The recipe for success in Asian banking is surprisingly simple, says IFR Asia bureau chief Nachum Kaplan.
Basel III is changing the way banks do business everywhere, but, in Asia, the challenge of winning more business without extending more balance sheet is forcing them into a game of connect the dots.
Asia has been a growth market for investment banking for the past decade, and the region’s markets have kept expanding and developing even throughout the global financial crisis.
Much, but by no means all, of this growth has been built with expanding balance sheets as banks have sought to develop relationships with the region’s best companies and those that will be regional and even global champions in the future.
However, the constraints that the Basel III capital requirements impose on banks, plus major changes in the way they are regulated, mean they need to become less reliant on their balance sheets in growing their capital markets businesses.
These changes will make it more expensive for banks to lend money, especially over longer maturities, making it harder to justify the conventional approach of using loans as a loss-leader.
Both commercial banks and investments banks are coming to same solution: they need to leverage their existing relationships like never before. Many believe the way to do that is by having fewer clients, but deeper relationships.
Big commercial banks have many kinds of relationships with companies. The cash management or custodial services parts of banks may have relationships with clients that the bank’s investment bankers do not.
They can leverage those relationships to win capital markets business from others without having to lend any more money. Banks like Citigroup and HSBC have gotten very good at connecting these internal relationship dots and, consequently, are starting to plug their entire banking operations into their clients. They are executing on their banking models more effectively than before.
Balance sheet has – rightly – never been a dirty word for commercial banks, and they are not going to stop lending suddenly.
However, higher capital costs means that other ways of growing their investment banking businesses will make more commercial sense, especially if regulators force a split of retail and investment banking operations and drive funding costs higher.
This will reduce the ability of the commercial banks to use their ultra-cheap deposit funding to win capital markets business. Many commercial banks clearly do this – even if finding one that admits to it seems as hard as finding a unified theory of physics.
Connecting the right dots can make the big commercial banks truly formidable. Getting it right, however, is difficult because of the sheer number of geographies, asset classes and products involved. Fortunately, they do not need to connect all of the dots to generate a significant up-sell, even a modest improvement gives them a big advantage over the pure-play investment banks.
For their part, investment banks that have never been as reliant on balance sheet, but are also facing higher capital and regulatory costs, are connecting dots of their own. Many have large private banks they are able to use not just to place paper – as has been done in the high-yield market this year – but also to help gauge appetite for deals and, crucially, as a source of capital-markets business.
This is a very neat play for investment banks in Asia. The region has far more family-owned businesses than the rest of the world and such owners are often already private banking clients.
If these family-owned businesses need capital-markets services, such as wanting to take their companies public or make strategic acquisitions, they may well be tempted to turn to the same institution with which they have a private banking relationship.
To exploit this, the investment banks are connecting the dots with their own private banks. Why build new relationships and risk valuable balance sheet when you are not even maximising existing ones? Of course, many commercial banks also have private banking arms, but their greater diversity means they are generally less focused on exploiting them.
How far regulatory changes will go is still unclear, but for now and if lawmakers insist on ring-fencing investment banking operations, then this approach will become considerably harder, especially for the universal banks busy connecting the very dots that regulators may decide they want unconnected.
In the face of higher capital costs, however, this focus on connecting the dots seems well placed. It is making banks in Asia – of all varieties – more efficient, and that can only be good for the region and its capital markets.
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