Curbing The Consumption-Financing Excesses

02 June 2002

An Internet-weary cynic, who was a yesteryear tech-junkie, said dryly "the 'new' economy is dead, long live the 'old' economy"!; paraphrasing the popular slogan associated with the royalty in the U.K. In a sense, this is a throwback to the days when the so-called 'new economy' made lots of financial returns for its early investors; who put their money where their mouths are. Subsequently, it burnt deep holes in the pockets (and caused much heartburn) of those that climbed on the bandwagon after it had had a meteoric rise in the stock market. They were all, as it turned out, chasing a mirage or seeing ghosts where there were none ! Be that as it may, what is now emerging is a convergence between the 'new' and the 'old' economies, driven by web-enablement and the information tools and techniques that the venture capital-driven, adrenaline-pumping, highly-focused, young entrepreneurs have created.

All these technology advances will stand the aggregate economy in good stead. Already the utilities and physical infrastructure sectors (such as power, water, sea and airports, irrigation works etc. i.e. those solid monoliths) have begun to benefit from the application of supply chain, logistics and other enterprise-management systems. It will not be long before each of the 'traditional' economic sectors automate fully to the extent possible. Even during these cost-cutting sprees, the infrastructure arenas can afford to pay and would be advantaged immensely from investing in communication and processing networks. They will indeed do so with a vengeance; just to prove that, while you cannot create something out of nothing (as was the case with the IT start-ups); it is a different ball game in the 'old' economy and that almost everything, including the money bags, are firmly and truly entrenched behind them !

Narrowing the focus to the banking bulwarks of the 'old' economy, we notice that technology is moulding their retail reach. This is one 'gravy' train that is still chugging away merrily; carrying many financial institutions on board. Consumer-financing or retail lending products and services; be they in the form of cash or plastic (i.e. credit cards or personal loans, car loans and the whole gamut of leveraging consumption) are seen by the banks as their last bastion; where they can still make 'super margins' in profit terms. There are only a few spaces left for such spreads to be gained. The spreads, some may argue, actually end up in their midriffs, given their generally generous girths ! There are the other high-risk, high-return activities such as private equity, derivatives, proprietary trading, foreign exchange, commodities, metals etc. The latter however are anathema to many of the dyed-in-the wool conservative bankers, as their risk tolerance is low. At the highest levels in bank boards, many of the directors do not fully understand these 'esoteric' businesses; having been steeped and sustained in the classical school of borrowing money 'short' (i.e. taking deposits cheaply and lending it for 'long'). Of course, they make a fetish of how difficult it is to assess risks these days, raise money to fund the bank and allocate capital efficiently; given the increasing complexities of the BIS norms and the Basle Capital Accord.

In its evolution during the last century, commercial banking took on the traditional task of 'intermediating' (to use that horrible management text book expression) between those that have the money and those that need the money. This activity soon got arbitraged and therefore, could not generate the continual healthy profits that shareholders had come to expect yet. Driven by the need to provide an innovative range of products and services to customers covering both sides of their balance sheets and yet, catering to the often exasperatingly demanding corporate, institutional and individual customers, the banks were forced to, willy-nilly, search for newer and greener pastures. In the process, they were fumbling, losing money and, in some instances, even getting battered in terms of non-recovery of loans.

This was when risk management became a fashionable expression and capital adequacy, the new magic mantra. Portfolio diversification of risks, was another chant that the staid commercial banking brethren borrowed from their country cousins in the investment banking world. Life proceeded on but not so smoothly and soon corporate banking alone got them nowhere.

All institutions were obliged to make huge investments in technology and the giants had amassed a wealth of capital and resources and could easily smudge on any semblance of competition into oblivion. These big boys thus brought their considerable armoury to the battles, whenever any of the midgets began to get too big for their boots !

Thus flowered the birth of boutique banks and investor-servicing shops. These 'private' banks soon carved out a neat little niche for themselves; through the sheer quality of their personalised service and attention. They kept the banking behemoths happy; by outsourcing some of their requirements. The relatively less crowded space in which they operated in, for their wealth management services, managed to produce some nice little nest eggs; particularly for the blue-chip Swiss and the English institutions. When competition in private banking began to hot up, the slogan of 'act globally, think locally' was coined. Retail banking products and services were re-discovered by the Fortune 500 banks (if there are still many there !). But they had to understand that, while in their home countries this worked well, the cultural and communication nuances that best applied to a particular foreign country, or a market, or ethnic group that they were expending into was not easy touch. Unless they could master this elan, all their gilt and glamour could not cut much ice with their overseas consumers.

One dynamic American bank, took the lead and converted consumerism and consumer banking into a fine art. It quickly spread itself across the globe as the vanguard of a complete retail financial services package; throwing in credit cards, charge cards, other plastic, ATMs and a whole host of direct sales agents (DSA), reaching out to all and sundry and becoming synonymous with consumer financing. GE Capital followed suit, albeit, working on a different genre. This and a few other icons part, the rest of the big bang banking community, only slowly, woke up from their slumber; having had to take huge 'hits' to the P&L from their big-ticket, corporate and investment exposures that came home to roost. They had to recoup and recover and turned their guns towards retail banking and consumer financing as the proverbial last refuge.

Politics, they say, is the last refuge of the scoundrels but retail consumer financing proved to be a similar (dis?)comfort zone for the financial services conglomerates. They were able to lend to a huge number of people in relatively small doses. Because the borrowers were, in the main, professionals, salaried class and the like, they inherently felt a much higher moral and ethical obligation than others to repay their loans on time.

This whole phenomenon on both sides, was predicated, therefore, on greed and fear. Greed on the part of the consumers who could not immediately afford all that they desired but the banks were prepared to help. Similarly, fear on the borrower's part of social disapprobrium from debt-servicing defaults, acted as strong brakes on delinquency and bad loans. However this theory was valid upto a point. When norms, credit criteria and scoring modules got diluted, problems began to develop. The banks advertised to the hilt, in a gung-ho manner to lend money, left, right and centre (similar to the African herd in heat!). It was apparent that all these were pointing to a disaster that was waiting to happen ! It soon took place, first in the U.S., wherein retail portfolios, particularly in credit cards, the delinquency rates rose sharply. Soon this was compounded by an economic recession in that country that affected all personal loans and low-cost mortgages. The banks that had been previously tempted by the high margins between their cost of funds and what they charged to the customers, found a new brick wall. Even on a portfolio basis, there were risks that had to be clearly analysed and contained; to remain viable.

Nevertheless, consumer-financing to this date remains the dazzling major opportunity for any new bank to get into, even in the UAE, as they make for such higher returns on assets (ROA) and their own return on equity (ROE) than other activities.

It is in this context that prudence, restraint and other rare, but vitally required virtues in commercial banking come to the fore as being crucial. Everything within limits, a sense of balance and perspective, are the quintessential golden mean; that should be pursued as an objective by all banks. These are the sine qua non irrespective of whether it is the old school banking or its version in the new economy.

The social impact of over-leveraging to the undeserving or the uninformed, simply means storing up problems for the future. For instance, pandering to the young's craze for buying cars, building houses and doing acts that they cannot reasonably or realistically afford, even in the medium-term. Banks should not feed the frenzy but ought to be a lot more responsible in conforming to the generally accepted norms and terms in retail lending. For instance, a good maxim is not to exceed 60% of a borrower's current income in loan repayments per annum, to sustain his ability to service all his debts. The problem gets compounded by multiple lending by different banks that are not correctly or completely captured in the various data available to individual bank(s). A person might get a credit card from one, a personal loan from another, a car loan from a third, a mortgage / collateralized loan from the fourth and so on. When they all add up and start to hit his monthly cash flow in terms of repayments, the cookie crumbles !

It is in this context, that the directives of the President, His Highness Sheikh Zayed Bin Sultan Bin Nahyan, a few years back, need reiteration. He had wisely recommended a sense of prudence in the avoidance of extreme forms of borrowings by advising that these are completely out of character with the ethos of this region. This message needs to be followed up vigorously and rigorously by our regulatory authorities. No one wishes to take anything away from the retail banks but a reckless rash of advertising and promotion in retail banking is a sure recipe for a future ailment that may well warrant surgery.

Consumer-financing is ultimately, a gravy train and like all others, must be allowed to stop in its tracks before it gets derailed. It should not become the gravy in which the bankers end up cooking their own goose ! Even, if they choose to do so, they should not willy-nilly or in an unintended way, cook the geese of their customers; as that would result in a complete burnout or blackout ! Not wishing to carry this analogy and the alliteration any further, let me conclude that what is good for the goose ought to be good for the gander as well !

(The author (sureshk@emiratesbank.ae) is a General Manager in Emirates Bank Group. The views expressed in this article are not necessarily shared by the Bank.)

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