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Sunday, 30 March 2014

‘Banks are closing the ranks’, according to Het Financieele Dagblad. Is that good or bad news for investors and savers?

Het Financieele Dagblad (, the financial-economical newspaper, is one of the finest newspapers in The Netherlands and a daily source of inspiration for me. They have very good journalists and generally dig deeper than the other newspapers in The Netherlands; especially when it comes to the big (and smaller) economic stories.

Yesterday, the FD published a peculiar article about the Dutch banking industry. This industry is apparently busy with an operation to ‘close the ranks’ among each other and return to their pre-crisis modus operandi, in order to enable a new golden age for themselves.

This is definitely a new development, which comes after more than five years of forced humility, passivity and obedience: deviant behaviour for this proud and even presumptuous industry. 

Nevertheless, most people in the banking industry understood that it was time to eat ‘humble pie’. There had been a series of rescue operations by the Dutch state, as a consequence of the economic crisis hitting the Dutch banks like a cannonball. And on top of that, a number of banks had received huge penalties from the international supervisors, in order to to punish them for economic blunders or even financial misdemeanors (f.i. Liborgate).

Nevertheless, according to the FD, a new dawn for the banks has seemingly started. Here are the pertinent snips from this article.

Less than one year ago, the bankers of ING and Rabobank were heavily quarreling during meetings of their own special interest association, the Dutch Banks Association (i.e. NVB).

There was open discord about the plans to recover the Dutch housing market, the annual contribution and the number of members [with respect to the NVB - EL]. And 2013 was also the year that the other banks showed uncovered ‘Schadenfreude‘ towards the Rabobank. This bank had to deal with a violent quarrel within the board of directors and on top of that the devastating Libor-gate affair, culminating in massive penalties from supervisors around the globe. 

In the eyes of the other banks, it was ‘what goes around, comes around’ for the Rabobank, as this bank had looked at the other banks with supremacy and disdain, directly after the economic crisis started.

However, lately it seems that a turnaround is underway within the banking industry. In the insiders’ circles, you can’t hear a bad word about the ‘concullega’s’ anymore [Dutch joint word for people, who are both colleagues and competition – EL]. 

The ‘mishit’ of ING with the payment data of its customers, led to little more than worries about the reputation of the banking industry as a whole; not to cynical statements from the other banks with respect to their competitor.

Also the choice for non-banker Wiebe Draijsma as new chairman of the Rabobank, triggered positive comments from the industry: both on and off the record. This was a big change, after the sarcastic remarks and Schadenfreude about the Rabobank in 2013

Question is: what triggered this ‘turnaround in thought’ within the banking industry?! 

It is definitely not introduced out of charity, but merely from a well-understood self-interest. The banks understand very well that the real enemy is ‘The Hague’ (the residence of Dutch politics). One closed front is necessary to deploy a different paradigm among the Dutch politicians and the Rabobank is definitely an indispensable part of this front. 

This seems like a coordinated counter-attack, aimed at The Hague. Bank officials are fed up with the continuous bank-bashing, coming from the residence. The plans of Dutch politicians to deploy more stringent capital requirements and a lower bonus ceiling upon the Dutch banks than ‘Brussels’ demands, is a real pain-in-the-neck. Consequently, this demands undisputed resistance from the banking lobby, which is the main task of the NVB.

After years of cutting and downsizing, the time has come to look ahead for the banks. ING almost repaid its state aid and wants to offer new horizons for its investors. The same is true for ABN Amro, which will probably return to the stock markets next year. This renaissance requires a foundation of unity.

This was for me an excellent and though-provoking article. Although I am a long-term employee at one of the biggest (Dutch) banks in Europe – albeit at a non-commercial department –, I didn’t notice this quite surprising change in attitude myself yet. At least, not to the degree that the journalists of het Financieele Dagblad did.

Yet, I am more than willing to believe that a new self-esteem and self-confidence has come across the Dutch banks, as well as a revived sense of urgency for cooperation against the 'mutual enemy in The Hague'. Nevertheless, I have my doubts whether this is a good or a bad development; for investors, as well as savers AND the Dutch government.

Many of the problems that caused the economic crisis in 2008, have only been partially solved or even not at all. Giving the banks ‘too much leash’ would mean that they could return to their old, in hindsight counterproductive activities of the years before the crisis: in favor of short-term gains, but at the expense of long-term viability and profitability. People, who follow this blog regularly, have read about some of the things that ABN Amro, SNS Reaal and the Rabobank did in recent years; well after the credit crisis started.

At this very moment, the banking industry still has to deal with some difficult problems. For the banks the following topics are a mutual pain in the neck, most of which have already been recognized in the aforementioned, excellent article:
  • The most important financial mill-stones for the Dutch banks are:
    • The more than 1 million underwater mortgages held by the Dutch population; 
    • The (often) overvalued residential real estate on the banks’ balance sheets, which forms the pledge against these and other mortgage loans; 
    • The bank’s vast portfolios of overvalued and seemingly unvendable commercial real estate, often at unfavourable locations;
    • The dire financial situation among numerous Small and Medium Enterprise companies – especially in the retail industry and the dangerous consequences of this situation, when it comes to the repayment of the outstanding bank loans;
    • The total lack of highly-profitable investments, which bring excellent yields against a reduced amount of risk;
  • Besides that, the banks have currently a bad reputation among the Dutch population and especially among some prominent Dutch politicians, like Finance Minister (!) Jeroen Dijsselbloem;
    • As a consequence of the often populistic approach towards the banks in The Hague, ‘Henk and Ingrid’ (i.e. the average Dutch citizens) feel a lot of envy and resentment against these banks. This led to various cases of political and public bankbashing;
  • There is the political downward pressure on the salaries and (especially) bonuses for the banking industry, which led to ‘stricter-than-Europe’ limitations for bonuses in The Netherlands;
  • There is also the desire among prominent politicians and economists for a higher unweighed capital ratio for the Dutch banks;
  • Both these developments can’t be separated from the general desire of (sometimes other) prominent politicians and economists for a smaller Dutch banking industry, in which the Dutch banks are local heroes, instead of global players;
    • This desire would definitely lead to reduced profitability and (thus) reduced attractiveness for shareholders. 

To start with the second bullet: the time of mindless bank-bashing should be over indeed.

The vast majority of people who work at banks are really honourable people, that do a decent job against a decent salary. The fact that the salaries for the executives and the top dealmakers and traders have gone totally out of hand, has really nothing to do with the average bank salary: this is absolutely not excessive. The same is true for the bonuses: the normal bank employee now has to suffer for the formerly massive bonuses of his executives. Jeroen Dijsselbloem often makes the impression that he doesn't see this or understands this properly.

Good and decently led banks operate as the lubricants in modern societies, as they transform the money borrowed from savers into:
  • Lending money for other people’s housing; 
  • Funding for small and medium enterprise (SME) companies;
  • Investment money for large companies. 
On top of that, most banks have gained a lot of financial and business knowledge that can be used for the benefit of the private people and companies, which are their clients. This makes banks an indispensable part of society.

Banks lend money to companies and private citizens, in exchange for a decent remuneration, expense coverage and risk fee. This means inevitably that there must be a solid margin between the money which is lended to companies and private citizens and the money which is borrowed from private and corporate savers. 

Banking is a labour intensive, as well as extremely capital intensive business. Banks are all about trust; maintaining this trust comes at the price of vast investments in people, technical infrastructure and ICT.

When banks lend money to small or large companies and private customers, they need pledges as collateral for their activities. Banks must do so, in order to keep their risk of losing money as limited as possible. Still, the higher the risk is that the borrowing party poses, the higher the risk fee is and shouldbe which must be paid by the private or corporate customer.

Nowadays, most banks in The Netherlands have understood more or less that this transformation of money and business knowledge belongs to the core activities of banks. And also that opaque trades in over-the-counter derivatives, collaterized debt obligations, sovereign bonds from unstable countries and companies or mortgage backed securities simply don't.

Of course, it would have a strong downward effect on the financial risks for the Dutch state, when the Dutch banking industry would consist out of smaller banks. Hence, although the chance for defaulting is somewhat higher among smaller banks, these banks pose much less financial risk when they do topple over.

On the other hand: one should not forget that The Netherlands is an extremely export-driven country. The vast amounts of imports and (re-) exports require financially strong banks, in order to finance the massive movements of goods and services. More exports and smaller banks: you simply can’t have both at the same time, in my humble opinion. So the Dutch government should make a fair choice, as far as this is concerned.

Still, under the influence of the ‘shareholder’s value hype’ of the first seven years of this century, the Dutch banks had forgotten what they were and what their role in society should be. Most banks – especially savings & loans banks and normal trade banks – simply cannot be very profitable. If banks become too profitable initially, they obviously take too much risk. And one day, that risk will come around to haunt them.

The margins of banks should be enough to cover all their expenses and to make a decent profit of approximately 5% to 6%, but not the 15% - 20% margins that shareholders required in the ‘good ole days’. In order to be able to deliver such margins anyway, in the years before the crisis, banks have:
  • Expanded their balance sheets to the extreme, thus reducing their equity to the bare minimum;
  • Invested with huge leverages, caused by massive amounts of borrowed money and very little investment money of their own;
  • Invested billions of euro’s in either overpriced and (even) excess commercial and residential real estate or in excess mortgages for totally risk-unaware people;
  • Purchased f.i. very risky collaterized debt obligations, vast amounts of sovereign bonds from (then) shaky countries, like Greece, Spain and Portugal and mortgage backed securities of suspect quality. 

Initially, the Dutch banks successfully spreaded the myth that the Dutch economic crisis was caused by the actions of the American banks alone, with their ‘subprime’ mortgages and other opaque and shaky investments. The Dutch banks were apparently innocent ‘victims’ of these American banks and they were strongly disappointed in their trust. 

In my opinion, this myth has been totally busted: one Dutch bank had about the highest leverage in the whole (Western) world and also the other Dutch banks were very much leveraged at the time. The Dutch banking crisis in 2008/2009 was mostly a Dutch problem; not a consequence of an American one. Lehman acted as the trigger for the Dutch banking crisis, but it was not the single cause.

In spite of the fact that most banks now officially promise to operate customer-centered, risk-aware and cost-efficient, they still look for the extra margin to keep the shareholders happy (f.i. ING;  see the red and bold text) or to enable a successful return to the stockmarkets (ABN Amro and SNS Reaal). Even the Rabobank is tapping alternative sources of investment money: their formerly exclusive member certificates are now for sale at the Dutch stock exchange!

On the other hand, the people that would benefit most from a healthy banking industry  the SME-companies and especially the retailers – are treated like damaged goods these days. If they get any money in the first place, they get it after meticulous scrutiny and after offering a whole series of physical and personal pledges. Apart from the question whether this is justified or not (It is, IMHO), it still puts a brake on the development of the Dutch economy.

And the elephant in the room is, that the Dutch banks still put too little effort in deleveraging their balance sheets. 

As far as I know, the Dutch banks still have massive exposure towards:
  • Overpriced and/or vacant commercial and residential real estate; 
  • Very vulnerable small and medium enterprises and retailers 
  • And last, but not least, excess mortgages on (often) underwater dwellings. 

Banks still fail to do something about the risks that these investments pose for their survival in the coming years. 

They still fail to write off sufficiently on the overvalued investments on their balance sheets. There is yet too much hope among bankers, that time will rejuvenate the bad investments and that it will bring the marked-to-market value of their investments in synch with the bookvalue on their balance sheets.

To put it even stronger: most balance sheets of Dutch banks have actually grown again during the last two years, instead of having shrunk. This is definitely not the necessary change that the Dutch banking industry needs so desperately, to regain the trust of the Dutch population and politicians. 

Summarizing, it is good for the banks themselves and for the Dutch Banks Association (NVB) that the large Dutch banks are cooperating much better than one year ago. 

However, if the banks use this improved cooperation to further postpone the inevitable changes within their industry, then it is not particularly good news for the Dutch savers and tax-payers.

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