Tag: banks


Banks Must Catch the Innovation Bug

Originally published in The Huffington Post on 5th March 2014.

Although I agree that Banks and Financial technology firms should be looking to partner and work together where possible to improve the proposition for customers, I don’t necessarily believe that this strategy will make banks more innovative and provide better services for you, I and our businesses.

As I have stated before, innovation occurs at 4 levels correlated with increasing returns for the business and customers:

  1. Process
  2. Product/Service
  3. Business Model
  4. Industry – changing the way participants compete

My experience in financial services is that banks are pretty good at Level 1 – by buying in tech to improve process – and not too bad at Level 2 in certain areas.

Just look at the advances in process and products around capital markets such as electronic trading, algorithmic trading and prime brokerage. They are pushed to be innovative in these areas as the buyers, other financial institutions, hedge funds, etc. have significant power.

Downstream, in commercial and retail banking, there is less evidence of innovation in practice; chip and pin was a startling improvement that put the UK ahead of most other countries, but then we look at areas such as international payments, where the correspondent banking system from the 70’s is still in place, or invoice finance, where I have personally seen green screen terminals in a bank that run core processes.

It is still far too common that banks, rooted in tradition, try and keep the benefits of innovation for themselves rather than sharing with the customer equitably. This has to change; when it does, it will be the foundation of a new evolved industry.

For banks to become more innovative requires them to adopt a change in approach (be it slow and adaptive) to the way they do things, to the way they frame their role as a service provider, to they way they define and then execute their strategy.

This change requires buy-in from the top, from the board. It will take time and needs to be planned and controlled to fit with the bank’s culture and to avoid widespread disruption. Openness and collaboration with the rest of the bank is key; not just for others to see the benefits in the new approach, but to be inclusive and create a stakeholding. Segregating the (innovation) team is the biggest mistake that can be made – it will stir resentment that will lead to failure.

The CEO of one of the larger European banks I have worked with put it to me quite eloquently,

“Our business is like a large oil tanker, it takes a lot of effort to make it change course. What we need are a few agile speedboats that buzz around the tanker. Eventually, as more speedboats catch the tanker, the wake of these boats will help make the tanker turn more easily.”

We have not really seen a major bank challenge the industry with innovation at Level 3 and 4. Saxo Bank and Well Fargo are recent examples of business model innovation, but it has not called the larger players to account.

I am certain that, as has occurred in other industries over the past 20 years, a new entrant or existing player will grasp the reigns of innovation, be it organically, or, more likely, acquiring capability through external talent, so wholeheartedly that it fundamentally changes the way the industry competes – Level 4. This is where real value is delivered to all – Apple (Music industry), Ryan Air (airlines), Skype (communications). We are on the verge. I am so excited to be involved in the new dawn of financial services.

The latest score: banks 3, SMEs 0

Orignally published in Entrepreneur Country, 19 June 2012.

Here we go again – bailing out the bankers under a veil of helping out small business.

I read the following article, published in the Wall Street Journal (and I am sure elsewhere) with a knowing smile on my face.

Lets leave aside the irony of a bunch of wealthy politicians preaching to a bunch of wealthy bankers at an expensive and exclusive black tie event about how they are going to help “the little people” (I love the pic!),  and focus on the proposal.

“Mervyn King announced plans to flood banks with cheap funds in an attempt to jump-start lending to British households and businesses….”.

Let me tell you a little about how banks work. They are privately held entities. Like other firms listed on the stock market, they do what is best to maximize return for their shareholders. If they have 100 units of capital, they, like any other private firm, will look to allocate the 100 in the most effective way to generate the maximum level of return on that capital.

Banks are not responsible for saving the economy, that is the job of the government through public policy and expenditure and by delivering the right incentives to the private sector to do what is best for the whole while also helping themselves.

So, by providing cheaper loans to banks is the government providing the right incentives to the banks to open up lending to SMEs and households? No – and they know it.

All the government is doing is helping the banks more easily raise capital. How they use that capital is not, and will not, be dictated. Yes, some of it will find its way to you, I and our businesses. However the vast majority will go towards the capital markets functions of the banks and in lending to large corporates. The reason is quite simple; lending to SMEs and households is the most expensive activity for a bank to conduct in terms of capital utilised.

A loan portfolio consisting of SME loans is considerably more expensive to hold then a loan portfolio of large corporate loans.  Obviously the revenue the banks earn also defines the return on capital. Let’s say, on average, a bank earns 8% on SME loans and 5% on large corporate loans. This 3 percent difference in no way compensates the difference in the capital requirement between SME and Large corporate loan portfolios, which can be as large as 20%.  Now also factor in the off balance sheet activities of banks – the complex derivatives they trade in the capital markets division that can reap them considerable revenues but cost the bank nothing in terms of regulatory capital.

So, if a bank has 100 units of capital available, what would it do it with it? Well given the incentive structure, in this case, the capital requirements dictated by regulatory bodies such as the FSA, Bank of England, the EC and the Basel Capital Accord, they would allocate zero of that capital to lending to SMEs in order to maximize their shareholder’s return. This is why Project Merlin, the effort by the Government to tie banks to lending targets, failed – though a token effort was made due to brand necessity, the proportion of loans made to SMEs relative to large corporates fell considerably and continues to fall. This is also why the stimulus package announced at the event covered by the Wall Street Journal will also fail – the incentives are simply not there for banks to lend to SMEs.  Given the current trajectory of regulation, I would even stick my neck out and state that banks will exit the business of lending and generally providing SME services within the next 10-15 years. SMEs should be looking at the new finance/Fin-tech sector for support as it is fundamentally the future for SME finance and banking services.

As a spin on the Government proposal and the general conditions for banking at the moment, why don’t you help me take advantage of the situation? I promise at least 20% Return on Equity for any investor who will help me set up a bank. Here is my high level business plan – any takers? 😉

  1. I employ some currently unemployed bankers (adding value to the economy)
  2. We raise £1 billion of equity
  3. We use the £1 billion to buy as much high-grade securities as we can (minus set up costs), paying maybe 4-5% coupon
  4. We use the securities as collateral to borrow £9 billion from the BofE at overnight rate of 0.5%
  5. We buy another £9 billion of securities at similar rates as the first batch. At this rate, we are earning at least £400 million per annum
  6. We continuously roll the overnight position with the BofE, pledging more of the security pool in collateral if required on margin calls
  7. We go public. After costs, the bank is earning at least £200 million a year with a high capital ratio (10% equity-to-debt), and the balance sheet will be clean (all low risk securities). Potential valuation of 20-times earnings: £4 billion. We sell 25% of the company for £1 billion
  8. Put the £1 billion raised to good use – go back to Step 3
  9. When market cap hits £10 billion, sell another 10% of the company for £1 billion. Go back to Step 3 again
  10. Expand to US. Fed is lending at 0.25%. Repeat formula. Start focusing on PR and social issues, buy branch networks from defunct banks and start making actual loans to retail and corporate consumers
  11. Exit for a ridiculous valuation. We all win!

The National Loan Scheme Conundrum

Originally published in Entrepreneur Country, 02 December 2011.

I watched George Osborne’s Autumn Statement on Tuesday with a great deal of interest. I was eagerly anticipating the statement confirming exactly how £20billion in funding will be delivered to SMEs, a story that had been circulating in the press for the previous few days.

I won’t bore you with my comments and thoughts on the overall statement, George’s performance or Ed Balls counter – If you are interested, please do take a look at my Twitter feed (@naszub) for the instantaneous reactions. (I will however reiterate one point that is still perplexing me – Ed used the phrase “illiterate fantasy” can somebody please explain that to me????)I will instead focus on the crux of my loss of sleep for the past few nights in the hope somebody can prove me wrong and put my mind to rest.The National Loan Guarantee (NLG) scheme was announced as a measure to provide SMEs with access to cheaper finance – a potential saving of 1% on the cost of borrowing George said. “Great!” I thought. The saving would come about as a result of the UK govt. providing guarantees for borrowing. “Woohoo!” Went my brain.Then, after a latte and a jog, being the curious fellow I am, I started to delve a little deeper into the proposal, started doing some research on how the scheme would be delivered. This is when neurons started popping in my head.

See, here is what I understand; and it worries me. I would dearly love for someone to correct what I must obviously have wrong: the NLG benefits the banks and not SMEs.

From what I understand, the NLG scheme will allow BANKS to borrow in the money markets, most likely by issuing bonds, to the tune of £20billion, backed by a government guarantee. I.e. if the BANK goes bankrupt, the government will pay out to the owners of the bank debt. As a result of this guarantee, the banks can borrow at lower rates, essentially borrowing against the Government’s AAA credit rating. It is then assumed that the banks will pass on the cost saving to SMEs seeking loans. SME loans are not actually guaranteed themselves.

The problem – I can’t find any evidence to suggest that the banks MUST use the £20billion they raise to lend to SMEs. This is extremely concerning, and as I said, nagging me to the detriment of my sleep.

If my suspicions are correct and the banks are not obliged to lend the money to SMEs, they will not; for the same reasons they are not lending today. Credit risk and the high (highest) capital charge for lending to SMEs will not change. The opportunity cost of lending to SMEs will continue to drive the use of funds in other areas of the bank – lending to larger corps (a shift in capital that is clearly apparent in Project Merlin stats) or, more likely, into their capital markets divisions.

In essence, without a contract forcing them to lend the money to SMEs, the funding raised under the NLG will be used to bolster liquidity in day to day operations within capital markets, thus further increasing the profitability of this part of the bank, by increasing the scale of the activity that can be carried out. In a similar vein to Quantitative Easing (who holds large quantities of government debt? The banks. Who processes the transactions for other institutions selling bonds back to the government. and charge a fee? The banks. What happens when the government announces a QE programme which runs for several months? The price of the bonds goes up – more profit to…..yes you guessed it, the BANKS), the wool is somewhat being pulled over our eyes; the banks are guaranteed to benefit, SMEs will likely be no better off.

It could be that more detail on the mechanics of the NLG scheme will emerge that subside my concern. It could be, as I have stated I hope, that I have got this completely wrong. For once, I really want to be.