Global growth-chasers:
Speeding over the hazards ahead

Even for those players with the most promising exposure to the world’s accelerating economies, warns KPMG’s David Sayer, there’s a real worry about the speed bumps in their path. He talks to ANDREW STONE about banking’s global prospects

They survived. And, in the last three years, the UK’s big banks have done much to restore the health of their businesses. That’s the positive bit. But the outlook from here is far less bright. And, even for those players with the most promising exposure to the world’s accelerating economies, there’s a real worry about the speed bumps ahead.

This much is clear from management consultancy KPMG’s latest analysis, UK Banks: Performance Benchmarking. The retail arms, it says, have two main things to thank for their strong performance last year: a marked improvement in credit performance and increases in back-book mortgage margins.

But there’s a mountain to climb in growing profits, warns David Sayer, KPMG’s Global Head of Retail Banking. “From being a pretty rosy environment, we think things will get more difficult from here. We don’t see a vast expansion of personal lending. On the contrary, we anticipate a more difficult period with tighter margins and higher impairments.”

Despite these barriers, though, not all banks are equally disadvantaged. Those with the largest access to the world’s emerging economies – notably Santander (in Latin America), Standard Chartered (in India and Asia) and HSBC (in Asia Pacific) – have achieved the best results to date and look set to continue to benefit from buoyancy in those territories, says Sayer.

“Around the world, banks are having to almost double the capital they need to run their businesses and more of that capital will have to be used in low-return liquidity. Those banks with strong franchises in economies that are growing strongly are advantaged.

“They can provide a growth story to the markets. Others, rooted in territories where we expected much lower growth, will find it harder. Success for them will have to be based on winning market share,” he adds.

And for the more UK-focused banks, the scope to push into emerging markets is now limited, he warns. “There’s no quick panacea in going to Asia or Latin America – for latecomers, the disadvantage is that the only businesses left to acquire will have a small residual market share.”

In any case, for all banks with current or latent foreign ambitions, the immediate overarching worry is the far from rosy macroeconomic picture overseas. The chances that global growth will hit a speed bump in 2011 are high: there are multiple sources of potential shocks.

And they’re not hard to define: unrest in the Middle East, sovereign debt concerns in the Eurozone’s periphery, fears that a Chinese property bubble may burst and the rising oil price. On top of these concerns, ongoing global de-leveraging, particularly in the secondary banking sector, weighs heavily.

Superficially at least, the UK domestic picture looks immediately more reassuring. “Retail banking has weathered the financial crisis well so far, thanks to the Bank of England’s decision to keep interest rates at historically low levels,” Sayer observes. “It means most borrowers have been able to afford debt repayments and, for many, their ability to cover their borrowings has actually improved.”

This, coupled with that strong business growth in emerging markets, certainly helped players like HSBC, Barclays and Standard Chartered to post higher profits than in 2009. Even the “intensive-care patients”, like RBS and Lloyds have returned to profitability (excluding exceptionals).

But the 2011 outlook is rather more worrying, KPMG finds. Increasing profitability from here will be an uphill battle for several reasons: the fragility of the domestic recovery, the shock 0.6 per cent contraction in the final quarter of last year, the confidence-damper as the government’s austerity programme really bites, the background uncertainty about inflation, the tough choices ahead about interest rate strategy.

Even the sources of short-term optimism, argues Sayer, conceal the scope for medium-term anxiety. A key reason retail banking has had what he calls “an extraordinarily good crisis so far” is the fact that mortgages have settled so far above LIBOR. But interest rate rises would threaten these fatter mortgage margins, and alternative means of preserving margins are not obvious, he says.

“Most other products have become less profitable. Savings accounts offer little profitability, overdraft fees have come down and are very far from taking off, personal lending has reduced. Three or four years ago, 25 per cent of retail banking profits could have come from payment protection insurance. That’s now tending to zero, which is a big fall-off.

“The current account as a generator of additional business has reduced considerably and cross-sold products are less profitable. It really leaves the mortgage as the sole profitable product.” And mortgage profitability is threatened anyway by rising bad debt as mortgage holders come under pressure from tax rises, public sector job cuts and inflation’s erosion of wage values. The growing competition between banks for back-book mortgages will further shrink margins, he thinks.

“Add to that the requirement for banks to raise retail funding to repay the Bank of England special liquidity schemes and to build up their own liquidity. The cost of securing retail savings will also rise,” says Sayer.

All of this reinforces the focus on enhanced customer service as the most likely route to higher sales and better margins. It’s instructive, says Sayer, how the new challengers in retail banking are offering higher service and higher cost banking. For the large established banks, the imperative in retaining (let alone winning) market share must also lie in service quality –more UK-based call centres, better online banking, enhanced ‘mobile banking’ among the burgeoning population of smartphone users.

Greater investment in branch refurbishments, longer opening hours and a more customer-facing role for branch managers are also underway among the big five. The major focus is on driving out costs and improving efficiency, although the scope here is inevitably limited by the investment that’s implied to do so.

“Their story has to be about growing market share, cross-selling through quality of service and becoming more efficient through cost efficiencies. There’s a real need for the banks to restore their reputations, which is why there’s so much investment in these areas.

And, while the headwinds the banks face are certainly strong, Sayer emphasises the progress they’ve made in putting their businesses on a sounder footing. “They’re far less exposed than they were. They have lowered their leverage ratio and paid less in dividends. They are much stronger than in 2008 and every month that passes makes them stronger and more resilient.”

Breaking up is hard to do

The big structural question facing the banking sector is whether there should be a clean break between the retail and investment functions. The interim report of Sir John Vickers’ Independent Commission on Banking edged towards this conclusion by suggestion a ring-fence round retail.

While it’s not yet clear exactly what form the ring-fence would take, an outline is emerging, says Sayer. “To date, there’s been an implicit guarantee that the taxpayer will provide support for systemically important parts of the retail system.

“That implied guarantee is becoming rather more explicit, although the definition of it is yet to be spelled out. It could include every part of the business apart from the capital markets element.

“The big uncertainty is how liquidity will be treated: will there be a restriction on the ability of the investment banking industry to use retail funding?” This clearly impacts on the competitiveness of UK banking.

“The Vickers report sends a signal to international banks that the UK is still open for business, but in the next downturn much more of the burden of failing banks is obviously going to fall upon bond-holders,” he concludes.

The benchmarking headache

HSBC heads KPMG’s latest (2010) rankings of UK banks. It sweeps the board on all key measures – pre-tax profits, total assets and net assets.

Lloyds (4th across the board) and Standard Chartered (5th in total and net assets, 3rd in pre-tax profits) hold their positions. RBS lags (5th in profitability) and drops back in the asset rankings (from 1st to 3rd by total assets and from 1st to 2nd by net assets). Barclays (2nd in profitability) loses its lead to HSBC, but increases its ranking to 2nd by total assets.

But the truth is that the markedly distinctive activities, circumstances and geographical footprints of the UK-based leaders make comparisons especially tough, confesses KPMG’s David Sayer.

“Barclays’ BarCap became a massive business after it acquired Lehman. RBS is very focused on a rundown of its non-core operations. Lloyds is effectively a UK domestic retail bank; HSBC is truly global and focused on a full range of services in Asia and the UK. Likewise, Standard Chartered is strong in Asia Pacific and its largest single business is now in India.

“Their different performances reflect the distinctive characteristics of their business. Those on a growth track, like Barclays and Standard Chartered, have increased their cost/income ratios, while the banks managing state aid issues and increasing the focus on their core operations have shrunk those ratios. Both are doing what’s right for their respective businesses, but this makes it difficult to compare them.”

Charges - does anyone dare?

The value of current accounts to UK retail banking has fallen markedly, according to KPMG’s UK Performance Benchmarking report, and there’s no easy way for them to reverse this trend.

Typically, banks don’t crosssell mortgages from their current account bases and the remaining products they do cross-sell have become less profitable.

The one obvious way to improve margins would be to impose charges on all current accounts, rather than purely for premium accounts, where banks are reaching saturation point, says the report.

That would have several advantages, making bank charging more transparent, stopping the cross-subsidy of relatively poor customers to more affluent ones and winning favour with regulators and government bodies, says Sayer. And it’s also championed by the Independent Commission on Banking to secure a safe and transparent source of income.

“Apart from customers, almost everyone thinks people should pay for current accounts,” claims Sayers. “Banks believe a fair price would create a more honest customer relationship. It’s quite possible that every single bank thinks it’s a sensible thing to do.”

But he doubts it will happen. Anti-cartel laws prevent the banks acting in concert, and the first to introduce charges risks losing business to rivals who decide to sit on their hands. “The first bank to charge risks seeing what happened when Lloyds introduced credit card charges in the 1990s: it lost 30 per cent of its customer base.”

David Sayer is Head of Global Banking at KPMG

Back to Special Report contents
Back to Magazine contents