Sometimes one has to do a double take and ask oneself whether one has just heard what one has just heard, read what one has just read and whether it might be time to pinch oneself. Yesterday brought on just such a moment when news broke that HSBC’s newly anointed CEO, Georges Elhedery, is floating the idea of merging the investment banking operations with those of the commercial bank. If I were an HSBC shareholder, I’d be reaching for the “sell” button.
I have of course no access to Elhedery’s working papers or to his detailed thinking but there are two elements in the news reports that put me on edge. He’s been in the job for no more than a week and has chosen to make his first mark not by looking to where the bank can increase its revenues but by looking at how much cost can be cut out of the organisation. After forty odd years of looking at corporate borrowers, experience has taught me that cost should be the second thing to look at and not the first. First comes the strategic review and then the cost base can be wrestled with. But to target the cost base as a first priority can in my book bring no good.
As I say, I don’t know Elhedery and I have not been party to any of his preparatory meetings so maybe I ought to be giving him, albeit counterintuitively, the benefit of the doubt. But where I come to a stop is with his plan to merge commercial and investment banking. Although I made my retirement pot in investment banking I was in fact trained as a commercial lender at the happy house of Barclays Bank International Limited. If you can’t find that name in the books, it is because in 1985 Barclays International effected a reverse takeover of Barclays Bank plc and then changed its name. It was deemed a lot easier for a bank registered in 80 or so jurisdictions to take over the one only active in one country and to then change its name than to gain approval and reregister the 80 subsidiaries. This was before Big Bang and before the great clash of retail and merchant banking cultures.
Commercial bankers are trained to ask one question when faced with a lending decision which is “How much might I lose?” while investment bankers, when looking at a transaction are trained to ask, “How much can I make?”. It might, at first observation, seem like a bit of a fatuous comment but trust me it is not. It is after all not without reason that in the aftermath of the Crash of ’29, American legislators in 1933 passed the Glass Steagall Act, more formally known as the Banking Act which very strictly separated commercial from investment banking. Commercial banks were prohibited from owning or even being commercially associated with investment banks. They were banned from dealing in non-government securities or investing for their own account in sub-investment grade bonds. In post-GFC parlance, commercial banks were locked out of casino banking.
In the early 1980s, I moved from commercial to investment banking – in those days it was still possible to make that shift – and therefore was on site when the strict rules of the Glass Steagall Act began to become porous although it was not until 1999 and under President Clinton that it was formally repealed. There was really no alternative as European banks such as Deutsche, Dresdner, BNP and SocGen had no such constraints.
One of the features of the investment banks had been their chronic lack of risk capital. That meant that underwriting transactions, whether for bonds or equities, had to be sharply and correctly priced. There was no option to put unsold stock on the back book and to wait it out. This led to fierce price competition between the investment banks although all of them knew that if they became too competitive, price the deal too aggressively, then it would not sell, that they’d have to clear their balance sheet and free up capital for the next deal at a loss. There are other rules and regulations with respect to how the distribution of underwritten securities had to be conducted that sit so deeply in my consciousness that they might as well be tattooed on me. Old bond dogs will wryly smile when reminded of “all sold telexes” to the SEC or the “40 day seasoning” rule.
At the time we generally thought of Glass Steagall as obsolescent and couldn’t wait for it to be gone. Had it still been in place, however, there would never have been a Global Financial Crisis. I mentioned above the lack of capital that had plagued the investment banks. That would be true, but it also kept investment bankers on their toes and honest. They needed to be fleet of foot. However, once they had gained access to the capital base of large commercial banks, it was in many respects game over. Securities underwriting mandates were no longer based on head to head competition between a number of houses but were linked to how much the banks in question had offered the issuer by way of balance sheet, which basically means how much they had lent them by way of commercial loans. Small firms, no matter how good they were, had no choice other than to sell themselves to big banks. The senior partners made out like bandits while those on their way up in the partnership found themselves cut off at the knees.
More to the point, commercial bankers began to pitch up in the investment banking arms. Compared to the old style investment bankers who were masters in ducking and diving, they were often nothing but muscle-bound oafs. Investment banking is transactional, commercial banking is about relationships. The two have never made comfortable bedfellows.
Thus it was discovered in 2007 and 2008 that when investment bankers have access to too much capital and can hide their sins in the depths of the parent bank’s balance sheet, things will eventually go to sh*t. Long before the GFC, I had a close relationship with an American executive who had been at the Pacific Investment Management Company – the legendary PIMCO – when it was acquired by Germany’s Allianz group. He had been sent from Newport Beach in California to Munich in Bavaria to help with bringing a bit of cold discipline into Allianz’s investment process. Perchance, Allianz also owned Dresdner Bank in Frankfurt, so my man went up to study the bank’s books in order to get a handle on the group’s aggregate risk exposure. He came back ashen faced, never having been able to believe that so much random and totally mispriced credit risk could fester in the vaults of a self-respecting financial institution. As far as he was concerned, Dresdner was a dead man walking and as we were a decade later to discover, so was Deutsche Bank.
I’m sure it was not entirely coincidental that both Dresdner and Deutsche Bank were covered with the fingerprints of Paul Achleitner who is to my mind the most Teflon-coated banker in Europe and who has made a tidy fortune while, under his watch, Germany’s two largest banks went to the dogs. I first came across Achleitner in the early 1990s while he was still at Goldman Sachs in Frankfurt and I’m afraid my first impression, to me at least, was the right one.
Anyhow, when the GFC hit and there was uproar over the way in which our large banks were spinning the roulette wheel with their customers’ deposits, there was a loud cry for the principles of Glass Steagall to be revisited as it became glaringly obvious that Senators Carter Glass and Henry Steagall had not been as wrong as many of us had previously assumed. The core principle of keeping securities underwriting activities at arms’ length from the bank’s capital has more than just passing merits. Access to excessive capital blunts the bankers’ pricing instincts. This will cost either the clients or the shareholders but rarely the bankers themselves.
And now, as CEO of HSBC, Georges Elhedery is proposing merging commercial and investment banking not for operational reasons but just to save costs. Were I the regulator, I’d call him in today, ask him to reconsider what he is proposing and make it clear that he’s barking up the wrong tree. It’s no secret that, relative to the size of the bank, HSBC bats below its average in investment banking. Even so, I can see no merit in stripping the investment bankers of their identity. There is nothing more dangerous than a commercial banker with access to a near-endless pool of capital who begins to think along the lines of “How much can I make?”.
Write to us with your comments to be considered for publication at letters@reaction.life
