As regulators attack the banks from all angles, new solutions will have to be found for international corporates investing in new markets.
It is essential in the case of any acquisition for the acquirer to quickly incorporate pre-existing banking services used by the target into the new structure and get control of cashflows, without inhibiting the target from doing its day-to-day trading.
Banks’ international business models are coming under simultaneous attack from different angles. There will be fewer individual banks capable of supporting the day-to-day side in any but a small number of “home markets”.
The UK Banking Commission is not the only regulator-based initiative to consider an enforced separation of “risky” and “non-risky” activities, either completely or so as to isolate the one from the failure of the other. Banks’ overseas offices have housed activities such as venture capital and proprietary trading under one roof with day-to-day banking. Any divorcing of the two both puts up costs and finishes the branch as a one-stop-shop.
These overseas offices are also under threat from recently introduced increased capital adequacy requirements under the heading Basel III. On one level these rules simply increase the cost of lending by imputing higher capital to each piece of risk-attracting business, pushing up loan margins and inducing banks to try to pay less for deposits. That affects all banks.
But there is a new element which will be hitting international banks the hardest. These are the rules around “unstable deposits” which compel banks to set aside a percentage of deposits in low-interest bonds, as a defence against a run on deposits. Overseas branches of banks tend to be bought-money banks, meaning their liabilities are unstable, bought in from other banks, corporate or institutional investors at a price relative to interbank rates, and for a fixed term of 1-3 months. The market is yield-driven. The bank has no branch network in the country and so has no retail deposit base. All its funding would count as “unstable”.
These regulatory attacks have to be considered against banks’ rationale for establishing international presence to begin with.
Banks have generally expanded internationally for two purposes:
- To support the overseas expansion of their home customers with local lending, on the basis that the customer is known to the “foreign” bank, but not to the indigenous banks;
- To generate local assets not available in the home market, for risk diversification, yield enhancement or simply because the bank has surplus deposits.
Acquisition finance can fall under both these headings. Under both scenarios a local lending base is needed so that the customer does not have to gross up the interest payments for withholding tax. The result is a branch that is a bought-money operation, probably with very low capital but also historically quite low costs: the bank was able to spin quite a big wheel on a small capital and cost base, with no worries about funding.
Now all the drivers for that have gone into reverse:
- Banks are short of capital generally;
- The market, especially the interbank market, is short of liquidity;
- Both the asset and liability sides of the balance sheet are having extra costs imposed;
- The operating structure of an international bank may have more cost imposed on it e.g. by the UK Banking Commission;
At the same time governments are putting pressure on banks to deploy what capital they have at home and not overseas: an erosion is taking place.
Firstly international banks will be narrowing their client lists, reducing the target market definition, and not allocating credit lines behind types of lending that do not follow the new model. Secondly the service range in the overseas branches narrows as well. Then its revenue is at best static and possibly falling, while the costs fall less sharply.
The premium placed in capital and credit lines also causes an organisational issue: the Global Relationship Manager for a particular corporate customer usually has their own P+L account. If a loan is requested out of a foreign branch, the GRM has to authorise the credit limit but the revenue, in all but a few banks, does not get credited to their P+L. If the banks is in expansion mode this does not matter: there are lines for everyone. In the opposite scenario the GRM will keep the resources for loans that feed their own P+L – at head office.
This emerging situation creates a major headache for international corporates, especially those investing in new markets. Not only will there be far less choice of international services for expanding businesses, there will also be a real difficulty in finding out about and accessing services in markets where the customer’s house banks are not represented or cannot deliver the required services themselves.
Technical solutions to this issue, such as having corporates connect onto the bank’s own communication network (SWIFT), are fine for retrieving balances and ordering payments once the customer has an account and has agreed credit lines and other services. But how do you get to that point?
The traditional answer – find a bank near you that is also operating over there – will be less viable going forward. The major banks over there may be maintaining an entry point in your country but you cannot count on it, and do you really want to run n different relationships on your own, without a coordinator in your own country?
Having made that proviso the solution is still to be found in dealing with major indigenous banks in each country. Those are banks that have the right service range and a sustainable presence in each of your markets, and will increasingly be the only game in town.
The second part of the solution is to implement a selection criterion on those banks that they should not only be leading providers in the local market, but that they should also be part of efficient international inter-bank cash management services as well.
This would be a new criterion; right now corporate clients usually select on either:
- A bank that can provide certain limited services but in many countries, usually through their own network; or
- A bank that is best-in-class in one country.
That does not work in the new environment because there will be too few choices in the first category and because the corporate will not want to manage the banks in the second category in isolation from one another.
The approach for the future would be to blend the two criteria and concentrate on building relationships with leading indigenous banks that are also members of international cash management organisations.
These offer channels into one another’s services, through relationship managers in the customer’s own country, working with designated teams in the other members to set up and support accounts and services.
Such associations have a viable financial model: each component bank has its own deposit base and economies of scale in their country. They can deliver a wide range of services and can act as sole bank in the country concerned. For the corporate that means an ability to access a full service range but not having to arrange and negotiate all of it yourself. Corporates can therefore be confident that there will be a banking service available to underpin the corporate’s own growth plans.
