Liquidity Optimisation - EUR banks quest for positive yield

When rates go negative, it can be costly sitting on massive cash balances. This is when liquidity optimisation specialists come to their fore. They typically ply their trade in the depths of Group Treasury at head office or in the more subdued areas of major trading rooms. The ratio of non-client assets to total assets has increased on the balance sheets of global banks post GFC. The banks with Treasury units that are most proficient in managing the non-client assets and the overall funding base have a key competitive advantage. In this environment it is hardly surprising therefore to see Deutsche Bank taking actions to reorganise Treasury.

https://www.ft.com/content/03b7d31c-c5bd-11e9-a8e9-296ca66511c9

However, if not done well, this can all end in tears. We have witnessed “low forever” interest rates in Japan for 20 years and so can make some educated guesses on how banks will respond in Europe. The search for yield will drive longer tenors. Think of the 100yr JGB . Now imagine how the 100yr price will fluctuate if somewhere down the road the rates head up quickly. These could be unexploded bombs in bank balance sheets as the revaluation hits the books. There will also be a move into higher risk areas - the Japanese banks have gone overseas in pursuit of yield which increased their vulnerability to dislocations in swap markets. The EUR banks will likely increase the proportion of non EUR non-client assets with associated funding risks , but will also likely delve into more complex structured investments.

This is all perfectly rational and if executed with the utmost skill of professional specialists it could all go well - but undoubtedly there will be instances of over-reach as the EUR bank quest for positive yield intensifies.

Global Bank vs Big Tech clash - HK the epicentre

As the dust settles from the avalanche of regulations post GFC the clash between the traditional bank incumbents and the tech led challengers moves to centre stage.

It is becoming apparent that HK is the epicentre for this drama. This is the inevitable consequence of the following:

• China big tech companies achieving massive scale and dominance in home market providing platform for growth elsewhere - in line with China BRI and RMB internationalisation initiatives

• UK HQ’d global banks historically strong position in HK now vulnerable to a rise in global trade tensions and mounting local frictions - and with the UK completely distracted by Brexit

The HKMA granting digital banking licenses to 4 China big tech companies is just the opening tremor.

This contrasts significantly with other major international financial centres where the leading incumbents appear to be much better protected from a true heavyweight clash.

In the US global banks are not unduly threatened by non bank competitors building massive share in products (i.e. mortgages) where returns are no longer compelling for banks due to regulatory treatment. Ginnae Mae is introducing stress test and living will requirements on leading non-banks mortgage lenders.

In the UK the challenger banks got off to a roaring start and continue to build clients, but losses persist. Regulatory scrutiny increases as the challengers build scale.

In Singapore the incumbent domestic banks have done a fine job in building out digital capabilities ahead of the recent announcements of new digital licenses to be issued by MAS. The value in having strong and stable incumbents is well recognised.

So for banking volcanologists it has to be HK…

Energy price volatility - as toxic as interest rate and FX volatility for small businesses

While most of the developed world has been experiencing “low for long” interest rates this has not signalled the end of price volatility challenges for small businesses. In the West most of the focus has been on FX volatility arising from Brexit but perhaps a more global headache for small businesses is energy price volatility.

Management of price volatility risk can be a major distraction and can add additional distress if the “hedge” is ill considered. Back in the days of sky high interest rates (30+ years ago!) a lot of companies got into difficulties by seeking out the lowest currency interest rates at that time (i.e. CHF or JPY) without any natural source of repayment in the same currencies. When these currencies appreciated there were calamitous losses. Others took out complex derivative hedges with opaque pricing and sometimes ineffective risk management.

On a recent trip to the beautiful, natural “Riverland” in South Australia there were multiple examples of innovative and dynamic responses to managing rising energy prices and increasing price volatility. These include diversifying energy sources, particularly to solar and balancing the load more optimally between multiple sources of energy. There is plenty of scope for additional improvement in energy storage and intelligent usage to allow small business owners to focus fully on their core activities. These need to take note and avoid the mistakes of the past in interest rates and FX risk management.

The abundant sun, massive geographical coverage and innovative mindset are making SA one of the most fascinating testing grounds in the world for the latest solutions for small businesses for managing energy price volatility. There are also very exciting developments in off-grid and near-grid solutions.

Surge in Chinese RMB denominated payments along the Silk Road

Don’t be fooled by the the Renminbi (RMB) modest #5 ranking in global payments and 1.88% share. The global numbers are dominated by the USD, EUR & GBP payments between USA & Europe.

Focus instead on what is happening along the Belt & Road Initiative (BRI) between Asia, Africa and Europe. This is how China is expressing its global ambition with infrastructure, trade and political connectivity along a vast historic trading route.

The SWIFT special edition RMB tracker June 2019 clearly illustrates how RMB is the oil that lubricates the BRI. Snapshot of RMB usage growth:

Europe (2014-2018) - Hungary, Turkey and Uzbekistan saw increases of 242%, 35% and 170% respectively

SEA (2014-2018) - Singapore has experienced payment traffic growth with China of 231%. Thailand, Vietnam and Indonesia also growing strongly;

Africa (2016-2019) - The total across all currencies shows an increase of 28%. But, during the same period, the proportion of RMB used for payments increased by 123%

The BRI is paved with RMB…

Japanese GSIB's stumble - overseas and domestic vulnerabilities exposed

It is not easy running a global bank based in a country with low forever interest rates, moribund domestic demand and anorexic margins. Japanese GSIB’s have spent the last 10 years pivoting overseas in search of yield and business growth. The building blocks have been solid - strong Japanese MNC relationships, deep pools of low cost JPY deposits available for deployment and active support from Japan inc.

But 2018 was a torrid year for Japanese GSIB’s. Japanese GSIB FY18 results presentations took place in May 2019, following the Japanese fiscal year end in March. They are not happy reading. Key financial ratios for returns (ROE), Capital adequacy (CET1), leverage (SLR) and efficiency (CIR) compare poorly with peer GSIB’s. So what happened.. ?

see 2018 GSIB Key Ratio’s Analysis - Japanese focus

MHFG results provide the starkest insights :

1) USD bond investments have been funded by shorter dated swaps, deposits and borrowings. The cost of funding has risen above the bond yields creating “negative carry.” The bank has cut the “negative carry” on its foreign bonds and rebuilt the portfolio to enable stable earnings - ¥150bn charge.

2) As domestic margins become suffocatingly thin the drive to take cost out of the business through technology becomes critical. There have been longstanding troubles with bank software that contributed to ¥500bn impairment losses on fixed assets.

3) Onerous capital treatment for cross shareholdings under new regulation has revealed CAR levels that are relatively low versus global peers.

The hope was that overseas would provide the cloud cover for domestic restructuring.. Not in 2018.

Hong Kong Heavyweight Clash - UK Global Banks vs China Big Tech

The stakes could not be higher as the battle heats up for one of the worlds most coveted banking markets.

Introducing in the incumbents corner HSBC and SCB. HK banking operations generate 58% and 42% of total group profit before tax for HSBC and SCB respectively. The earnings are of the highest quality with substantial retail components and are also readily repatriable, as opposed to other parts of their extensive networks. The incumbents have got a large share of the market and long established relationships with older consumers and corporates. They also offer extensive global banking connectivity.

Introducing in the challengers corner, Tencent, Alibaba, Ping An and Xiaomi. These big tech players from China have just been granted digital banking licenses by the HKMA. WeChat pay and Alipay have already garnered a huge share of the worlds largest mobile payments business by Chinese spending domestically and abroad. Ping An is the worlds largest insurer. Xiaomi is the worlds 4th largest smart phone maker. The challengers have got massive financial resources and proven entry points for the younger, more tech savvy consumers.

Don’t expect a first round knock out. The global financial crisis and regulations have taken their toll on the incumbents so there are questions as to how well they can respond to the speed and power of the incumbents. However, the challengers have less experience in operating under strict banking regulatory requirements. There could also be partnerships and agreements between the contenders that limit the ferocity of the encounter.

This promises to be an epic clash- that will likely set the tone for what will happen across the other major financial markets in Asia and beyond.

https://www.ft.com/content/b5f48a50-7240-11e9-bf5c-6eeb837566c5

China GSIB's - Ready for all comers in quest to be world champs

China GSIB 2018 full year results are out and they underline just how formidable these banks will be as they expand globally. Here are a few pointers see CHI, UK, EUR, US, FY-18 Stats

• CHI GSIBs are delivering returns well above cost of capital on a sustained basis even though ROE is not their primary goal (ROE > 13%)

• CHI GSIB’s are the least leveraged (highest statutory leverage ratios) of all large global banks (SLR > 7%)

• CHI GSIB’s have a massive cost advantage over other GSIB’s, (CIR circa 30%) particularly those Asia focused international banks with CIR >65%

• CHI GSIB’s maintain steady dividends around 30% NPR with no buy backs, maintaining funds for growth and further investments

Imagine banks that put delivering a well planned long-term growth strategy aligned with state priorities first; do not pay massive salaries and bonuses; have modest payout policies for shareholders and have access to some of the most compelling technology developments in the history of finance.

Now compare that to the situation of the mooted “national bank” champions in Europe.

No contest!

Global bank tech spend - how much? how transformative?

It is easy to compare the cost income ratio’s (CIR) for the global banks ranging from 30% to 90% and to make some fairly common sense observations on levels which are unsustainable and that require more radical changes to business models, culture and approach. It is far harder to develop comparative analysis on tech spend by global banks even though this is one of the most critical determinants of their future relevance and viability.

JPM spent $10.8b on tech in 2018 and is projecting an increase of $0.6b in 2019. That’s around 10% of total revenues ($111.5b) and around 25% of pre-tax income. Around 50% of the total spend is on current support and 50% on “change-the-bank” or transformation. JPM CIR is 57%. So now we have a straw man to use for other banks.

The UK & EUR banks with CIR >75% do not have sufficient capacity for transformation spend, particularly while they are also trying to return more capital to shareholders. For these banks the quantity of transformation spend has to increase - and then be directed effectively. That requires more radical action on legacy costs.

The global banks in the 45-65% CIR range have available funds and need to make the transformation tech investments count. For them it is about the quality of transformation investments.

For the Chinese global banks and Asia regional players with cost income ratio <45% transformation investment will be their defining strength.

source links below

https://www.ft.com/content/06ead662-3f88-11e9-9bee-efab61506f44

https://www.jpmorganchase.com/corporate/investor-relations/document/2019_firm_overview_ba56d0e8.pdf

https://www.moodys.com/research/Moodys-Global-investment-banks-need-to-become-agile-to-tackle--PR_392185

UK, EUR, US GSIB

UK's Asia focused global banks at tipping point - HK new digital licenses, game changer

The recent announcement by HK authorities that digital banking licences are set to be issued to 6 companies including Tencent, Ant Financial and Xiaomi is troubling news indeed for the UK global bank stalwarts (HSBC & SCB). While HSBC has at least got the UK as another major “home market”, SCB is very dependent on HK for bolstering results in extremely challenging times.

Pre global financial crisis (GFC) there were 4 UK global banks active in Asia, (HSBC, SCB, RBS, BARC) and a 5th (LLOYD) present in Wealth Management. Since then RBS and LLOYD have retreated to UK / Ireland and BARC has focused on UK / Transatlantic opportunities. While HSBC and SCB have slightly sharpened their international focus they have struggled to adapt to higher capital requirements, lower returns, out-dated legacy platforms and most importantly, high and inflexible costs. The cloud of conduct and compliance fines will take more time to fully clear.

The 2018 FY earnings results are now out for all UK, EUR and US GSIB’s. ( Link to FinTorque analytics UK, EUR, US GSIB’s FY18. They confirm just how difficult it is for UK GSIB’s to lift returns to cover the costs of capital circa 9-11% and the high costs of maintaining large international networks including many countries that drag down overall returns.

It is going to get tougher still with the big Chinese tech companies entering the fray in HK - but don’t expect an overnight revolutionary change as the authorities are much too savvy to allow an overly hasty transition that could amplify systemic risk or cause market dislocation. However, it is going to compel UK’s Asia focused global banks to direct more resources at defending the HK crown jewel and this will require more radical cuts elsewhere. This is a tipping point. Bold actions are needed.

EUR GSIB 2018 FY Results - The bps don't lie.

The view that the performance bar set by US globally systemically important banks (GSIB’s) for FY 2018 would be too high for EUR GSIB’s to match has been borne out by the results releases to date. There are many plausible explanations for the relative under-performance (GDP growth, interest rates, tax and regulatory response, rigid cost structure etc etc) but the basis points (bps) don’t lie. The previously posted analysis on 8 US GSIB’s has been updated to compare the results with the 6 EUR GSIB’s who have reported so far.

For analysis please click the link EUR & US GSIB FY2018 Stats

Here are the key points:

Returns: EUR GSIB Returns on Equity and Tangible Equity lag behind US GSIB’s, with several struggling to achieve returns above their cost of capital  (≈10.0%) even 10 years after the GFC.

Capital Adequacy: Core Equity Tier1 ratio’s for EUR & US GSIB’s are coalescing around target areas of 11-13%, however EUR GSIB’s arguably face higher compliance & conduct fine uncertainties.

Leverage: Supplementary Leverage Ratio’s are 4-6% for all EUR GSIB’s, above the regulatory minimum 3% but well below US GSIB’s that have a higher requirement.

Efficiency: There is a bifurcation of EUR GSIB’s Cost-Income Ratios with the most efficient operating in the 45-55% range but the rest above 70%, which suggest the need for more radical actions on costs and business models.

Distributions: EUR GSIB Net Payout Ratio’s are well below US levels due to a lack of income to finance share buy-backs to supplement dividend distributions.