SPECIAL GUEST BLOG By Harley Murphy, Strategic Change Mentor, Mentors.ie

The headline above was the title of a paper in October 2007 by Carl Tannenbaum, of the Chicago Federal Reserve Board, in Business Economics. It was sub-titled “ fewer players in a riskier, more complex game.” In referring to Ireland’s banking industry the main title could remain unchanged but the sub-title should become ‘ fewer players in a less profitable, more traditional game.’

The inflating of the Irish Banking Industry

The charts below, based on Central Bank figures, featured in Morgan Kelly’s paper – “The Irish Credit Bubble” capture in graphic form the bubble inflating. The chart on the left shows bank lending to non-financials in 1997(red) and in 2008 (blue) for Ireland, UK and other Eurozone countries. The right chart shows the growth in mortgages and loan to developers.

How to deal with the rupture ?

McKinsey, in their July 2004 Quarterly, write about their considerable experience in consulting to ailing banks, identified three broad areas critical to banks’ survival after a financial crisis:

1. Managing liquidity
The highest priority for Irish banks at this time must be the restoration of depositor confidence. This will allow them to reduce over time their dependence on ECB funding (euro 97.3 billion: Nov10) and focus on the all important traditional banking ratio of deposits to lending. This ratio will and must be their ‘health’ barometer over the next decade.

2. Reducing the number of high-risk loans; and
NAMA has certainly done the banks no favours in its severe discounting of purchased high-risk loans.

3. Adding fresh capital
With the exception of Bank of Ireland this is being provided by taxpayers. In all cases the required 12% capital ratio will have a severe drag on bank profitability.

What happens next ?

The following are some of the key areas the Irish banks need to focus on over 2011:

• Staffing – Shrinking assets and profits must also result in shrinking personnel numbers. In order to understand the possible scale of these cuts we can look at earlier severe banking crisis in other countries and McKinsey here refer to the 1998 South Korean economic crisis, where more than 30 percent of the country’s banking employees lost their jobs. This will be tempered somewhat in the short term by the NAMA loan transfers, however, in the medium term we are looking at significantly lower numbers of staff in the Irish banks. Based on my own experience, the way the banks handle these staff reductions will have a crucial bearing on the progress of the banks in once more becoming successful institutions.

• Corporate Governance – the Central Bank recently introduced a ‘Corporate Governance Code for Credit Institutions and Insurance Undertakings’. This obliges the banks and insurance companies to take governance much more seriously and gives the Financial Regulator strong powers to ensure Boards are knowledgeable and include truly independent non-executive directors. The banks and insurance companies have until June 2011 to put their ‘governance’ house in order and consign to history the cronyism that prevailed for so long in their boardrooms.

• New Management Teams – a lot has been done here but more change is needed at senior levels in the banks to ensure those who created the conditions for ‘bust’ have no say in the necessary transformation.

• Cultural Change – related to all three of the above bullet points is the complex issue of changing culture within the banking industry and I will deal with this specifically in the next blog on banking.

• Restructured Business Models – ‘back to the future’ is probably the best way to describe the business model the banks now need to embrace. A model which has at its core organic growth driven by strong customer loyalty must be the way forward. The chart below highlights the choices and combinations bank management must consider in developing this ‘new’ way:

• Wholesale revamping of their credit & risk management procedures – this is an obvious area of focus and one that will require significant reengineering given the past failures and the changed business model. Once the loan books are ‘cleansed’ and classified and the staff re-skilled, the banks need to move to a more decentralized model to reflect the inevitable increased emphasis on SME business.

• Reduce costs & outsource non-critical activities – in the new environment the banks must relentlessly prune any unproductive activities and become as efficient as the best companies in other sectors. For non-core activities outsourcing is a proven approach in translating variable costs into a lower fixed overhead. This process, however, must be tightly managed.

Ultimately, execution of these activities becomes the determining factor in success.

Interestingly in their July 2004 report McKinsey used the example of my former employer, Mellon Bank, as an example of a bank that successfully executed a turnaround in its fortunes after uncovering major problems in its loan portfolio in the late eighties, a few years ahead of the general US banking crisis.

“We are at an extraordinary period of history.
It is a time of crisis and unprecedented uncertainty,
even fear; but it is also a time of opportunity for
change and profound transformation.”
Klaus Schwab, Chairman, World
Economic Forum 2009