12:   Chameleon Bank

William Krehm

Many are the prerogatives of power. If you have enough of it, you own the theatre, choose the repertory, decide who is cast as hero, and when the curtain drops. Remember when the banks sold the politicians and the public their new program of one-stop banking? To save us shoe-leather they were going to put credit cards, mortgages, sub-prime debt, derivative boutiques, underwriting, stock brokerages, insurance and just about everything else at a single address. But before we knew what had happened, we found ourselves dealing with an ATM machine out in the cold. It was hard explaining to it that character, character and character, as the bank once assured us, decided whether we got a loan or not.

The protean aspect of banking has not stopped developing since then. When they get burned gambling big-time and are bailed out by the government once again, they simply remake their persona.

At this game, some are smarter than others. You may have the impression that to be rewarded with all those options and bonuses the top executives have only to close down bank branches and dismiss enough staff. But apparently that’s no longer always the case.

A More Successful Bank that Does Some Things Differently

Let’s consult a front-page story of The Wall Street Journal (23/9, "Royal Bank’s Road to Riches: Stay Divided, Conquer…. It Defies Industry practice and Juggles Rival Brands" by Erik Portanger):

"London – On New Bridge St. near the Thames, two bank branches are backed in a fierce battle for customers. Royal Bank of Scotland [not to be confused with Royal Bank of Canada] woos them with a floating credit-card rate averaging a competitive 16.9%. A few steps away, National Westminster offers a flat 17.4%. Royal touts itself to students by offering an interest-free line of credit; NatWest does the same but throws in a $65 cash gift.

"Behind this rivalry is an odd fact: both banks are owned by the same company. Royal Bank of Scotland Group PLC bought NatWest 3.5 years ago. Since then it has turned one of the most commonly held tenets of banking on its head. Where once large banks have studiously built ‘financial super-markets’ around a single brand – slashing away at their combined operations to reduce overhead – Royal Bank has bought myriad brands and left them to duke it out.

"With that stealth strategy, Royal has built a many-tentacled empire in the UK and the US, where it has expanded through 24 acquisitions in the past decade or so. It now has more branches than Chase Manhattan. Twenty years ago the banks did little more than provide basic lending and deposits to Scots. Today, it is the world’s fifth-largest bank by market value, ahead of J.P. Morgan Chase & Co. Its net profit in 2002 totaled about $3.2 billion, compared with about $17.4 million in 1992.

"For years, banks have been scrambling for the right formula to keep their profits growing in a rapidly maturing industry."

We should pause here to establish what "rapidly maturing" might mean. As used in the growing up of humans, it includes developing a sense of what is realistic and responsible, at the very time that physical growth stops. In banking, however, this no longer seems to hold. For the WSJ goes on: "Some [banks] have pushed into high-risk, high-reward markets such as investment banking. Others have focused on squeezing out costs. At the same time, many have bet heavily on a strategy to extract more money out of existing customers by offering them everything from credit cards to mutual fund products under a single roof." Nor is it unusual for that one roof to be leaking.

"So far, though, this supermarket approach hasn’t lived up to its billing. ‘For most banks it’s still an unrealized dream,’ says James McCormick, president of First Manhattan Consulting Group in New York."

Royal Bank of Scotland is on a different route – one that could offer US banks an alternative path to growth. Rather than trying to be all things to all people in one place, like a Wal-Mart, the Scottish bank operates more like a shopping-mall. It presents a variety of products under multiple brands – letting customers choose what they like, but profiting from whatever choice they make. It makes the strategy work by combining back-office operations to save on costs while benefiting from the exposure of its different brands to the public.

"So rather than kill brands, Edinburgh-based Royal Bank collects them. Its current total is 22. [The bank] then makes them compete for customers, many of whom never know they’re ultimately dealing with the same institution. The logic: If the bank’s own units don’t provide effective competition for each other, other financial institutions will." In a sense it seems to work on the theory of give the customer the sense that he is running away, while making sure that he has fewer refuges to run to, and is kept in the dark as to where they might be.

An Acknowledgement that Bailouts-cum-deregulation hasn’t Helped Banking’s Image

"Running these businesses separately and under different brand names allows you to be different things for different people,’ says Fred Goodwin, Royal Bank’s CEO. It also avoids turning off customers wary of dealing with conglomerates." In one sense then RBC’s strategy is an acknowledgement that the speculative mad-house that the last bailout-cum-further-deregulation has made of banking has done little for its image.

"Royal Bank’s approach is fueling rapid growth while many of its UK rivals such as Barclay’s PLC and Lloyds TSB Group PLC, which just a few years ago were much larger, increasingly find themselves in a strategic straitjacket.UK regulators have effectively barred any more mega-mergers because of anti-trust concerns. Expanding significantly in Europe remains troublesome for UK banks because national regulators and politicians there aren’t welcoming to foreign intrusion. The US banking landscape is littered with the failed ambitions of UK banks, including NatWest and Lloyds.

"There are drawbacks to Royal Bank’s low corporate profile, chiefly in attracting new investors and talented recruits. ‘You go to graduates and ask them, "Do you want to join RBS?"’, says Mr. Goodwin, and they respond, ‘No I’d rather join a big bank like Barclays, [actually] a smaller UK bank. Later this year, it will make a concession to global branding by affixing a tiny, barely visible version of its "snowflake" logo to some of its materials.’

"In theory, maintaining multiple brands is costly and inefficient. But what customers don’t see is that behind the bank’s many facades lies a massive, centralized technology and purchasing infrastructure that handles everything from cleaning toilets to tracking purchases. The bank’s chief executive of manufacturing, for example drives hard bargains by purchasing 17 million checkbooks a year for NatWest, Royal Bank of Scotland, Coutts and other UK brands. According to its most recent results, Royal Bank’s cost-to-income ratio – its expenses as a percentage of profit – stood at 43%, a full 11% points lower than Barclay’s.

"In the US, Royal Bank hasn’t been able to pursue the same multibrand strategy. All of Royal Bank’s acquisitions carry the Citizens’ Financial name, the legacy of a 1988 purchase of Citizens Financial Corp. in Providence, RI. In some cases, such as the purchase of Pittsburgh-based Mellon Financial Corp.’s retail network, the name wasn’t for sale. In others, the name was considered more of a liability than an asset. Yesterday, Citizens Financial agreed to acquire Philadelphia-based Thistle Group Holdings, the holding company of Roxborough Manayunk Bank, for $136M in cash.

Instead of Just Copying the Yanks, the Scots Innovate

"Royal Bank was founded in 1727. A year later it claims to have invented the bank overdraft – a standing line of credit attached to a checking account. It also was the first bank to print multicolored and double-sided banknotes in a bid to combat fraud. But until the 1980s, it remained little known outside Scotland. One ground-breaking idea was the 1985 creation of Direct Line, a car-insurance unit that promised to keep costs low by serving customers entirely by telephone. It attracted 250,000 customers in three years, and Royal Bank soon began offering household and other insurance under the Direct Line banner. In 1997 the bank launched a joint venture, Tesco Personal Finance, with British supermarket chain Tesco PLC. The venture offers banking and insurance products that compete directly with Royal Bank’s own offering and those of other units such as Direct Line.

"In 1999, Royal Bank took its biggest leap yet, with a $40 billion hostile bid for NatWest, a record for British banking at the time. Not only did Royal Bank preserve the NatWest brand and others under the NatWest umbrella, it didn’t close any of NatWest’s 1,790 branches around the UK, as many others have done after a merger.

"Royal Bank also looked for other ways to expand into complementary businesses. It was buying so many cars for its corporate fleet that it decided to buy the seller, Dixon Motors."

Keeping open the branches of other banks acquired is an interesting departure from the Canadian model, where banks bailed out by the government and decontrolled to engage in even bolder speculations, shut down hundreds of the branches acquired as an "efficiency." Undoubtedly that helps cover some of their losses in their new non-banking speculations. And, of course, it has contributed to our baffling high-tech wonder – our "jobless recovery."

And, of course, there is an unspoken and unspeakable advantage that goes with any bank merger: the amount of cash reserves to cover negative net balances in the daily cheque clearances goes down. I don’t refer to the statutory reserves that banks must hold with the central bank as a percentage of the short-term and chequing deposits they take in from the public. Such reserves were abolished in Canada by 1993, and have been reduced in the UK to .35 of one percent. I refer to the cash voluntarily kept in the till to honour cheques drawn on one bank by a customer of another of the two banks that merge. Depending on the size of the banks acquired and their location, this can amount to an important net gain. Here, too, once more, the advantage is that they end up more frequently dealing with themselves.

These are interesting details of banking, that our political leaders would be well-advised to study. However, still another key point that emerges from the WSJ article, must not be passed over: its net profit from US$17.4 million in 1992 to $3.2 billion in 2002. That’s an increase of almost 2,000%. Whether due to acquisitions or other sheer market speculations, such growth rate gets extrapolated into the indefinite future and incorporated into the stock-market price of its stock. That means that they must continue to grow at that rate or face a price-collapse. And that has a whip-lash effect on the economy as a whole. There are not enough banks to go on acquiring to continue supporting the price of the stock. The result is, despite its best intentions, and in spite of the morality that its CEO may have been taught at Sunday school, the bank will be pushed ever more into speculative and morally questionable adventures. The alternative is simply not an option open to banks showing such growth. That is why banks are always feeling the mating itch. Governments should consider whether deregulation that puts banks on such a course of exponential growth is in the nation’s interest.

William Krehm