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European Banking, Beyond the Crisis

European Banking, Beyond the Crisis. Jean Dermine, INSEAD Amsterdam, 24 June 2009. European Banking, Beyond the Crisis. Identify / Clarify Strategic Issues Economies of Scale and Scope, Myth or Reality Bank Strategy: Seven Models Financial Markets Architecture. A TALE OF ONE BANK,

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European Banking, Beyond the Crisis

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  1. European Banking,Beyond the Crisis Jean Dermine, INSEAD Amsterdam, 24 June 2009

  2. European Banking, Beyond the Crisis • Identify / Clarify Strategic Issues • Economies of Scale and Scope, Myth or Reality • Bank Strategy: Seven Models • Financial Markets Architecture

  3. A TALE OF ONE BANK, LLOYDS BANKING GROUP (1983 - 2009)

  4. From Mr. BRIAN PITMAN, CEO , andSir JEREMY MORSE, Chairman (1983) ! "We are committed to the idea that our function is to create shareholder value" . ! "The key-issue for management is : What collection of divestments, acquisitions and reallocations of capital is necessary to change our return on equity, market value".

  5. Value Creation, the Case of Lloyds-TSB (1983-2008) • 1983, new CEO: Brian Pitman • 1988 Merge with Abbey Life (UK) • 1984-1992: withdraw from North-America, Portugal, Bahrain, Far East (China, Singapore, Taiwan) • 1992: conditional bid for Midland (withdrawn) • 1994 Buy Cheltenham & Gloucester (C&G) (UK) • 1995 Merge with TSB (UK) • 1997 Sell Corporate Banking Paris, SMH (Germany) • 1999 Buy Scottish Widows (UK) • 2000 Buy Chartered Trust (UK) • 2001 Sir Brian retires • 2003 new CEO: Eric Daniels sell Lloyds Brazil + operations in New Zealand/Argentina, Paraguay (2006) • 2007 Consider bid for Northern Rock (UK) • 2008 Buy HBOS (UK). 2009 Chairman Victor Blank resigns.

  6. Value Creation, the Case of Lloyds TSB

  7. Lloyds in 1992Worst Recession in Britain since WWII 1992 Results(£m)BarclaysLloyds Total Assets 149,118 61,004 Pre-tax profit -242 801 Sources of Profit of Lloyds in 1992 ???

  8. Value Creation,the Case of Lloyds Banking Group ROE2000 = 28.4% ROE2001=29.1% ROE2002 = 23% ROE2003= 33% ROE2004= 25% ROE2005 = 25.6% ROE2006 = 25.1 % ROE2007= 25.2% ROE2008= 7 %

  9. Lloyds vs HSBC

  10. Diversification across Businesses or CountriesDoes it Create or Destroy Value ?

  11. The Benefit of Diversification: Avoiding the Costs of Financial Distress • Clients run away (deposits, borrowers, asset mgt) • Missed investment opportunities (high cost of external finance) • Sale of assets at low price to restore regulatory capital ratio • Expropriation by the State at low share price

  12. Crises do happen ! Be prepared ! • 1982 Global emerging market LATAM crisis. • 1982 US S&L crisis • 1991 Global real estate and NPL crises • 1992 Japan bank losses • 1997 Asia financial crisis • 1998 Russia • 2000 End of tech & telecom bubble • 2002 Argentina default • 2007 Subprime crisis J. Dermine, INSEAD 2009

  13. Lloyds Banking Group, Strategic Issues • Focus vs. Diversification • Domestic vs. International • Sources of Growth J. Dermine, INSEAD 2009

  14. Key-Banking Challenges Strategy: Seven Options Environment: Four Sources of Change Economies of Scale and Scope Myth or Reality ?

  15. FOUR SOURCES OF CHANGE in FINANCIAL MARKETS ! INTERNATIONAL INTEGRATION ! DEMOGRAPHICS, SAVINGS and CAPITAL MARKETS ! INFORMATION TECHNOLOGY and NEW COMPETITORS ! FINANCIAL CRISIS

  16. International IntegrationExample of a Shock, the Euro (€)

  17. EURO and CREDIT RISK,NEED FOR DIVERSIFICATION ? Economics of Optimal Currency Area: Need for synchronisation (correlation) of business cycles • Some regions could suffer from ‘europe-wide’- monetary policy • Additional need for portfolio diversification of credit risk

  18. International Loan Diversification

  19. FOREIGN EXPANSION2007 Market Share of Foreign Banks, (%)

  20. Four Sources of Changes International Integration Demographics

  21. Three Growth Engines at ING(Michel Tilmant, Chairman of Executive Board, 2005) • Retirement services in USA, CEE, Asia, LatAm • Direct banking (ING Direct) • Life insurance in CEE and Asia

  22. Four Sources of Changes International Integration Demographics Information Technology and New Competitors

  23. Information Technology ! E*Trade Securities ! Instinet ! Tradepoint ! e-issue of bonds (World Bank , Fannie Mae) ! Charles Schwab ! E-Loan /Europloan ! Egg (Prudential, Citibank) ! ING Direct

  24. ING Direct, a Success StoryNumber of Clients and Funds Entrusted (2003)

  25. FOUR SOURCES OF CHANGE in FINANCIAL MARKETS ! INTERNATIONAL INTEGRATION ! DEMOGRAPHICS, SAVINGS and CAPITAL MARKETS ! INFORMATION TECHNOLOGY and NEW COMPETITORS ! GLOBAL FINANCIAL CRISIS

  26. Global Financial Crisis • Recession • Higher costs (liquidity, capital) • Subsidiary (host regulation) • Low interest rates imply less profit in collecting deposits. Necessity to price payment services

  27. Economies of Scale and Scope,Myth or Reality

  28. SCALE AND SCOPE ECONOMIES IN BANKING ! Economies of Scale (cost) ! Economies of Scale (brand) ! Economies of Scale (revenue) ! Economies of Scale (implicit guarantee) ! Economies of Scope (cost) ! Economies of Scope (revenue) ! Financial Diversification ! X-Efficiency ! Oligopolistic power (client, supplier) Source : J. Dermine, “European Banking, Past, Present and Future” inThe Transformation of the European Financial System, editor Gaspar et al., ECB, 2003

  29. Strategy, Seven Models

  30. Seven Models !DOMESTIC CHAMPION !CROSS-BORDER MERGER (top-down) ! THE CO-OPERATIVE MODEL (bottom up) ! GLOBAL SPECIALIST ! NICHE + OUTSOURCING ! DOMESTIC CHAMPION + NEW MARKETS !INTERNATIONAL INNOVATOR

  31. Domestic Mergers in Europe

  32. International Mergers in Europe

  33. SOURCES of GROWTH : NEW MARKETS ! Santander + Banco Serfin (M) + Banespa-Banco Real (BR) + Sovereign (USA) ! BBVA + Bancomer (M), Texas Regional and State National Bancshares, Compass Bancshares (USA) ! Citigroup + Handlowy (P) + Fubon (Taiwan) + Banamex (M) ! HSBC + CCF (F) + Republic National Bank of NY (USA) + Bital (M) + Household Intl (USA) ! SCB + Nakornthon + Grindlays + pieces of Chase, UBS, CIBC, Korea First Bank ! Barclays + ABSA (SA) ! KBC (B) + CEE + Russia

  34. Le Taux Modèle

  35. Taux Modèle on Savings Deposits (France) Interest paid on Savings Deposits (May 12, 2004) 5% (for three months) 3.05 % (up to € 3 millions) € Interest Yield Curve (May 12,2004) Financial Strategy Long term fixed income assets funded by short term deposits

  36. ING Direct 2008 (year end)

  37. ING Direct 2008 (year end)

  38. Issues Arising from the Crisis • Impact on Financial Market Architecture (policy makers) J. Dermine, INSEAD 2009

  39. Financial Markets ArchitectureG20, de Larosière Report (EU), Turner Review (UK)Group of Thirty (Volcker), Financial Stability Board (FSB) • Control of liquidity risk (stress tests) • Control of market risk (stress tests, illiquid assets, re-securitization) • Control of capital (tangible equity, core tier 1, procyclicality, dynamic provisions, leverage ratio) • Control of counterparty risk (clearing house) • Control of compensation schemes (clawbacks) • Control of cross-border institutions (College of national supervisors. European System of Financial Supervision - ESFS) • Control of systemic risk (European Systemic Risk Council- ESCR)

  40. «The dispersion of credit risk by banks to a broader and more diverse group of investors has helped make the banking system more resilient. The improved resilience may be seen in fewer bank failures». IMF Global Stability Report, April 2006 (quoted in the Turner Review) J. Dermine, INSEAD 2009

  41. Excerpts from Basel II (2004): “# 738. Market risk: …Emphasis should also be placed onthe institution performing stress testingin evaluating the capital to support the trading function” . “# 741 Liquidity risk:Liquidity is crucial to the ongoingviabilityof any banking organization. ….especially in a crisis. Each bank must have adequate systems for measuring, monitoringand controlling liquidity risk” . J. Dermine, INSEAD 2009

  42. Financial Markets Architecture:An Incomplete Reform Agenda • Need to increase accountability of banking supervisors. • Large and complex financial institutions (LCFI) (systemic institutions): Too big to fail ? • Control of cross-border banks: College of national supervisors or European entity ? J. Dermine, INSEAD 2009

  43. TO CONCLUDE • RETAIL MARKETS Consolidation (domestic , cross-border ?) in mature markets New entrants: When ? • CORPORATE MARKETS Size, International Niche (sophistication) • EPS GROWTH Cost (consolidation) Cross-selling (“organic” growth vs. “external” growth) New markets Innovator • DIVERSIFICATION Avoid costs of financial distress

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