By David B. Moore
Gresham’s Law, according to Wikipedia, is an economic principle which states that: “When a government compulsorily overvalues one money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.” It is more commonly stated as: “Bad money drives out good”.
A classic example of Gresham’s Law at work is the case of silver coins that were widely circulated in Canada (until 1968) and in the United States (until 1965 for dimes and quarters, and 1971 for half-dollars). As Wikipedia further explains: “These countries debased their coins by switching to cheaper metals as the market value of silver rose above that of the face value. The silver coins largely disappeared from circulation as citizens retained them to capture the higher current or perceived future intrinsic value of the metal content over their face value, using only the newer coins, comprised of cheaper metals, in daily transactions.”
Any informed post-mortem of the recent global banking crisis must conclude that a Gresham’s Law of management permeated the banking industry’s executive suites between the mid-1990s and mid-2000s; that is, bad management drove out good. More specifically, most bank executives who were deemed excessively cautious (“appropriately” cautious, in hindsight) during the late-1990s and early-2000s were either demoted or their influence reduced as the credit/housing bubble made excessive risk-taking, among other bad management practices, look prudent. By 2007 most overly (again, “appropriately”) cautious bankers no longer had a voice at the table.
To wit, among the myriad damning passages buried inside the Federal Deposit Insurance Corp.’s complaint against former executives of Washington Mutual, Inc. (“Wamu,” a $330-billion asset savings bank holding company that failed in 2008) is the following:
“Wamu’s compensation structure for loan officers was based on the volume of loans originated, and thus loan originators were incentivized to push as many loans through the system as possible, creating additional risk to Wamu. For instance, Wamu’s 2006 compensation plan for loan originators stated: ‘Rewards will be based on the dollar volume of loans funded each month.’ Wamu’s compensation policy for underwriters similarly created strong incentives to increase the volume of loans.”
Now, imagine the reaction of Wamu’s senior management to the executive who suggested in, say 2004, that maybe, just maybe, basing compensation solely on the volume of loans originated might lead to lax underwriting standards (and in some cases – gasp! – fraud), thus potentially “creating additional risk to Wamu”. The reaction was likely to resemble closely that of someone being either demoted or fired. Thus, because caution in the banking industry for so many years failed to remunerate, extreme risk takers all too often were the last executives standing among the ranks of senior management as the financial crisis unfolded. In too many cases, bad management and poor practices had driven out good management and sound practices because the former had been more profitable than the latter for too many years.
The case of Dirk Röthig, a former executive with Germany’s IKB, is instructive as a specific case in point. Röthig had in the early-2000s set up an offshore vehicle for IKB called Rhineland Funding that borrowed in the (short-term) commercial paper market and invested that money in longer-term structured credit products such as US subprime bonds. By 2004 Rhineland seemed like such a good idea that other German banks were setting up their own versions of Rhineland in order to acquire subprime-mortgage bonds for themselves. Röthig had created Rhineland at a time when the company was being paid well for the risk it was taking. By the end of 2005, however, Mr. Market was extremely optimistic and the price of risk had collapsed.
As author Michael Lewis explains (in a recent issue of Vanity Fair): “Röthig says he went to his superiors and argued that IKB should look elsewhere for profits. ‘But they had a profit target and they wanted to meet it. To make the same profit with a lower risk spread they simply had to buy more,’ he says. The management, Röthig adds, did not want to hear his message. ‘I showed them the market was turning,’ he says. ‘I was taking the candy away from the baby. So, I became the enemy.’ When he left [in 2005], others left with him, and the investment staff was reduced, but the investment activity boomed. ‘One half the number of people with one-third the experience made twice the number of investments,’ he says. ‘They were ordered to buy.’”
And buy they did. After Röthig left, the IKB portfolio went from $10 billion in 2005 to well over $20 billion by the time the market crashed in 2007. Having lost over $15 billion against $4 billion in capital, IKB had to be rescued by a state-owned bank in July 2007. Gresham’s Law had proved out again: bad management had driven out good.
In hindsight, it is clear that the Greenspan-era Fed’s interest rate policies – specifically, to reduce interest rates anytime even a hint of economic weakness was in the air (the so-called “Greenspan Put”) – artificially extended the U.S. economy’s expansion, thus playing an unintentionally important role in keeping reckless financial executives in place. Had the Fed allowed a more normal business cycle to transpire, perhaps we would have witnessed a garden-variety recession during the early-2000s – accompanied by modest financial stress and related management cleansing – and avoided the disastrous credit bubble-cum-financial collapse that transpired instead.
Unfortunately, there is no simple solution for this Gresham-related predicament. After all, as Upton Sinclair noted sagely, “It is difficult to get a man to understand something when his salary depends on his not understanding it.” Nevertheless, it remains the principal role of bank boards and regulators to ensure that a Gresham’s Law of management doesn’t permeate the institutions under their purview. That board members and regulators have done such a pitiable job over the past decade doesn’t change this fact. All we are left with after the dust has (seemingly) settled is the hope that the past will not be prologue.
David B. Moore is a managing director with Resource Financial Institutions Group.
- Financial performance impacted by the pandemic
- Expected credit loss (ECL) charges of £45.8 million recognised on loans and advances to customers
- Profit before tax (PBT) was impacted by the adverse effects of COVID-19 and the subsequent provisions set aside, reducing by 89% to £5.9 million
- Customer deposits rose by 25% to £7.6 billion while capital remained strong with a CET1 ratio of 12.3%
- A total of 15.9k payment holidays granted across the Group
- The specialist bank continued to operate effectively through COVID-19
- 98% of employees moved to remote working within days and no staff furloughed
- Successfully achieved accreditation under UK Government’s CBILS
- Continued investment in technology to digitalise the business
- Shawbrook “cautiously optimistic” as momentum begins to return to certain specialist sectors
Shawbrook Bank has today (Monday 10 August 2020) published its half year financial results for the period ending 30 June 2020.
The specialist bank confirmed it had set aside £45.8 million of provisions to provide for potential future loan impairments caused by COVID-19. The bank reported it had also granted a total of 15.9k payment holidays to support its customers through the pandemic, of which 10.8k remained in force at 30 July 2020.
As a result of such provisions, the bank’s profitability was impacted with a reduction in PBT by 89% to £5.9 million.
Despite the challenging market conditions, the bank retained its active position in the UK savings market, increasing its retail savings deposit base by 25% to £7.6 billion. During the period, Shawbrook also successfully completed a £75 million Tier 2 re-financing to further optimise its capital structure.
Ian Cowie, Shawbrook Bank’s Chief Executive Officer, said that COVID-19 has had a clear impact on the bank’s financial performance, but Shawbrook remained in a position of strength.
He commented: “Prior to COVID-19, the Group had continued to make good financial progress, starting 2020 with a strong balance sheet and prudently positioned capital and liquidity base.
“To further optimise the Group’s capital structure, during H1 2020 we initiated a Tier 2 refinancing and, despite the challenging market conditions, successfully completed the £75 million issuance in July.
“We have also maintained our active position in the UK savings market. However, the longer-term economic impacts of the pandemic remain hard to predict and as a result we have recognised expected credit loss charges in the period on loans and advances to customers of £45.8 million and on loan commitments of £1.5 million.
“While this has clearly had an impact on profitability, our capital strength positions us well to support our customers and grow our business in line with appetite as we enter the second half of the year.”
Throughout COVID-19, Shawbrook maintained full operational functionality, with no staff furloughed and 98% of employees transferred to remote working within days of the UK lockdown being announced.
The bank adopted a series of concession opportunities across its product range to help alleviate the financial impacts of COVID-19 on its customers. During this time, Shawbrook also successfully achieved accreditation to the UK Government’s Coronavirus Business Interruption Loan Scheme (CBILS) to provide further funding support to its SME clients.
Mr Cowie added: “Since the outbreak of COVID-19, our focus has remained on supporting our staff, customers and partners while at the same time safeguarding the long-term sustainability of our business.
“When the UK lockdown was announced in March 2020, we acted with speed and agility, moving to an almost entirely remote operation within days. Led by a stable and experienced management team and with the support of new and existing technology, we have continued to operate effectively throughout this period.”
Throughout the first half of the year, the bank also continued to identify investment opportunities to further digitalise its proposition, with a core focus on its SME offering.
Mr. Cowie added: “Notwithstanding the pandemic, we have continued to invest in our business to help drive our strategic ambition to become the UK’s Specialist SME Lender of Choice. As well as the ongoing deployment of targeted digital solutions across the Property, Consumer lending and Savings businesses, our investment in the development of a new growth platform in our Business Finance franchise will serve to further modernise our offering, delivering an enhanced customer journey as well as significant operational efficiencies.”
Looking to the future he continued: “Although significant uncertainties regarding the broader macroeconomic impact and pace of recovery remain, we are cautiously optimistic in our outlook as we start to see signs of momentum returning to certain of our specialist sectors.
“Our management expertise and prudent approach to credit decisioning, combined with investment in our digital propositions, means we are well positioned to adapt and respond to opportunities as they arise throughout the second half of the year.”
Better banking—everyday in everyway
By Bruno Pešec president at Pesec Global.
Some of the most innovative companies are also great at continuous and incremental improvement. I want to talk about three key points when it comes to succeeding with implementation of continuous improvement.
First is acknowledging that employee empowerment is at the heart of continuous improvement. The second is striving for total involvement by everybody, everywhere, everyday. Final, third point is that improvement is improvement. Cents turn into dollars.
Let’s expand on each.
Employee empowerment is at the heart of continuous improvement
In “Kaizen: The Key To Japan’s Competitive Success” Masaaki Imai divulges following as the core principles of continuous improvement:
- Process orientation. “Before results can be improved, processes must be improved, as opposed to result-orientation where outcomes are all that counts.”
- Improving and maintaining standards. “Lasting improvements can only be achieved if innovations are combined with an ongoing effort to maintain and improve standard performance levels.”
- People orientation. “Improvement is people-oriented and should involve everyone in the organization from top management to workers at the shop floor. Further more, it is based on a belief in people’s inherent desire for quality and worth, and management has to believe that it is going to “pay” in the long run.”
These principles are interlinked and interdependent. Without empowered people there can be no improvement. Micromanaging and overbearing bureaucracy stifle human creativity and desire to do better.
Due to the nature of my work I have residence in two countries, Croatia and Norway. Consequently, I have bank accounts in both as well. On one occasion I was had to make a bank transfer while in Croatia, and went to my local bank office to do so.
To my surprise they requested my debit card. I explained that I’ve forgotten it, but surely that shouldn’t be a problem as I’m here in person, have my national ID as well as passport, and cash required for transfer. The bank teller explained that he can ask branch manager to approve it, but it takes seven days.
Since the manager was right there, I asked why can’t we do it right now, since we are all here. “Sorry, such are the policy and procedures. I know it doesn’t make sense, but we must follow them.”
Banking is a highly regulated industry; fraud detection and anti-money laundering processes must be impeccable; but above is neither.
Everybody, everywhere, everyday
Bottom up is usually brought up when discussing implementations of continuous improvement. While it is true that those closest to work are most suitable to improve it, they often lack decision making power and budget to do so on a scale.
That’s why “everybody, everywhere, everyday” is a better mental model. No one is absolved of improvements. At any given moment there are at least hundred things you can improve right now, right here.
Think deeply about following:
- Everybody in the organisation should be aware and have an understanding of organization’s strategy and objectives. There’s shouldn’t be multiple interpretations, and it should be unambiguous. Without clarity improvement efforts are going to be scattered and without impact.
- No elitism, no absolution. Everybody should be actively committed to daily improvement, regardless of their rank or seniority. Leaders should be especially cognizant of leading by example. After all, how can they demand from others what they themselves are not doing. That’s hypocrisy at its finest.
- To improve is to learn, and to learn is to improve. Unlock even more value from your continuous improvement efforts by capturing the learning and sharing it broadly and deeply within the organisation. Ideas spawn ideas, perpetuating a virtuous cycle. Peer learning is also a powerful intrinsic driver.
Improvement is improvement
Director of one European bank invited me to their customer service centre, and we were to discuss how could they innovate better. After the meeting I asked him to take me on the walk around the office so I can observe the processes. He was more than happy to oblige.
The walls were plastered with wallpapers and dashboard, colourful metrics were displayed one the hanging screens, and there was a special area dedicated to the “Hall of fame.” Much to my delight there was a wall dedicated to the improvement ideas.
It was covered with large sticky notes, each with few sentences about the problem and potential solution. I picked a few at random, and noticed that they have dates written in bottom left corner. All of the dates were months ago.
Perplexed, I asked the nearby call operator to illuminate me. What’s going on? She fired her response like she was just waiting for someone to ask her that question:
“After each call we used to write down some improvement ideas. At the end of the week we collated and submitted them to the improvement department. They were constantly rejecting our proposals for either being too small or not innovative enough. After few weeks we stopped sharing and tried to implement what we can. That resulted in one of us being scolded for taking initiative without approval, so we just stopped altogether.”
Director was blushing, but hasn’t said anything. I thanked the operator for her honesty, and told the director that he should find time to fix this. By ignoring small, incremental improvements, they are effectively atrophying their organisational muscles. And not to mention all the savings that are left behind, lost forever. Cents turn into dollars.
I’ve talked about three key points in regards to the role of employee empowerment in the implementation of continuous improvement, and what you can do to use them well. Let me remind you that if you really want to engage in this, the first thing to do is take any of them and start today.
UBX appoints new Chief Investment Officer
In line with its strategy to explore and invest in companies and platforms of the future, UBX—the Fintech and Corporate Venture Capital arm of Union Bank of the Philippines (UnionBank) — is announcing the appointment of Matthew Kolling as the company’s Chief Investment Officer (CIO).
As CIO, Kolling will be managing UBX’s Corporate Venture Capital (CVC) fund. He will also play a key role in raising capital for UBX while assisting the company in key corporate transactions, including the structuring of joint ventures and acquisitions.
Prior to his appointment at UBX, Kolling has been Head of Venture Investments at Aboitiz & Company since 2019, wherein he had been working with UBX on investment portfolio decisions. Before that, he held senior positions in Private Equity, Venture Capital, and Investment Banking at firms such as Providence Equity Partners and Morgan Stanley in New York.
Kolling has more than 20 years of experience in managing investments and deals in the Technology and Telecommunications industries and is active in Venture Capital and startup communities in the Philippines and the Southeast Asian region. He currently chairs the Manila Angel Investors Network, among others.
“We at UBX are excited to welcome Matt as our new CIO. We firmly believe that Matt will be instrumental in driving value creation opportunities, both within the CVC fund and our corporate ventures. We look forward to working with him as we fulfill UBX’s vision of a future where banking services are embedded into everyday experiences that matter,” said UBX president and CEO John Januszczak.
Meanwhile, UnionBank president and CEO Edwin Bautista said, “The addition of world-class talents in our pool reinforces our strategy to future-proof the organization and our business as we prepare for many new opportunities that come with the changing times.”
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