking at a critical time for finance generally. The essence of the experience is in this lecture's title: High Financier: Sir Siegmund Warburg and the Art of Relationship Banking. As a young banker fresh from university, I had a lot to learn about relationship banking - and I think we would all do well to re-learn the lesson. And it is an art not a science. Sir Siegmund insisted on knowing the client in almost intimate detail. He famously remarked that if you want someone to be a client you should make him your friend first. At S.G Warburg & Co, the bank he opened in 1946, Sir Siegmund almost parodied the process. He instituted a unique regime of having two sittings at lunch. The intention of course was that clients would not feel neglected. He created space for that most enduring of relationship building - human contact over a meal. The wily client would accordingly at 1.28pm turn to their host innocently and say: "And now, about the fee...?". Another, doubtless unintended, consequence was that partners occasionally found themselves eating two lunches a day! I fear that in the present climate many bankers can only dream of clients being their friends. For precisely that reason, however, this could not be a better time to think again about relationship banking. As we speak, a debate is raging about the future of banking. Was a breakdown in traditional banking relationships with clients responsible for the financial crisis? Can a modern, integrated bank be relational? Is the only way to re-establish the primacy of relationship banking to break banks up? I will leave Niall to ponder on what Sir Siegmund would have made of the modern integrated bank. But I think weakened relations between banks and clients were and are part of the problem. That said, I will argue tonight that the cause has not been integration or size. The cause has been values. The crisis from which we are slowly emerging was the outcome of duties owed but not met, responsibilities incurred but not fulfilled. I believe that the failure in the market was that there was no relationship of trust with the person at the other end of the telephone. The values of relationship banking point to how we can restore that relationship of trust - and with it the essential contract between banks, clients and society. Dismembering banks is not the answer. The answer is to reinvigorate the art of relationship banking within integrated banks. The road out of crisis is signposted "Relationship Banking". 2.1 Decline of relationship banking What is relationship banking? Sir Siegmund died in 1982 and today the idea is often taken merely to mean that you spend a lot of time in expensive restaurants or at the nineteenth hole. Agreeable as that may be, relationship banking is much more profound. At bottom, it is about good moral practice as well as good business practice. It is about finance's relation with society at large, the silent partner to any transaction who in the end legitimises what we do and makes it possible. It is integral to the moral basis of capitalism, the fundamental fusion of values and value creation about which I have talked in previous lectures. This means that relationship banking is not a subset of behaviour, suitable for parts of an institution when convenient. It has to be embedded in the DNA of the whole institution. If the financial crisis and ensuing recession show that capitalism has slipped its moral moorings, we have much to re-learn from relationship banking. In important respects modern finance has become too abstract. In the welter of information bombarding every screen, transactions can assume the faux reality of a video game. Data has substituted for wisdom. Time has become a foe instead of a friend. We are long on knowledge and short on wisdom. In corporate banking, where I have mostly worked, the notion of the house bank - the long trusted advisor and facilitator - has been seriously eroded with the emergence of transaction banking. But the pendulum is swinging back. The common denominator of the abuses of mis-selling products, "liar loans" where incomes were self-certified and the other conflicts, was the failure by many banks to think in terms of relationships or invest enough in them. Let me spell out what I mean: Short-term profit has been valued more than a long-term relationship with a customer; Banks have not properly managed conflicts of interest with their customers; They failed to recognise that they have a relationship with the communities in which they operate as well as with their customers and their market counterparties; Many banks seemed to forget that they are sustained by trust - trust from customers, trust from the markets, and trust from the societies in which they operate; They also did not recognise - or did not act on the recognition - that they have duties to customers (to give advice in the customers' best interests), to the markets (to state their true exposure to risk), and to society (to seek to make their profit through activities with real long-term social benefits rather than through excessively risky financial manipulation of dubious social value). Those failures to think in terms of relationships and duties led, inevitably, to banks becoming isolated and detached: They lost touch with their clients, their depositors and borrowers; Bank boards lost touch with their shareholders and the activities of their traders; Several banks forgot what makes bank regulation essential today - their interconnectedness, leading to systemic risk; Relations with regulators became unconstructive and even antagonistic. The result was that many bankers behaved as if each bank was an island, an autonomous institution whose sole necessary relationship was with its shareholders and whose sole motivating value was the pursuit of profit by almost any means. But of course the crisis revealed that banks are not autonomous islands but are embedded in, and depend on, the confidence of the societies in which they operate. The gargantuan scale of the wealth destroyed in the financial meltdown and the burden of the bailout on taxpayers is evidence enough of that dependence. 2.2 Benefits of relationship banking The fact is that relationship banking has real, hard-headed benefits which affect profits. For a start, lending decisions are likely to be better at the outset, reducing the risk of borrower default. We should not forget that the principal financial cause of the crisis was old fashioned bad lending judgements, not losses on exotic instruments. Monitoring costs ought to be lower because of the nature of the relationship. Should a borrower run into difficulties, a re-scheduling is more likely to be agreed and the terms to be better for bank and customer. And, critically in my view, relationship banking optimises profitability in the long term rather than being seduced by gains which are enticing but fleeting. Conversely, there are real costs to losing or reducing these benefits. One casualty is the concept of service, much talked about by financial providers but much distrusted if customer satisfaction surveys are a guide. Unfortunately, banks tended to think of consumers and counterparties rather than customers and clients. The language may seem pedantic but it is heavily freighted. Service is much more than a moral and sustainable way of making profits. It is the practical manifestation of a different view of the market which sees the market as servant rather than master, a means of improving the lives of the silent partner to each and every transaction bankers undertake. What we have also lost, therefore, is confidence in partnership, the automatic understanding that what is good for the bank is also good for individual clients and for society as a whole. I fear that courage has been lost as well. Sir Siegmund was renowned - if not notorious - for his willingness to defy convention. In 1959 he engineered the first major hostile takeover of a British company, when Reynolds Aluminium of the US won the "Aluminium War" for control of British Aluminium. David Kynaston, in the fourth volume of his monumental history of the City, observes that some diehards never forgave Sir Siegmund and that the episode was regarded as a watershed. The herd behaviour - timidity about speaking and acting differently - which has become pronounced in global markets partly stems from tenuous banking relationships and corruption of the values underpinning them. Moreover, relationship banking is about what happens inside as well as outside banks. Relationship banking encourages the attitude among employees that what is good for the client is good for the bank too.
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