Corporate bankers, despite a general upturn in performance aided by better market conditions, continue to struggle in their efforts to enhance revenues, trim costs, and carve out a path toward profitable growth, according to a report released today by The Boston Consulting Group (BCG), a leading global management consulting firm.
The new report, Delivering Profitable Growth in a Crowded Market: Global Corporate Banking 2005, is based on analyses from BCG’s Global Corporate- Banking Benchmarking Database — which includes comprehensive performance data gathered from more than 75 leading financial institutions worldwide from 2000 through 2004 — as well as on findings from BCG’s most recent survey of 20 advanced banks around the globe. The recent survey focused on examining the drivers of operational efficiency in credit-business management, and on assessing the evolving role of credit-portfolio management for leading players.
According to the report, most corporate banks improved their performance between the end of 2002 and the end of 2004, thanks largely to significant cuts in loan losses resulting from an improved economic environment. Slightly more than half of BCG’s survey participants — 55 percent — created value above the cost of capital, compared with only 33 percent two years prior. BCG says the result is encouraging but at the same time disappointing because many corporate-banking businesses are not pulling their weight relative to other banking divisions. The average annual return on equity (ROE) for BCG’s survey participants, 17 percent, was only one percentage point above the estimated cost of capital. Over the past five years, revenue growth and cost reduction have played minor roles in profit improvement for corporate banks, BCG says.
Small-cap companies were the most attractive to serve for corporate banks from 2002 through 2004, delivering a consistently high ROE (20 percent per year, on average) with the lowest level of volatility. Deposit-focused strategies were most pronounced in this segment, and led to extremely high levels of ROE for top-performing banks-in the range of 70 percent, the report says.
Average ROE in the mid-cap segment also rose-from 14 percent in 2002 to 20 percent in 2004-indicating that, on average, players in this segment generated value. However, the improvement in ROE obscures underlying trends, BCG says. Although loan losses fell significantly and net operating profit increased, revenue growth remained a major hurdle for most mid-cap players.
A lack of opportunity for market growth beyond GDP growth made it more difficult for banks to reduce their dependency on credit, according to the report. As much as 45 percent of revenue for BCG survey participants came from interest income on loans. Such dependency is dangerous — and will likely be felt when the next downturn in the credit cycle hits, the report says. “Excessive credit dependency is one of the major reasons why the ROE level of top performers is lower than it is in other segments,” says Juergen E. Schwarz, global head of BCG’s wholesale banking practice and lead author of the report. “Nevertheless, top performers have managed to reduce their credit dependency somewhat by garnering additional interest and fee income from deposit and transaction-banking business.”
The report says the large-cap segment also improved from a value-creation perspective. However, although average ROE for serving large-cap companies increased to 13 percent in 2004, up from 3 percent two years earlier, it remained well below the cost of capital. Therefore, the segment continues to destroy value. “Given that a more positive economic climate still has not created value for most large cap players, executives now need to thoroughly rethink their business models,” says Schwarz. “Winning strategies in the large-cap segment are always driven by superior revenue generation. Cost control is important, but not as critical as it is in the other segments.”
The report explores numerous levers that banks can use to drive growth both in home markets and abroad. At home, BCG says, top performers have been able to distance themselves from the pack through smarter segmentation — which has enabled management teams to differentiate clients clearly by profitability, potential, and specific needs — and through rigorous sales management.
“Corporate-banking growth outside a bank’s home territory is possible but requires an even more focused and disciplined approach,” says Kilian Berz, a BCG vice president and coauthor of the report. “Segmentation and deep client understanding are a prerequisite. But even more important is a clear understanding of which additional capabilities a player brings to the foreign market that are unique, that can’t be easily replicated by local players, and that provide added value to the local clients. Only when these additional capacities are in play is profitable growth possible through competitive differentiation.”
Excellent credit-business management is a key to success in corporate banking, the report says, particularly in the small-lending segment (loans under €500,000). BCG’s research shows that operational costs account for up to three times the average cost of loan losses in this segment. The report offers five levers that can be used to improve related performance, drawn from BCG’s most recent survey of 20 advanced banks in North America, Europe, and the Asia-Pacific region. “Only leading players skillfully use operational efficiency and portfolio management both to lower operating costs and to improve value creation in their credit business by more-effective capital allocation,” says Schwarz.
The report adds that in order to turn well-defined corporate banking strategies into successful market operations, banks must improve their efforts to overcome organizational and cultural barriers to success. BCG recommends that as new strategies are formulated, goals set, and implementation plans developed, a structured evaluation of the organization’s readiness to implement those strategies is also undertaken.
“This evaluation can produce clear accountability for new initiatives and encourage the right behavioral changes,” says Michael Shanahan, a BCG vice president and coauthor of the report. “It can also help management gain insight into how best to balance performance disciplines with personal motivators, which is becoming a top priority for banking executives in advanced markets in their drive for profitable growth.”