Retail banking: HSBC scales back retail banking

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By:
Peter Lee
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Operations in 39 countries under review; Bank must be wary about abandoning its command-and-control culture

HSBC chief executive Stuart Gulliver

"The reasons for holding our stock in a crisis become less relevant in recovery and, in our view, we now risk losing ground to more agile competitors"

Stuart Gulliver, HSBC

Last month HSBC outlined ambitious plans to boost its lacklustre return on equity by sharply cutting costs, exiting some non-core retail banking businesses and allocating capital in a much more disciplined way than in the past to remaining businesses. The bank’s new senior management team, led by chief executive Stuart Gulliver, invited analysts and investors to listen to a whole day of presentations from the executives running HSBC’s most important businesses and geographies on how they will achieve $2.5 billion to $3.5 billion of annual cost savings, reduce the cost-income ratio from 55% to between 48% and 52%, and boost returns on equity from the 9.5% achieved in 2010 up to between 12% and 15%.

HSBC had a good credit crisis, thanks to the abundant funding husbanded through a conservative advances-to-deposits ratio of about 80% and similarly conservative capital ratios. It remained sufficiently profitable throughout the calamities that beset the developed-world banking system from 2007 to have paid out $31 billion in dividends over the past four years, a total surpassed only by China’s ICBC. Yet as the financial system crisis abates, HSBC’s shareholders might grow increasingly restless.

Struggle for a story

"The reasons for holding our stock in a crisis become less relevant in recovery and, in our view, we now risk losing ground to more agile competitors," says Gulliver. "Or, to put it another way, we’re a very large firm that delivers significant profits, but we’re complex and historically we’ve struggled to tell a coherent story about why our shareholders should own us." It’s a long-standing failure. The stock price has been flat for a decade.

Gulliver has made new appointments to two dozen senior positions at the bank in his first three months as chief executive, many being long-serving veterans now given new and expanded roles. But as each of these pitched their story to investors, Gulliver himself condensed the key message into one arch comment. "Going forward, do not mistake the marketing strap-line, ‘the world’s local bank’, for our strategy."

Gulliver’s own ascent to the top of HSBC is a reminder that it is at heart a commercial bank that has also grown a first-rank global markets and investment banking capability. It is on these businesses, the ones that Gulliver used to run, that the future of HSBC depends. It also sees the chance to grow a global wealth management business. But it has abandoned any ambition to be a large retail bank in all the 87 countries around the world in which its commercial bankers and investment bankers operate. As HSBC now looks to cut costs, expect the burden of justifying continued existence within the group to weigh heaviest on its retail operations.

Pleasing to rival

As the investor day wore on, excitement grew for some of those listening in. The news of a scaling back of retail banking ambitions was warmly welcomed in the Asian offices of Citigroup, where senior executives presented it to Euromoney as a retreat from the battlefield of the US bank’s most feared competitor. Stock market investors welcomed it more cautiously, perhaps doubting the capacity to deliver cost savings quickly. HSBC shares sold off as the day wore on, limping by the end of May to roughly the same level as before the investor day. Delivery won’t be taken on trust.

Total shareholder return over the past 16 years 

Rebased to 100 at end 1994
Includes capital appreciation and dividends. Calculation adjusted for equity raisings
Source: Thomson Reuters Datastream

Perhaps because many of the equity analysts that cover the bank do so from two centres, London and Hong Kong, where it is also a prominent retail bank, the importance of retail banking to the group might have been overstated. Gulliver intends to correct this notion. He says: "I often find that one of the things being put to me is, "Well, if you’re the world’s local bank, you know, being in 87 countries isn’t enough." Gulliver takes almost the opposite view, as he surveys the key long-term trends – continued growth in trade and requirement for financing alongside rebalancing of global GDP towards the larger emerging economies – against which to position HSBC. "The world is actually surprisingly concentrated," he says. "If you dig into trade flows, 35 countries account for 90% of growth in trade flows over the next 10 years, and that also holds true for external debt, bank profit growth, wallet available for bank profits and, indeed, FDI." He adds: "We are not going to try to be all things to all people in all markets."

The bank has big ambitions to grow a global wealth management business, focused on wealthier retail customers in just 18 of the 87 countries in which the group operates, through which to derive benefit from fast wealth accumulation and high savings rates in the larger emerging markets. Meanwhile, it is already exiting retail banking in some of the 61 countries where it now operates in personal financial services but sees slim prospects of achieving scale. HSBC has already quit Russia. Paul Thurson, who was appointed HSBC’s first global head of personal financial services in March 2011 and now runs a renamed global retail banking and wealth management division, says that most of its profits come from just 15 of those 61 countries. And while some less profitable ones justify investment now to capture future growth, he is reviewing 39 countries where the bank either lacks scale or is not very profitable.

Strategic review

A big question mark hangs over the future of its US credit card and retail banking operations, which are now subject to strategic review. The US credit card business is profitable but clearly not core to the group’s strategy of building businesses that depend on its international connectivity. While HSBC’s ample capital and funding means that it is not a forced seller required to take a low-ball bid, it is not immediately obvious which potential buyers might be interested in its US credit card operations, although some analysts mention Barclays and Capital One.

Scaling back in the US would correct one of the hidden costs of HSBC’s disastrous acquisition of Household: the bank’s reduced exposure to emerging markets just as they accelerated out of their own crisis at the end of the 1990s. It was this strategic mis-step back in 2003 that allowed Standard Chartered to position itself as the bank stock of choice for investors wanting exposure to growth in emerging markets. Perhaps this is part of the reason why HSBC’s stock performance has not reflected growing excitement over the importance to the world economy of the Bric countries. It also mired HSBC in the US sub-prime mess.

Ludicrously, HSBC’s former management presented Household as a means to deploy the group’s abundant deposit funding into high-margin loan assets and even as a source of expertise for banking emerging retail customer groups, such as in India. The Household model worked no better on the subcontinent than it did in the US and HSBC has had to restructure its personal financial business there, recently acquiring the Indian branch network of RBS.

Simon Samuels, bank analyst at Barclays Capital, notes: "We see opportunities for a reallocation of capital through an early exit from a large part of the outsized US credit card business and a scaling back of HSBC’s US branch presence. In total we estimate that a reduction in the scale of these businesses could free up around $25 billion of capital for use in the higher-return and faster-growth emerging markets businesses."

HSBC says no final decision has been taken, although the direction in which it is leaning is abundantly clear. The bank will continue to invest in such key retail banking markets as India and China. Continued investment in many others is dependent on strict review of their capacity to generate returns and to support the overall strategy of the group.

No retreat

HSBC is at pains to emphasize that it will not pull out of the US. It sees big opportunities to bank US corporate clients, especially those manu­facturers doing more business abroad. It has a new model in mind of its US operation: and that is the more limited branch network HSBC deploys in Canada, where it has a large commercial bank and a retail operation serving the Asian and Latin diasporas on the country’s western and eastern coasts.

Meanwhile, even those retail operations that survive the bank’s strategic review will have to operate differently in future. HSBC’s new senior management takes the view that substantial overhead has been built up because the group’s separately capitalized subsidiary model has led to a federal structure, with no standardization of retail financial products and inefficient and high-cost separate IT systems with local idiosyncrasies. This it intends to change, with global banking and markets, run as one business with a cost-income ratio of 49%, as the model.

Retail banking and wealth management 
PFS key historical financials,
Total PBT 2007 to 2010= –$3.7bln 
Source: HSBC

This is all patently sensible stuff that probably should have been done years ago but wasn’t a priority when funding was abundant and ample profits allowed easy capital generation. It also slipped down the list of priorities as HSBC dealt with the crisis and raised capital. Now the group has to focus on it. Analysts remain tough to convince. Mark Phin and Pawel Uszko at KBW estimate that HSBC might just hit the top end of its 48% to 52% cost-income target range come 2013.

Worries about control

There is, however, an intangible worry for HSBC. Removing layers of product and geographic management is very easy to justify in terms of financial returns to shareholders. But as well as removing cost, it removes a degree of control in an industry where employees are all too often tempted to prey on customers. And while Citi executives might welcome HSBC’s reining in of its global retail banking ambitions, they might do well to consider the sorry history of their own bank. In the run-up to the crisis, Citi found itself subject to regulatory investigations around the globe as it failed to control employees.

Gulliver will need to wrestle with the vexed question of how to ensure good behaviour among staff after some layers of command and control are removed. In his investor-day presentation, Gulliver touched briefly on this and the bank’s plans to train 300 senior employees in business ethics under an initiative called courageous integrity. Compliance with ethics and values will be included alongside return on equity and cost efficiency targets in evaluating senior HSBC staff. "This courageous integrity is not just some happy-clappy strap-line," Gulliver insists. Unfortunately, that’s exactly what it sounds like.