Boomer Banker

One of the key promises of the Trump campaign was to drain the swamp. This concept is based on a belief in part that the legal and regulatory system that exists in Washington DC is too often beholden to the rich and powerful at the expense of the average person. Given the complexity of the modern US economy and the needed regulation for that system, this promise to drain the swamp does have solid reasoning behind it. The question is whether or not it is actually happening.

A recent proposed rule from the US Department of Labor as documented in the Financial Times suggests that the promised draining remains only a promise. In effect it will prohibit pension fund fiduciaries from voting on a shareholder proposal “unless the fiduciary prudently determines that the matter has an economic impact on the plan.” This rule appears to be supported and pushed by corporate lobbyists – swampier creatures probably do not exist. Corporations are clearly not interested in having their owners (e.g. the pension funds) vote their shares on issues which may make them more accountable as well as more focused on ESG principles.

Furthermore this proposed US Department of Labor rule is based on an assumption that it is easy to determine if a shareholder proposal has an economic consideration. I can only suspect that that determination will be in the eyes of the beholder – the corporation who will seek to avoid a shareholder view on issues its considers inconvenient. So it appears that draining the swamp has still quite some distance to go.

The investment case for banking in both Europe and North America is not very positive. Low levels of profitability, concerns over risk costs arising from COVID-19 and an interest rate environment that will continue as central banks seek to support an economic recovery all point to unattractive banking returns. This depressing challenge was nicely summarised recently in the Financial Times. Whilst that article paints a slightly more positive picture for banks in North America, the overall conclusion does not provide support for investors returning to the banking sector. The only potential positive is that the very low level of share price relative to book value, especially for European banks, may provide a reason to invest. But the more challenging issue is raised in the article that talks about the “Japanification” of interest rates in Europe – a description that may also fit the US.

But perhaps there is an upside to all this gloom. The financial sector grew substantially relative to the economy in the last several years. This growth and “over-financialization” of the economy is probably not a healthy long term trend. Reducing investments in banks should lead to a reduced size of the banking sector over time. Hopefully that will lead to a focus on the real economy that should also reduce overall financial risk in the system. But it is likely that the transition will come with some pain as the sector re-adjusts to this new reality.

This week Shayne Ebudo in the Financial Times described his experiences in the banking world as a Black person. He relates experiences that are truly shocking not only in their racism but also in the utter lack of common decency and politeness by people in power, all of whom were White and generally male. As banks consider their role in addressing social and economic inequality, they also need to reflect and change internal cultures that allow this behaviour to be tolerated. Similar stories also arise over the treatment of women in banking. Can banks attract talent from all sections of society or must they only take on White men with noxious attitudes to be successful?

Under European Union rules, asset managers will need to provide clarity on the sustainability of their investment portfolios. This reporting is to be in place by March 2021. But of course now that date is coming closer, there is a push to delay it. An excellent article in the Financial Times provides more insight into this issue including a clear discussion of the challenges facing asset managers. However, given the fact that this request has long been known and that there is considerable evidence that attention to ESG factors leads to better financial returns (see the work of George Serafeim for example).

As noted in the article there is a lot of work to be done and not all companies will have the data available. But with any change, starting is the best way to get to the desired end state. And the need to address “greenwashing” is critical if companies and investors are going to move forward to address the challenges of climate change and social and economic inequality. If not today, then when?

As Sergeant Joe Friday in Dragnet would often say: “Just the facts ma’am.” This is also good advice when it comes to approaching the issue of carbon emissions – especially for banks. In today’s Financial Times there was an excellent commentary from Marilyn Waite of the William and Flora Hewlett Foundation. She clearly outlined why banks and other financial institutions should provide consistent data on the carbon footprint of their portfolios. She notes: “(b)anks and other financial institutions are happy to make broad, long-term commitments about reducing climate impact by 2050, but granular metrics are essential to tracking such progress.” She further notes that the impact of climate change is likely to be quite high in the financial system due to the impact of it on portfolio quality.

She goes on to cover various initiatives underway within the financial sector of which the most important is the Partnership for Carbon Accounting Financials. This initiative began in The Netherlands with support from all of the major financial institutions. It is now expanding globally with significant support from the Global Alliance for Banking on Values. This drive to create an open source but consistent way of measuring the carbon footprint of financial portfolios will usefully create the transparency so that investors, clients, co-workers and regulators will have insight to just the facts about a financial institution’s exposure to climate change.

Robert Armstrong in the Financial Times provides his strong perspective on the role of ESG investing. Whilst there is much in his view with which I disagree, he makes several useful points as well. He makes the critical point that is not possible for “shareholders’ economic interests and the social good (to) always harmonise over the long run.” This view is one that is too often ignored by proponents of ESG investing in their goal of having their cake and eating it too. Armstrong correctly notes that “corporate leaders must sometimes make choices that benefit stakeholders at the cost of shareholders.” I believe that view is a healthy dose of realism in this discussion.

He correctly notes that when “companies subordinate everything to maximisation of shareholder value, it backfires.” I would note that the example he uses focuses on IBM’s focus on a specific earnings per share target.  I am not sure that earnings per share are necessarily the best target for creating longterm shareholder value although I fully support his point that exclusively focusing on shareholder value is not always helpful for a company’s long term survival.

Armstrong goes on to say that “(s)hareholder capitalism is an excellent way to manage our corporate economy and we should stick with it.” However throughout his perspective he neither cites studies that specifically prove this point nor the increasing number of studies that show a focus on ESG can deliver greater shareholder value. I find it interesting that proponents of a pure shareholder value perspective require academic proof of the ESG value proposition without requiring a similar standard of support for their own assumptions.

Finally Armstrong addresses a substantive issue related to public policy and politics. He notes that “(m)ost US companies are incorporated in states where the law requires them to put shareholders first” which while true ignores the efforts by B-Lab to make changes in this approach. But perhaps my greatest criticism relates to his final point that “democratic action and the rule of law, . . . allow us to, for example, set minimum wages, tax carbon emissions and change campaign finance laws.” This factually correct statement ignores the significant and successful efforts by corporations and wealthy individuals to subvert the democratic process through the use of their economic wealth to avoid these goals being achieved.

There is often a discussion that banks are too big to fail or too big to jail. And lots of evidence that both of these simple expressions are true as we see many banks that should fail but are bailed out by their governments to avoid the damage to the real economy from their failure. Or banks that have obviously crossed legal boundaries but receive neither institutional or personal consequences as the risk of jail or criminal conviction would also lead to consequences for banking licenses that would negatively impact the real economy. But I have often thought there is a third expression too little used: Too big to sail.

A new book by Christian Dinesen, Absent Management in Banking would seem to provide strong historic evidence of this expression. I have only had a chance to read a review of it in the Financial Times but from that review a few key remarks can be extracted. As noted in the review, Dinesen concludes that in recent years for banks “growth was unmanageable.” The review also traces some of the recent problems to a combination of “the introduction of morally hazardous limited liability through the retreat from partnership together with the liberalisation of markets” which I believe is a solid analysis. This combination has proven very problematic whereas one or the other of the changes might have been much less damaging.

In conclusion the review notes Dinesen’s view that the regulatory approach did not “simplify (the banks) to make them more manageable.” Along with the reviewer, I believe this “analysis bears thinking about, though many will find the prescription uncomfortably radical.” Time to order the book and get even more insight for how the banking system should be restructured to meet the needs of society.

Berkshire Hathaway, the company run by Warren Buffett, has significantly reduced its investments in US banks in a recent filing as reported in the Financial Times. Assuming that Berkshire Hathaway invests based on its analysis of the future prospects of the companies in its portfolio, this shift would suggest concerns regarding the future profitability of US banks. Undoubtedly this thinking is based in part on the likely impact of COVID-19 on bank profitability. The Financial Times on 10 August published a somewhat detailed analysis of this impact and the prospects for banks resulting from COVID-19. In general the story is not a pretty one made even worse by the lack of certainty. Clearly banks face a very challenging and uncertain environment due to the impact of COVID-19.

Perhaps what Warren Buffett is thinking is that it is time to be cautious with banks. A lesson for others?

Paul Krugman on 13 August in the New York Times provides a very helpful history lesson. Although his column focused on recent remarks from President Trump regarding a “war on the suburbs,” he incorporated very helpful historical context on the US housing and mortgage markets. Citing Richard Rothstein’s “The Color of Law,” Krugman notes: :”F.H.A. guidelines specifically cautioned against loans in communities in which children might share classrooms with other children who ‘represent a far lower level of society or an incompatible racial element.’ ”

The power of that policy was enormous as the F.H.A. and mortgage insurance from the V.A. were covering more than 50% of US mortgages by 1950. This insurance was in essence not available to people of colour or in communities that were not White. As a substantial source of wealth creation post World War II came from home ownership, it is clear that the financial institutions that were helping White people acquire homes were also preventing Black people from access to this same source of wealth accumulation.

As banks consider their role in addressing the issue of inequality of opportunity, they also need to consider how to make amends for their participation in the creation of that inequality. And they also need to review their current policies and practices to ensure that there are not other ways in which they continue to use their financial power and less than transparent processes to continue practices of discrimination.

There have been many articles, some cited in this blog, on the trend of European banking consolidation. The typical approach to consolidation is through mergers and acquisitions among market participants. But a recent article in the Financial Times shows that market exits will also lead to consolidation. Although the article focused on the exit of ABN Amro and BNP Paribas from commodity finance, their move is indicative of what other banks in Europe are likely to do as well. Lacking scale and/or competitive advantage banks will begin to exit activities where they will never be able to earn an acceptable return on the capital deployed. These exits will also drive consolidation in the European banking market.

With a bit of pain in my heart from my years of working at ABN Amro, a Financial Times article earlier in the week further emphasised how this consolidation will take place. As noted in the article, ABN Amro stated about its exit from Commercial and Investment Bank (“CIB”): “Over the years, CIB has been unable to generate the required profitability at an acceptable risk level.” The challenge facing ABN Amro in large scale commercial banking also faces many of its European peers. But there has always been pressure to maintain those activities to meet the needs of country specific large commercial clients. The question is whether a local bank is really needed to meet the needs of those clients, especially in competition with truly global banks with a broad product range. ABN Amro has decided the answer to that question for the bank. Will others in Europe be following?