Macquarie's winning ways

It's very challenging to integrate wholesale investment banking with broad-based consumer services because the sort of skills and approach which are needed to be successful are somewhat different.

Nicholas Moore: There is however a conventional wisdom that we are moving towards a world of maybe five global banks that will incorporate the whole range of financial services - investment banking and commercial banking included.

We have to remember that it was only 12 years ago that people thought that Japanese banks were going to dominate the world.

But surely if there is disintermediation of the commercial banks by bond markets they must enter investment banking?
Moss: Commercial banks need to redefine their roles. The successful ones, such as Lloyds, are focusing on the consumer. They're making most of their money out of providing services to consumers. That model seems to make a lot of sense. Margins are going to be very thin at the wholesale end. You can charge people at the consumer end because consumers are willing to pay for convenience and there are a lot of them. That's why Lloyds is doing so well.

Moore: It's a question of scale. A commercial bank is a basic production business. Commercial banking like making motor cars will be a question of who can get the unit cost down. That's all commercial bankers talk about now: how much does it cost to process a mortgage, how much to process an account. And that's all about scale. Someone like Virgin could take them on, but they've got to get the customers, get the systems, get the scale. Once you're in the game you tend to be like Microsoft, you get bigger rather than smaller.

Moss: We've got a long way to go in terms of the consolidation of financial services. If you compare it to most other major international industries - oil, computers, cars - consolidation has barely begun.

But consolidation should exclude mergers of commercial banks and investment banks?
Moss: The successful consolidation will be mergers of commercial banks. It's true of almost every industry in the world that the people who are doing well are becoming global products specialists, whether its chemicals or motor cars. The conglomerate model is widely accepted to be outdated.

What about the argument for conglomerates: the diversification of earnings streams?
Moore: If you're a commercial bank and you're not good at investment banking, you're not going to make money there. It's a binary sort of industry. You either make a lot of money, or you make nothing.

Moss: There's no evidence that diversification of income streams in financial services reduces cost of capital. The diversification argument has been discredited and that's why industrial conglomerates have been broken up around the world.

You spoke about new entrants lacking scale to compete. But you entered the Australian mortgage market through securitization and shook up the big four commercial banks. You took 5% of Australian mortgages almost overnight.
Moore: That's true. We obtained the level of scale to survive. Just. There's no doubt, however, that if Commonwealth Bank were running our portfolio we'd be making more money. They can process cheaper than us.

But you performed a useful economic function. You brought down cartelized rates.
Moore: We did. We halved mortgage margins in this country. It wasn't necessarily that we were more efficient than the major trading banks. It was just that we were less greedy.

There will be niche areas where the mass providers of financial services get too greedy - there's no question about that. People like us coming in and doing securitization will help to keep the major trading banks honest. But as a generalization, the successful commercial banks will focus globally on retail financial services.

You run a very dynamic institution. You currently have 47 business units.
Moore: If we have 47 businesses today we're going to have more than 47 in the future. Some businesses we have today are dead. At the ground level and the executive level people are always looking for new opportunities. New businesses (less than five years old) contribute 30% to profits.

How fast has the number of business units grown?
Moss: In 1987 we had 25 units, so there has been a near doubling in 12 years. In the last five years we have added 10 units.

How do you decide a business is no longer viable?
Moss: It's a matter of business judgement and understanding what is going on in the business. There's no easy rule of thumb. One of the few businesses we shut down was our government bond desk. It was clear there that despite trying hard we were not going to achieve a sufficient market position to make the business worthwhile in terms of risk reward.

What return on capital was that business making?
Moore: Actually we were losing money.

Moss: We'll support infant businesses for a long time. We've got an excellent metals trading business now, dealing copper, zinc, aluminium and gold. When we moved into that it took us five years to make any kind of decent money. But we felt we were on the right track so we persisted with it.