Corporations’ exodus from traditional banking

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.

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 29^th 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 17^th century, while Bank of New York, Caja Madrid and JP Morgan Chase were all founded in the 18^th century. By contrast, Cigna is the only publicly-listed firm in the United States which has survived in its original form from the 18^th 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.

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[1] http://www.wsj.com/articles/u-s-firms-shoulder-rising-debt-1430689085

[2] http://www.ft.com/intl/cms/s/0/c6ff0ebc-29c4-11e3-bbb8-00144feab7de.html#axzz3h3liUxx1

[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

[5] http://www.economist.com/news/business/21648684-message-chief-executives-do-not-try-turn-your-firm-goldman-sachs-risky-business

[6] http://www.economist.com/news/business/21648684-message-chief-executives-do-not-try-turn-your-firm-goldman-sachs-risky-business

[7] http://www.businessspectator.com.au/article/2015/3/31/china/are-chinas-shadow-banks-going-bring-economy-down

[8] Banco Nacional de Desenvolvimento

[9] http://brazil-works.com/?p=1698 (via FT.com)

[10] http://www.wsj.com/articles/indian-companies-bypass-banks-1435854415

[11] http://qz.com/393093/the-mysterious-fund-in-the-desert-that-manages-apples-cash/

[12] https://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=10&Header=1

[13] https://euobserver.com/institutional/128520

The Bank they never told you about

Which bank has considered a return above its peers for each of the past 42 consecutive years? The answer isn’t obvious; most people reach for Citigroup, Barclays, Deutsche Bank or even BNP Paribas. The giants of European and American banking have all had their moments of turmoil in that period, however, most notably the recent global financial crisis. The bank in question in Svenska Handelsbanken AB, or simply Handelsbank – Sweden’s largest bank.

The fact that Sweden’s largest bank has performed so well perhaps shouldn’t come as a surprise. This is a country which invented the seatbelt, patented it and then gave it to the rest of us for free – a gift to humanity. It seems the whole culture of the country is based around providing value for the collective rather than the individual and Handelsbank is just one small part of that culture which operates in the financial system. The bank might even have a thing or two to teach some of its more well-known counterparts.

The temptation is to believe at the outset that something about Handelsbank’s characteristics make it more prone to growth than other banks. Perhaps its size, government subsidies (more than Citibank or Barclays? Hardly) or the fact that it resides in Sweden give it a critical advantage. Certainly, Handelsbank has received government assistance but nothing like its Anglo Saxon peers. Likewise, it employs 11,500 people across 800 branches in 24 countries. It’s a global bank in the fullest sense.

To better understand Handelsbank, we need to step back and look at some factors surrounding the bank such as its history (not always rosy), the Swedish economy and its values. What emerges is a picture of a bank, which is more concerned with creating long-term value rather than the exorbitant bonuses that we have come to associate with many of the world’s leading banks.

The Swedish Economy

Sweden’s economy is often cited as proof that a socially minded economy can both function and provide growth over a long period of time. It is sometimes said that the Swedish mentality was developed by cold winters, where food became scarce and had to be stored away for when it was too cold outside. Such an inhospitable environment encouraged community and a sense of sharing among its people that continued until modern times and was the hallmark of its economy.

The Swedish economy has thrived on a strong export base since before the beginning of the 20^th century, thanks to quality manufacturing, a strong merchant navy and good trade links in Europe and the United States. Most people don’t consider how many Swedish products that underpin this export industry that they use in their everyday lives. The list is long but you can start with H&M, Electrolux, Ericsson, IKEA and even more technological firms such as Spotify and Skype (subsequently purchased by Microsoft).

Like most export-led economies, the country suffered during the global financial crisis, not least because its products are almost always at the high end (respectfully omitting IKEA). Unlike most of its European counterparts, the Swedish government can manipulate exchange rates to ensure the Kroner is working for the economy at any one time. Currently it’s hovering at around 9.25 against the euro, down from 9.16 on the back of recent lower-than-expected economic growth.

Nevertheless, the economy has rebounded well – better than most, in fact – after the financial crisis. This year, growth is up 1.9% on the same period for last year, with household consumption rising 2.9% and exports up 1.7% in the same period. All indications – confidence surveys, purchasing managers index and others – suggest that the recovery will continue to be steady in the short to medium term. In addition, the government is expected to keep interest rates at 0.25% in line with the EU and the UK.

The Swedish Financial System

Sweden’s financial system had its boom and subsequent fall in the last 10 years. Even financially prudent Swedes aren’t averse to a few years of cheap credit. However, the fall wasn’t nearly as bad as elsewhere in Europe. Unlike the Anglo-Saxon model of banking outpacing the economy, Sweden’s government and central bank have set an agenda whereby the banking system grows a percentage point or two slower than the economy, insulating it from ballooning like those in other economies.

In 2013, the then Financial Markets Minister said, “the dream scenario would be that the economy grows a little faster than the banking sector.” The same Minister – just recently replaced by Magdalena Andersson in October 2014 – ordered banks to hold higher capital reserves than any other banking system in Europe. Sweden’s banking system is around 4 times the size of its economy and is one of the world’s most centralized, so one might argue that such measures are necessary as much as they are prudent.

How strict are these capital controls? Quite strict but the figures tell their own story. Basel III demands that banks hold at least 7 per cent Tier I capital by 2019. Swedish banks, by contrast, are required to hold 19 per cent Tier I capital by 2015. If this seems harsh, it’s worth noting that the three largest banks, Handelsbank, Nordea and Swedbank have also promised returns over equity of 15% this year – thus far, the Finance Minister’s plan for the banks to grow slower than the economy isn’t quite coming off, then.

Sweden is one of around ten to fifteen countries in the world whose banking system is dominated by four large banks, being Handelsbank, Nordea Bank, Skandinaviska Ensilkda Banken and Swedbank. These giants of the banking industry account for around three quarters of the entire market. However, in recent years, they have been joined by emerging niche banks, internet banks and even foreign banks. As of December 2012, there were over 117 different banking companies operating in Sweden.

Like Sweden’s manufacturing, industrial and technology industries, the financial industry is also quite outward looking with all these banks having extensive overseas operations. It should be interesting to see in the future how these banks compete with foreign competitors given their extremely high capital controls but until now, they have prospered. And their overseas operations are not just a source of growth for the financial industry of a small country, but also a way to diversify its exposure to risk.

Likewise, to counter against concentration of banks and the systemic risk that brings, the government has created a framework in which the insurance industry can begin to offer banking services, while the “big four” now all offer a full insurance service. This is in line with most countries’ financial sectors since the 1970s and 80s. In the broader Swedish financial industry, banks are just one type of player in which the insurance companies mentioned above, mortgage providers and mutual funds also dominate.

The Handelsbanken Story

The environment above could be seen as fertile ground for a world class banking operation. Enter Handelsbank – founded in 1871 (thus approaching 150 years of impressively consistent returns to shareholders), it provides universal banking services that include corporate transactions, investment and consumer banking and life insurance products and services. Since its inception, it has been a model banking organization but it has had its own ups and downs too.

For example, in the midst of a severe financial downturn in Sweden at the beginning of the 1990s (whose causes were similar to those of the more recent US Subprime Crisis), Handelsbank was one of the Swedish banks that was obliged to accept government assistance. However, thanks to a unique and strongly decentralized organizational style that it has held since the 1970s (which allows mortgage lending decisions to be made by local managers rather than remote analysts, for example) it recovered better than most from the crisis.

In the decade that followed, Handelsbank even managed to prosper. In 1991, it offered telephone banking services to its customers with online banking services later being introduced in 1997 (incidentally, both occurring well before banks in most European countries). That same year, in 1997, it purchased a large mortgage firm, Stadshypotek, from the Swedish government, which gave it a strong position in a housing market which was just about to take off again.

The following year, in 1998, Handelsbank's operations in Denmark, Norway and Finland were organised into regional banks, and began operating with a more substantial presence in the same way as Handelsbank had operated in Sweden since the 1970s. It was around this time as well that most EU economies were just about to start a more-or-less unbroken ten year growth stint. Handelsbank got in on the ground in 2000 in the UK, opening four branches in an increasingly competitive environment.

At present, there are over 170 branches in the UK – representing phenomenal growth in the space of 14 years – five of which have been marked by tumult in the British banking industry. In 2015, they have promised to launch a fifth UK regional bank for the North East of England, consolidating its presence there. Outside of the UK, its main markets are the Netherlands, Norway, Sweden, Denmark and Finland while the bank retains smaller operations in countries like Poland and Russia.

Introducing Pär Boman, the Handelsbank CEO

The bank’s current CEO, Pär Boman, is under little illusions what needs to be done to maintain Handelsbanken’s position. He has been immersed in the company’s culture since joining in 1991 (at a time, let us recall when the Swedish banking landscape was in the depths of a crisis) and worked his way through the ranks. Being in various departments of the company provided him with an opportunity to see at first hand what makes the bank so successful.

According to him, it’s a precision focus on the customer experience. He is noted in the industry as being the only CEO who will spend a few days a year working in various branches (even as a bank teller), in an effort to see where the Handelsbank experience can be improved upon. The changes implemented on these efforts can be as simple as allowing clients to deal in cash in all of its Swedish branches despite the related costs and the general move in banking away from cash.

Handelsbank has become the subject of case studies under his stewardship but given the manner in which he tailors the situation to the Swedish client and their needs, it’s not necessarily a model that translates to every country well.This is demonstrated by the fact that as most CEOs are constantly driving towards modern, Boman finds a good balance between traditional finance and modern, more innovative solutions. Sometimes Handelsbanken’s peers call it the “Taliban of banking” due to its fundamentalist methods. Boman is constantly at pains to stress to leaders in his bank the 15-20 year business cycle theory that have traditionally been the downfall of banks and their leaders who utter the immortal lines, “this time it’s different.” In that sense, the bank always operates like a crisis is just around the corner – demanding that managers thoroughly analyse the loan book four times a year and are especially particular in loan deals exceeding 1 million SKR.

Handelsbanken: Now and in the Future

Handelsbank’s growth is underpinned by focusing its operational activities primarily around customer needs and requirements. Maintaining strong relationships with the client are a top priority at Handelsbank - with banking decisions being made with the clients best interest in mind at all times. When most banks were falling over themselves to centralize, Handelsbank’s modus operandi was to decentralize and get closer to the customer and make informed local decisions.

These decisions are constantly being updated and reconfigured. The bank was among the first in Europe to offer phone and internet banking – and Sweden’s population has one of the highest take up rates in the world for these serves, leading to efficiency across the board for Handelsbank and a return on invested capital which would be the envy of many peers (particularly those in southern Europe, which are heavily invested in retail outlets but low on telecoms infrastructure).

More impressive still is that this move to telecommunications-based banking transactions has not come at the expense of customer satisfaction. Remarkably, since surveys began in 1989, Handelsbank has been the number one bank among Swedish banks every single year. Twenty five years in the number one spot for customer satisfaction. This satisfaction was no doubt driven by providing services and products that address customer needs with a long term and sustainable perspective in mind – something that was missing from many of the other banks that needed government assistance in 2007 and 2008.

The bank’s 14% return in 2013 beats even Goldman Sachs, who only achieved 10.9% in the same period. Recall that this return is more impressive still against the investment bank when one considers the tight capital controls imposed on Handelsbank. At the time of writing, its common equity Tier 1 ratio was 20.1% - comfortably ahead of any other western European banks outside of Scandinavia.

Banking sector analysts are especially optimistic about Handelsbanken performance over the coming years because of the Swedish bank's unique strategy. The bank has devised goals that are not centred on growth targets, but instead the bank is focussed on small scale elements of business, such as corporate lending, developing long term client relationships and developing services and presence across the globe outside the Swedish borders.

In July 2014, Handelsbanken was rated as one of the world’s strongest banks for the fourth year running, by financial information provider Bloomberg. Furthermore, the 143-year-old Swedish banking institution was recently ranked as number one for customer satisfaction and loyalty for the fifth year in a row, in an independent survey of British banks’ personal and business customers​ – demonstrating the consistency and ability of the bank to perform at a high level both within and outside of the Swedish border.