Does the name Alexander Gerschenkron ring a bell? For many readers of this column, I would imagine probably not. Among the Pantheon of famous practitioners of economics – a science that appears more dismal by the week when invoked by hyper-emotional UK politicians – his name is absent. But is he relevant today? Absolutely.
Gerschenkron was a leading practitioner of the post-war Austrian School of economics and one of the central tenets of his lifetime work was that universal banks (he used Germany as an example) are a prerequisite for industrialisation. In other words, Mr Gerschenkron was a fan of the universal banking model.
He defined these as “banks that accept deposits, and engage in both short and long-term lending,” but let’s assume he would also be a fan of the current meaning of the term as a bank that engages in commercial banking and investment banking as well as offering other services such as wealth management.
These are the likes of HSBC, Deutsche Bank, Barclays and JP Morgan from the West and Bank of China, State Bank of India, ANZ and DBS from Asia-Pacific, just to take some well known examples.
There are many more, but what is striking when you compare those in the first group with most of those in the second is that the Western universal banks are underperforming their Asian peers when return on equity is used as a benchmark.
Barclays has recorded an average ROE of just 1.33% over the past five years and was in negative territory in the first quarter, while Deutsche slipped into its worst ROE performance in the first quarter of –10.15% having averaged just 1.25% over five years. HSBC has better metrics, averaging 8.6%, although it also slipped to 6.6% in the first quarter.
Contrast this with the big Chinese universal banks, which have averaged around 17% ROE over the past five years, or DBS and SBI, which came in at 12% over that period.
WHAT EXPLAINS THIS divergence? Well, there are numerous factors. For one, the regulatory and compliance cost of banking business in the West is far higher than in the East. And government ownership and implied support reduces the cost of capital in the banking industry in China and India and boosts net interest margins. Balance sheets going into the global financial crisis were also far healthier in Asia than in the West, where many of the universal banks are still struggling to sell toxic legacy assets.
There are two themes here: one is that the universal banking model as practised in the West is fundamentally flawed and ergo that its large universal banks ought to be broken up; the other is that Asia is a better place to conduct banking business than the US or Europe.
The first is not a straightforward argument, since the revenue split for investment banking versus retail banking for the big Western universal banks is reasonably balanced.
Whether break-up would be a panacea is moot, given the natural hedge that retail and commercial banking provides for earnings when capital markets downside volatility is high, as it was in the first quarter, hence those inauspicious ROE numbers.
As for Asia, the argument seems easy: many of the big Western universal banks see it providing the only ray of light as far as future prospects for return on equity are concerned.
HSBC IS A prime example of a universal bank recalibrating its business model based on the assumption that Asia will be the world’s economic growth engine over the next few decades and a fertile source of quality future earnings.
CEO Stuart Gulliver is working through the sweeping revamp he first announced last year, which involves divesting businesses that have struggled to deliver returns since the financial crisis – such as its operations in Brazil – and diverting assets from the investment banking operation towards investments in China.
Brickbats have been thrown at this approach from industry players who suggest HSBC is a long shot to compete in the local commercial and retail banking space against the entrenched Chinese state-owned domestic outfits.
Meanwhile Credit Suisse is also seeking to pivot its long-term growth strategy towards Asia, amid the reduction of its global investment banking business. It intends to focus on wealth management in the region and allocate a large chunk of capital to an APAC division that aims to serve Asia’s growing ranks of rich entrepreneurs.
The precise definition of “universal bank” shifts somewhat elusively amid the sprawling structures of outfits such as HSBC and Credit Suisse. For example, the latter’s “Swiss universal bank” – which offers a range of services in the bank’s home country – has outperformed the rest of the group’s ROE and is set to be spun off next year. And there is talk that HSBC will sell its UK high street retail business.
In all this, fragmentation of geography and product is the somewhat inelegant strategy being adopted by the universal banks, with Asia the long-term revenue provider. It might not be quite what Mr Gerschenkron envisaged when he rhapsodised about that banking model. But then again in his heyday return on equity at most universal banks was around 30%. How times have changed.
