As Royal Bank of Scotland, Barclays and HBOS seek new funds from investors with varying degrees of desperation, it’s tempting to ask with regard to UK banks – where did it all go wrong?
UK retail banking has traditionally been a profitable but lazy business. Banks have made easy money by charging borrowers high interest rates while giving little or nothing to current account holders. Meanwhile customers have traditionally been inert, partly because they don’t believe they will get any better service by switching to another provider.
This laziness means that UK banks have long been laggards in terms of increasing the number of products they sell to each customer. In countries such as France the largest banks would expect to sell at least five products on average to each of their customers. In the UK, retail bank chiefs would do cartwheels down the high street if they could reach an average of two.
But the UK remains highly competitive and heavily banked, with six major high street operators and a host of smaller, but sizeable, competitors.
To increase profitability against this backdrop, most UK banks adopted the same approach – to increase leverage, and to go further and further into sub-prime. For much of this decade the strategy worked. Easy credit meant more easy money, and banks even faced calls for windfall taxes to curb their ballooning profits. Now, as the UK housing market begins its inevitable crunch-induced crash, inflation creeps up and credit card operators begin to stress about the level of unsecured debt they have allowed cash-strapped customers to accumulate, the long-term growth strategy is in jeopardy.
Meanwhile RBS, and to a lesser extent HSBC and Barclays, compounded their exposure to heavily banked markets where the only way to grow was to increase leverage and go deeper into sub-prime by attacking the US market.
With hindsight, the large UK banks might wish they had looked closer to home for expansion. It is going to be awfully tough, not just in the short-term crisis but also over the longer term, to squeeze out growth higher than low single digits from developed banking markets.
The best opportunities lie in emerging markets. UniCredit, the Italian bank, recognizes this. Despite consolidating the Italian banking market over the past few years, it announced in June plans to concentrate on expanding in eastern Europe. At least it has a network there – the biggest, indeed, of any bank in the world. With all the best banking assets in the region already in foreign hands, UK banks have missed out on the growth potential of the only relatively unbanked markets on their doorstep.
Meanwhile, a competitor has emerged in their own backyard with a strong domestic franchise, a large exposure to growth in the emerging markets, and a history of maximizing revenue from existing clients. Abbey, owned by Spain’s Santander group, was apparently responsible for almost a third of new mortgages in the UK in the second quarter. All of these had LTVs of less than 75%.
UK banks may have solved their capital crisis. But it is far from the end of their worries.
