Rebuilding the Asian Financial Institution
“ In the past few years, while the Global Financial Crisis has remade the financial landscape in the US and Europe, most Asian financial institutions have emerged intact and largely unscathed. However, this has not meant that these institutions have left the lessons of the crisis unheeded, as veteran Taiwan banker James Sheu shares with us the opportunities and tasks facing Asian banks in the aftermath of the crisis in this exclusive interview. ”
Stamford Advisory: Given the limited size of the domestic Taiwanese banking market, and the economic growth in Asia, what do you think are the opportunities for Taiwanese banks, in general, to expand their operations, in terms of new markets, customer segments and products?
James Sheu: East Asia/Greater China is a very dynamic market, and its sheer size and growth rate offers many opportunities to both Taiwanese and Asian banks for expansion, tapping the growing demand for financial services. To be sure, the competition here is intense, both from Asian and Western financial institutions. However, I believe that Asian financial institutions do have several key advantages for succeeding in this region, such as a similar management culture, and being in the same time zone. Even though financial institutions claim to be open for business 24/7, in a region as diverse as Asia, with differing customer needs and regulatory standards, having the bank’s management being able to respond to these issues within the same day stills has an advantage.
In Asia, a significant edge will also derive from financial institutions being able to offer their customers cross border, complete and tailored solutions to their banking needs, for example across trade, credit, capital markets, and wealth and asset management. While much has been said about the potential for Asia as a market for wealth management in particular, and for trade services, the truth is that a franchise built upon integrating this broad range of customer needs is a more stable and profitable one.
Although banks sometimes complain that the banking regulators in this region have moved more cautiously than their Western counterparts in liberalising the markets, I believe that this is for the better, as we have seen how unsustainable deregulation can be if carried out too rapidly. In particular, having learnt from the lessons of the past few years, regulators in Asia are now in a position to leap-frog the existing regulatory frameworks to ensure that the growth in financial services can be sustained indefinitely.
In Asia, a significant edge will also derive from financial institutions being able to offer their customers cross border, complete and tailored solutions to their banking needs, for example across trade, credit, capital markets, and wealth and asset management. While much has been said about the potential for Asia as a market for wealth management in particular, and for trade services, the truth is that a franchise built upon integrating this broad range of customer needs is a more stable and profitable one.
Although banks sometimes complain that the banking regulators in this region have moved more cautiously than their Western counterparts in liberalising the markets, I believe that this is for the better, as we have seen how unsustainable deregulation can be if carried out too rapidly. In particular, having learnt from the lessons of the past few years, regulators in Asia are now in a position to leap-frog the existing regulatory frameworks to ensure that the growth in financial services can be sustained indefinitely.
Stamford Advisory: Asia has had a number of major financial and banking crises over the past two decades, but has come out of the latest one in pretty good shape. What are the lessons you have learnt from these crises which are of the utmost importance for steering a bank through them?
James Sheu: What we have seen most clearly is that boom and bust cycles in economic growth are inevitable, and what really matters is how deep the recessions following the booms are – too deep, and there is a chance that the economy will not recover from it for many years. Financial institutions have a role to play in this, in ensuring that they do not become either the originators or transmitters of such boom-bust cycles. For example, increasing bank leverage, increasing risk taking, looser credit underwriting, selling higher-risk products to customers, these are all actions which contributed to propagating the last boom and making the subsequent recession much deeper, and recovery from it much slower. To borrow a popular analogy, in a race between evenly matched cars and drivers, the race is often not won by the fastest car in the straights, but by the driver who brakes best in the corners.
To be able do this, to stand against the flow, to be contrarian in a market which threatens to leave a bank behind should it not fall in line with what its competitors are doing, requires clarity in the bank’s mission and risk appetite, and in management enforcing a transparent risk and management culture, not just in strategy, but also in policies and processes, across the senior management, the front, middle and back offices, as well as critical support functions such as Human Resources within the bank.
To be able do this, to stand against the flow, to be contrarian in a market which threatens to leave a bank behind should it not fall in line with what its competitors are doing, requires clarity in the bank’s mission and risk appetite, and in management enforcing a transparent risk and management culture, not just in strategy, but also in policies and processes, across the senior management, the front, middle and back offices, as well as critical support functions such as Human Resources within the bank.
Stamford Advisory: In rebuilding bank risk management after the global financial crisis, what do you think are the most critical areas to focus on, and what do you foresee as the most important challenges in risk management going forward?
James Sheu: One of the findings about the crisis which really struck me was how, a few people in a small, and sometimes obscure department within a much larger financial institution, could have engaged in highly risky activities, overlooked by both senior management and risk management, and subsequently brought down the entire financial institution. AIG is the prime example, but the same applies to Lehman Brothers, Bear Stearns and even Citigroup. What this tells me is that the traditional way we have managed risk is probably too specialised, fragmented and sometimes too detached from reality, and often too trusting of successful leaders, managers and traders to “do the right thing”.
This indicates that the way to rebuild the risk management function is through an integrated approach – reconciling our traditional narrow, specialised, bottom-up risk measures with a top-down macro view of the institution’s health, and ensuring that pockets of inter-related risks, which may be insignificant on a individual basis, but which may aggregate and correlate into something more lethal for the bank, are properly captured and challenged. This macro view has certainly been lacking in the way we manage risk.
Such an integrated framework would also force more consistency in its application, across bank strategy, policies, supervision, incentives and compensation etc., and by everybody within the financial institution, from the Board of Directors, down to the staff in the branches. Consistency also means that we manage our customers’ risks in the same way as we manage our own risks – if a position or a product is too risky for the bank, the same should apply for our customers.
This indicates that the way to rebuild the risk management function is through an integrated approach – reconciling our traditional narrow, specialised, bottom-up risk measures with a top-down macro view of the institution’s health, and ensuring that pockets of inter-related risks, which may be insignificant on a individual basis, but which may aggregate and correlate into something more lethal for the bank, are properly captured and challenged. This macro view has certainly been lacking in the way we manage risk.
Such an integrated framework would also force more consistency in its application, across bank strategy, policies, supervision, incentives and compensation etc., and by everybody within the financial institution, from the Board of Directors, down to the staff in the branches. Consistency also means that we manage our customers’ risks in the same way as we manage our own risks – if a position or a product is too risky for the bank, the same should apply for our customers.
Stamford Advisory: The reforms in the Basel capital framework and international banking regulations will likely require a large increase in capital for banks in the Western markets – so far, most Asian banks have been well capitalised. In spite of this, do you think that the rapid expansion of banking and finance in Asia, and the new risks emerging over the horizon, e.g. in the BRIC economies, in the slowdown of global economic growth and trade etc., will require Asian banks to raise more capital and be more conservative going forward?
James Sheu: Let’s be honest – even under the new Basel requirements for capital adequacy, the capital cushion at a typical “well capitalised” financial institution is still small relative to the amount of leverage it usually has! At the end of the day, capital is used as a last resort, and even then, it is not completely reliable. The way I see it, the requirement for higher capital ratios is a means of weeding out financial institutions which are less prudently run from those which are, as the higher cost of capital required will quickly accumulate and hurt their profitability.
To make the capital adequacy framework work in practice, we will still need to strengthen the 3 lines of defense in the bank – ensuring that the front office staff are responsible in taking on and managing their risks, and that senior management and risk management have a clear understanding of the risks in the institution. Good corporate and risk governance is the key for ensuring that the capital adequacy framework works well. Finally, it is also critical for our staff to have the highest levels of integrity, and faithfully abide by the mission of the institution – at Chinatrust, our mission is to “protect and build” for all our stakeholders, not just the shareholders, but also our customers, our employees and the community, which translates into managing risks responsibly.
That said, higher capital ratios for us are still needed, as a sign of our shareholders’ commitment in making sure the bank is prudently run. For us, in managing the bank, we will go further still, ensuring not only are the capital levels more than adequate, but also ensuring that our provisioning, our controls, our governance, are also more than adequate.
To make the capital adequacy framework work in practice, we will still need to strengthen the 3 lines of defense in the bank – ensuring that the front office staff are responsible in taking on and managing their risks, and that senior management and risk management have a clear understanding of the risks in the institution. Good corporate and risk governance is the key for ensuring that the capital adequacy framework works well. Finally, it is also critical for our staff to have the highest levels of integrity, and faithfully abide by the mission of the institution – at Chinatrust, our mission is to “protect and build” for all our stakeholders, not just the shareholders, but also our customers, our employees and the community, which translates into managing risks responsibly.
That said, higher capital ratios for us are still needed, as a sign of our shareholders’ commitment in making sure the bank is prudently run. For us, in managing the bank, we will go further still, ensuring not only are the capital levels more than adequate, but also ensuring that our provisioning, our controls, our governance, are also more than adequate.
Stamford Advisory: Many established Western private banks have been shifting their focus to the newly emergent rich in Asia. Will Asian private banks be able to compete against these established banks, and how do you see the wealth management industry and landscape changing over the next few years in Asia?
James Sheu: To understand how we should position ourselves for this market, it is instructive to see how Asian companies in other industries have developed in their respective markets. In the manufactured goods markets, while Greater China/East Asia is the workshop of the world, perhaps half or more of the profits accrue to the Western MNCs which control the distribution channels, marketing and branding of these goods. Similarly, in the financial sector, while Asia leads in terms of supplying capital, and investments overseas, most of this flow of capital is managed by the large Western investment banks and asset managers. Finally, in terms of the flow of information, while Asia is home to the most wired nations in the world, the media industry, credit rating agencies and the research activities still reside in Western MNCs. Asian companies, regardless of how large or successful they are, make money the hard way, and this is unlikely to change in the short run.
But what does this tell us when we approach the Asian wealth management and private banking market? It tells us the importance of building up the necessary infrastructure to compete effectively with the global financial institutions in this sector. This is something which would take time, for sure, but in order to capture the majority of the future flow of profits, it is something which needs to be done.
Within wealth management, we must therefore devote our efforts to building up the platform for succeeding in this sector – in terms of building up the distribution channels for delivering solutions to clients, in building up the platforms for cross border financial services, in building up our capabilities for providing a range of products and/or solutions for wealth management, hedging and risk management etc. Only then, will we be in a position to compete effectively with the global banks in wealth management and private banking, and to be able to grow this business not just domestically, but also regionally and eventually, globally.
One area where I believe we can do better is in the area of customer protection – both in compliance and risk management. With ever stricter regulations on anti-money laundering and tax shelters, one can only imagine that these and other compliance issues will be key going forward, and it is also an area where financial institutions have not invested enough in. By making this a core part of our wealth management and private banking infrastructure and platform, Asian banks will be well positioned to do well in this sector.
But what does this tell us when we approach the Asian wealth management and private banking market? It tells us the importance of building up the necessary infrastructure to compete effectively with the global financial institutions in this sector. This is something which would take time, for sure, but in order to capture the majority of the future flow of profits, it is something which needs to be done.
Within wealth management, we must therefore devote our efforts to building up the platform for succeeding in this sector – in terms of building up the distribution channels for delivering solutions to clients, in building up the platforms for cross border financial services, in building up our capabilities for providing a range of products and/or solutions for wealth management, hedging and risk management etc. Only then, will we be in a position to compete effectively with the global banks in wealth management and private banking, and to be able to grow this business not just domestically, but also regionally and eventually, globally.
One area where I believe we can do better is in the area of customer protection – both in compliance and risk management. With ever stricter regulations on anti-money laundering and tax shelters, one can only imagine that these and other compliance issues will be key going forward, and it is also an area where financial institutions have not invested enough in. By making this a core part of our wealth management and private banking infrastructure and platform, Asian banks will be well positioned to do well in this sector.