Great size is a warning of trouble ahead in the banking industry; and the trouble may be for the taxpayer as much as the shareholder.
We were just starting to get used to the extraordinary conjunctions of names in the City of London today. Dresdner Kleinwort Benson, Deutsche Morgan Grenfell, ING Barings, SBC Warburg Dillon Reed. Goodness knows what the original wing-collared Mr Kleinwort and Mr Benson, Mr Morgan and Mr Grenfell, think of all this as they look down, stiff-necked and wing-collared, from their portraits in the lunch rooms.
Still, we all knew this was the future. Big balance sheets were best in modern banking. Full service financial conglomerates would drive out other players. But suddenly no-one is quite so sure. UBS, having carelessly lost its chairman, is reviewing the scope of its activities. The continental universal banking scene is shaken, perhaps even stirred.
The merger of UBS and SBC made the combined bank the largest in the world, measured by net assets. In achieving this, it pushed the Japanese bank Dai-Ichi Kangyo into tenth place in the world banking league. It is not long since Dai-Ichi Kangyo was the world’s largest bank. Not much longer since Citicorp held that position. Once, Bank of America was the biggest bank. And, within living memory, that title was held by Britain’s Midland, who ceded it to Barclays. Soon after, each of these banks not only lost their leading position, but dropped out of the top ten.
Much the same thing happened to other banks from the same countries. Hard though it is to believe today, the British clearing banks once dominated the world banking scene. The Americans took over, although their growth was inhibited by restrictions on out of state retail banking: still, Citicorp, the largest bank in New York, and Bank of America, biggest in California, found their local areas more than sufficient to provide support for their wider ambitions. But by the end of the 1980s, the list of the largest banks was dominated by the French and the Japanese. Not any more. While the merger of Bank of Tokyo and Mitsubishi has kept one Japanese bank up with the leaders, the pole positions today are taken by continental Europeans: Deutsche, Credit Suisse, and the new UBS-SBC combine.
This story has several important lessons for today’s ambitious bankers. Size has never been the key to future success in banking. Indeed size has almost invariably been a warning of problems to come. In most markets, you have to persuade customers to give you money: in lending, you only have to persuade them to accept it. That makes it rather easy to grow, but the growth can be subsequently reversed if the customers fail to pay it back. And that has happened rather often in banking history.
We also see the insatiable herd instinct of bankers. Citicorp is constantly eyeing Bank of America, Barclays vying with National Westminster, SBC with UBS and Credit Suisse. Not daring to be left behind, they all make the same mistakes together. Much safer, in the banking world, to be wrong in good company than to be right alone.
But the key lessons lie further below the surface. Banks as we know them originate in a time when they collected small savings to provide capital for businesses. The traditional local bank manager, his roots in the community, was well equipped to garner the deposits and assess the borrowers. Today, the skills of the financial services retailer are very different from those of the business banker. Securitisation of markets broke any necessary connection between taking deposits and making loans. In any case, large corporations could themselves access the capital markets on better terms than their bankers. The rationale for the traditional association of functions which we call a bank has simply disappeared, and most of these specific functions – retail marketing of financial services, financial advice to companies, monitoring the creditworthiness of large firms – are better done by some specialist institution which is not necessarily a bank.
Still, big banks remain big companies by any standards. There is a particular advantage for big retail banks in becoming financial conglomerates. It is the opportunity to use their retail deposit base as collateral for unrelated and risky activities in securities markets such as trading, market making and placing. For banks that are big enough to be too big to fail – banks whose collateral is effectively underwritten by the world’s governments – this opportunity is particularly valuable.
It is hard to believe that taxpayers would, if they focused on the issue, really choose to pledge their personal credit to allow banks to make speculative profits but in practice they have little choice. National banks have to compete internationally, and the attempt by the United States to enforce the separation of retail and investment banking ultimately proved unsuccessful. But the results are clear. Banks with large retail deposits have competitive advantages in providing other financial services that have nothing whatever to do with the skills and competences of these organisations – often the reverse. And regulation whose primary purpose is to protect small savers and investors has to be extended to the full range of wholesale market activities that big banks engage in.
Perhaps, if we were to have a world financial services regulator, this might be an issue to consider. Or perhaps, the issue will resolve itself. The problems which arise because retail deposits are pledged in support of proprietary trading, the problems which arise because the skills needed for a derivatives operation are very different from those of retail bankers, are not just problems for the world financial system. They are internal control and management problems for financial conglomerates themselves. And it will not be surprising if more companies come to the conclusion in the next few months that these management issues are too hard to handle.