In any discussion
about corporate banking, it is important to remember that from the perspective
of corporations, banks are a means and not an end. For example, what became
apparent during the financial crisis that began in 2008 is that corporations
tend to use banks as one of their funding options in times of duress. Evidence
of this can be seen during the same period, when despite a dramatic fall in the
quantity of new loans to large corporations of over 40%, banks’ balance sheets
still experienced a spike in commerical and industrial loans (Sharfstein and
Ivashina, 2010.)
At a time when credit
was severely restricted, banks were able to leverage their relationships with
banks to draw down existing credit lines and presumably achieve funding terms
at better rates than had a relationship not been in place. Corporations may
need to maintain these relationships if current figures are anything to go by.
In the period after the financial crisis, a low growth environment combined
with five years of near zero interest rates have incentivized corporations to
increase their debts. As of the second quarter in 2015, corporate debt is at
historically high levels: Net leverage for US companies, calculated as debt
less cash as a multiple of annual income, was 1.88 at the end of 2014 – the
same indicator was 1.63 on the eve of the financial crisis[1].
One of the
consequences of the financial crisis for banks was the introduction of the
Basel III framework, requiring banks to increase the level of low-risk
high-quality capital on their balance sheets. One of the best means for banks
to achieve this is through retaining corporate clients and their bulging cash
reserves. Despite four hundred years of corporate banks existing, companies
have yet to replace the deposit reserve function that those banks offer with
anything better. This paper will outline several of the ways in which
corporations are slowly moving away from banking insitutions and forwards some
suggestions as to how banks can address this movement.
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| Bankers in the good old days. |
Banks on the run
The recent and
ongoing scandal involving the tax returns of US corporate giants was remarkable
for several reasons. When a company such as Google pays tax of £11.2 million on
receipts of £4.9 billion[2],
plenty of comment will inevitably be generated. However, one of the most
comment worthy facets of the story almost went unmentioned: the diminished role
of banks in the process; aside from providing a medium (a bank account) where
funds could be transferred from one jurisdiction to another, banks did nothing.
The procedures were instead devised by these firms’ considerable financial
teams and ‘big four’ accounting firms.
This is indicative of
one of the many issues that banks currently face: corporations are not a
captive audience; the services that they look for (M&A advisory, foreign
exchange, tax consulting, etc.) are provided by a growing market of players at
increasingly competitive prices. Corporations – aware of the large fees
commanded by corporate banks and others for these services – have even began to
develop teams within their walls which carry out the same functions. For
example, in 2011, GE established a Latin America acquisition team whose role
was to find and acquire attractive targets in Latin America[3].
The lines between
banking and commerce have also blurred significantly. The Glass Steagall Act of
1933 banned the mixing of commerce and banking. In the United States, over time
various parts of the act were either circumvented (as in the case of GE
Finance) or repealed (as was the case in 1999[4]).
As one Economist article[5]
notes, ‘the case for a split is clear. Managers are even worse at dealing with
financial risk than bankers are.’ Sceptics of companies taking over too many of
the financial duties argue that managers of firms are better at dealing with issues
like firm strategy and sales.
However, if the
low-growth environment that corporations in the US and elsewhere currently find
themselves in persists, it’s hard to see any way other than a gradual
diminishing of the responsibilities assigned to corporate banks by their
clients. Where there is an imperative from shareholders to ‘produce’ growth,
firms can have the option of opting for M&A (risky), innovation (difficult
to predict outcomes) or financial engineering, which more of them are turning
to in greater numbers.
In this global climate, non-financial firms own
$9 trillion of currency derivatives[6].
In China, low interest rates offered by corporate banks has led firms into
shadow banking,[7] which
offers higher returns but much less regulation than traditional corporate
banking channels. In Brazil, corporate banks have effectively been crowded out
by the national development bank, BNDES[8],
which subsidizes financing for corporations at the expense of taxpayers. In
2014 alone, it borrowed $190m to corporations – 60% of them large
multinationals – at an average rate of 5.5%[9]
As of July 29th 2015, the interest rate set by the Central Bank of
Brazil is 14.25%; it’s not easy for corporate banks to compete with such
policy.
In India and elsewhere in Asia, companies are
turning away from banks for funding and opting instead for commercial paper.[10]
Bonds issued by first-time buyers have grown by close to 20% CAGR over the past
five years. Presumably, this can have more dramatic consequences in places like
India than in Anglo-Saxon countries, as close to half its 1.2 billion
population don’t have regular bank accounts – amounting to far less cash on the
balance sheets of banks to issue credit to corporations and others.
Even the largest company in the world by market
cap has largely turned away from corporate banking; when the question arose
‘what is Apple going to do with its massive cash pile,’ the answer given by
most analysts was to return the cash to stockholders through a buyback. Apple
did that with some of the cash but most of it found its way to Braemore Capital
in Nevada – a hedge fund which is a wholly-owned subsidiary of Apple Inc. and
now probably the biggest hedge fund in the world by assets under management[11].
The aforementioned discussion highlights many
of the difficulties faced by banks and explains why the number of commercial
banks startups has virtually dried up in the past decade. Since 1990, an
average of nearly 200 banks were established per year in the United States.
This number inevitably fell during the financial crisis and by 2011, no banks
at all were founded[12]
– the first time this happened since 1934 and the introduction of the
Glass-Steagall Act. Compare this to the number of financial startups on private
investor platform Angel List – at time of writing, the number of these startups
was in excess of 4,500 with an average valuation of over $4 million – and you
might begin to wonder if we’re witnessing the beginning of the end for
corporate banking.
Corporate
Banks: Fighting Back
What is notable about most corporate banks is
their longevity. In a comparison between the average age of the oldest banks
and the oldest non-financial companies, banks come out on top and by some
distance. Well known multinational banks such as Bank of Scotland and Barclays
were founded in the 17th century, while Bank of New York, Caja
Madrid and JP Morgan Chase were all founded in the 18th century. By
contrast, Cigna is the only publicly-listed firm in the United States which has
survived in its original form from the 18th century.
Longevity matters for several reasons. Firstly,
it shows the systemic importance of corporate banks, even if, as the figures in
the introduction suggest, this importance is falling for the moment at least.
Secondly, it shows that banks have always had accesss to large amounts of cash,
which is one of the secrets of longevity, allowing them to see out downturns.
Thirdly, and closely related to the second point, is that the tenets of
corporate banking have not changed to the extent that most industries have in
the past three centuries (although more on this later). Finally, to give some
credit to modern corporate banks – it shows that they are above all,
resourceful.
In terms of being resourceful, there are
examples everywhere. For example, the average startup figures in the previous
section can be a little misleading when it comes to corporate banks. One of the
reason for the fall, not just in the number of startups but the number of
existing banks, has been the huge consolidation that has occurred in the US
banking industry since the 1980s. The current number of over 5,000 is around
40% of the total number of banks that existed in the United States since the
1980s. The United States isn’t alone. In countries as diverse as Sweden,
Australia, China, Japan and Spain, the domestic banking sector is dominated by
four banks.
Also, few industries have been shown to be as
shrewd with legislation as corporate banks. Every financial crash is defined as
much by the new raft of legislation as much as the aftermath of the crash
itself. Corporate banks have learned to adapt to these changes quickly. Most of
the major banks have capitalized their balance sheets well in advance of the
deadline set by the Basel III regulations. This has also taught banks to
develop lobbying. In April 2015, several large corporate banks announced they
were increasing their lobbying spend in the EU; among them, JP Morgan Chase
raised its costs from €50,000 in 2013 to €1,499,999 in 2014, while Goldman
Sachs’ rose from €50,000 to €799,999 and UBS rose from €200,000 to €1.7 million[13].
This lobbying doesn’t just give sway to banks –
it can also lend influence to their largest clients. There’s a real unspoken
element here of how it’s better for corporations to be onside with banks and to
piggybank on some of their lobbying. Leaders of the large banks effectively
become spokesmen for heads of industry – and not just the banking industry – at
the government table. There is probably little that financial innovation can do
to change this, providing another reason why most banks will still be around
long after many of today’s largest corporations.
[3] http://www.bloomberg.com/news/articles/2011-04-29/general-electric-starts-m-a-team-in-latin-america-as-regional-orders-surge
[4] http://www.usnews.com/opinion/blogs/economic-intelligence/2012/08/27/repeal-of-glass-steagall-caused-the-financial-crisis
[7] http://www.businessspectator.com.au/article/2015/3/31/china/are-chinas-shadow-banks-going-bring-economy-down
[11]
http://qz.com/393093/the-mysterious-fund-in-the-desert-that-manages-apples-cash/