'MARGIN' for Error & Profit

15 Feb, 2003

Imagine an early 20th Century banker or regulator turning in his grave; gently at first and with a jerk later! If he were to walk around in the region today, he will find that, ipso facto, banks run raffles / lotteries to declare cash prizes or several kilograms in gold, give away air tickets galore and at the least, arrange valet parking and Marhaba airport service. Some announce periodic forgiveness of interest on loans and others offer to "buy" your loans, i.e. refinance at a cheaper interest rate. He will soon be sure that he is truly and firmly in the land of consumer or retail banking!

The old school bankers (the ones who turn in their graves!) believed that banking needed to be simple and straight forward. 'No frills and no thrills' banking was synonymous with trust and exclusivity. Cheque books were not issued to anyone, unless they were found to be fully deserving / creditworthy. A cheque drawn on a leading bank had an implicit market acceptability that was not to be cheapened by offering it to all and sundry. Today, however, you can open accounts on the Internet and have your cheque books delivered to you by a local courier. The earlier half of the 20th Century saw banks focused largely on industrial or commercial finance and later they moved into property financing as well as 'large ticket' lending items.

It was the American banks that suffered huge losses during the 'depression' days who went on to discover that there was a pot of gold in lending to individual customers. Thus retail / consumer banking was born and with a vengeance! The mass retail market could be treated, felt the neo-bankers as one holistic segment to which banks could offer a range of standardised products and personalised service; appealing to the individual customers and embellishing them with bright colours and promotional activities. They could then be lured into parting with their money into low cost current and savings accounts (or checking accounts as the Americans would call them).

Because many of the consumer banking clientele were professionals or 'working class', they were known to cherish or value their 'name' in the society and would not want it to be sullied or muddied. Thus loan default rates could be contained within a maximum of say 5% of the aggregate portfolio amount. Through aggressive marketing and automating the 'reach' to this segment, the bank could comfortably make money. A diversified portfolio of a large number of borrowers tended to minimise the risks of a few loans going wrong. Unlike corporate banking, where one or two large exposures going sour, could seriously scupper a bank's balance sheet or create a huge P&L impact in one quarter, the retail portfolio can easily absorb and survive comfortably a few mishaps; as it produces high margins on each of the product. The pricing is generally determined on the basis of what the 'traffic' bears.

The seasoned finance professionals in large businesses, on the other hand, keep the corporate bankers on their toes and tenterhooks as far as pricing is concerned. So the corporates get fine pricing and the relationship maintenance remains intense in effort, time and profit and yet they generate low profit margins for the banks. It is true that the corporate volumes make up for thin spreads but competition for deals is fierce and capricious.

In this region, there are some unique brands of consumer banking. It is a no-holds- barred 'battle royal' in Dubai, where many things may be hyped up and offered as temptations i.e. "get something for nothing" is the universal motto. Most banks have willy-nilly been forced to jump on to the promotional bandwagon; undeterred seemingly, by what the regulators might say. In some parts of the world, the central banks frown upon inducements to customers or activities of this nature and bar the banks from getting caught up in this zero-sum game. Some Omani banks recently picked up on similar promotional activities where the Dubai banks left but exited soon. Of course such raffle-draw syndromes can become akin to riding a tiger i.e. once you have started them, you are forced to keep them going; just to retain your customers; or else, attracted by the possibility of gaining even bigger money through the lucky draw of a rival bank, they will move quickly to another institution who may be offering better products.

The banks also find that the margin for errors in mass banking is low, because of the probability of default rates; as highlighted earlier in the piece. There are some statistics available regionally and internationally to support loan loss provision rates. The other margin (for profit) is extremely healthy; as typically, banks net upto some 5% p.a. on personal and car loans and atleast 2% on credit cards in terms of costs passed on to the customers in one form or the other. Again, being low-cost and fast-track items in production terms and where credit can be offered, these products are amenable to economies of scale. Thus, they could be marketed vigorously and bundled with other products. A customer told me recently that he was rung up five times, by a telesales operator over two days, offering credit cards. He was told that any information or service that he required could be possible only if he were to first accept the credit card that had already been mailed to him! A few retail sales staff are like second hand car salesmen (no offence meant!) as they tend to be persistent. They expect you to take a loan and use a new credit card, even if you already have them or do not need them at all; all because they generate fees and income for them. Some banks have now begun to undercut one another by offering lower "interest rates" or by reducing upfront fees / costs etc. to customers. By and large, there are enough safety margins against potential credit losses for them to incentivize the sales staff generously. Of course, the customers end up paying for all these; although he may not even realise it! Strictly speaking, for the high overall credit quality of the retail loans or cards portfolio, the pricing or cost to the customers can be lower. However, unless collectively, the borrowers are able to form a consumers forum or ginger group to force the banks to reduce the margins or make them wary of spending excessive money on advertising, promotions, incentives etc., they have little clout as of now to influence the pricing. There could be consumer courts, as in some countries, that represent their group interests effectively and rules on inequitable or unjust market practices. The President of the UAE, a few years back, cautioned on excessive personal lending that resulted in litigations, bounced cheques and police cases. This has a salutary effect albeit briefly, in curbing unwise trends in the UAE.

Ultimately, it is this balance in terms of reasonable margin for errors and profits that will determine the long term viability and durability of consumer banking as it is practised.

Not just during times of stress say during recession or economic / war induced downturn; when there could be stepped-up default ratios in the consumer lending book and when the shoe will pinch, but the golden mean is needed as a measure of good socio-economic prudence. At the moment, the gravy train is chugging along nicely and no one wants to upset the apple cart. But it is better to practise restraint and reach hard decisions during such good times (see bank profits this year!) than when the chips are down. Or else, the gravy train may come to a grinding halt or worse, get derailed for some. Ultimately, over-lending to or leveraging hapless consumers by assaulting them (via advertising) towards consumerism, has social cost and consequences. It will be a sad day and a sordid tale to tell if banking gets viewed as another shopping fad and not a bonding of trust and credibility. Relationship, quality service, ability and capabilities to lubricate efficiently the wheels of personal, corporate and institutional finance, should be the hallmarks of enduring banking. Few will sympathise with banks when supermarkets offer consumer banking a lot better than many brick & mortar banking entities / edifices.

(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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