Euromoney is not a cheerleader for the UK. It just reports on global finance. And the evidence is compelling that Lloyds and HSBC are now industry-leading examples of the two very different business models that have emerged among the world’s top banks since the financial crisis.
Lloyds has specialized within one country. In 2019, regulators will require UK banks to place their domestic retail and business banking operations inside distinct legal entities with their own capital and liquidity buffers that cannot be drawn down to cover losses incurred in supposedly riskier international investment banking.
Around 97% of Lloyds’ activities will fall within the ring-fenced bank.
Its determined chief executive, António Horta-Osório, who has restored the bank to the point where the UK government sold down its last share in May, has focused ruthlessly on costs. With a cost-to-income ratio now at 49%, Lloyds appears to have opened up a formidable competitive advantage.
Offering basic banking services at low cost holds out the promise that banks might actually provide returns to shareholders without boosting profits by mis-selling to retail customers and later charging the compensation costs to equity investors.
Lloyds reported a 14.1% return on tangible equity for 2016, fully 10 percentage points above the average of other UK listed banks. That is why it can throw £1 billion at digital, both to improve customer experience and tighten its efficiency ratio even further.
Keeping risk low, meanwhile, helps Lloyds in its one area of competition with other global banks: not for customer business but for capital, where one of the lowest five-year credit default swap spreads constrains its weighted average cost and bolsters margins at a bank that still funds a portion of its assets in the capital markets.
HSBC stands at the other extreme of complexity and diversity. One of just two truly global banks left standing, next to Citi, it still operates in 68 countries, with global businesses spanning traditional commercial banking, transaction banking, financial market trading and investment banking, as well as having big retail banks in the UK and Hong Kong, smaller retail operations in 30-odd countries and a private banking division.
It does not match Lloyds for efficiency or for return on equity. But it is still a core holding for portfolio managers of many active, long-only funds, thanks to stable revenues and profits. Lloyds has paid out £5 billion in dividends to shareholders since it resumed paying them three years ago. HSBC has paid out £30 billion in cash over the same period and has also recently bought back shares to help neutralize dilution from the scrip dividends that its Hong Kong investors still love.
While Horta-Osório has focused on simplicity and efficiency, Stuart Gulliver, group chief executive of HSBC, has taken on the mission of cleaning up a global network and releasing its value.
Take a look at its global banking and markets division. Just 25% of its revenues come from customers HSBC serves in just one or two regions of the world and where it faces competition from regional banks. Fully 50% of revenues come from serving customers in four regions of the world, and so are accessible only to global banks. When you consider that 70% of these revenues come in businesses where HSBC has top-five positions, these start to look like high-quality and stable earnings.
Perhaps talking their own book, HSBC bankers will point out that for all the anguish over a new era of trade protectionism, the number of ships entering and leaving ports has not fallen. The decline of certain commodity prices has dented the headline dollar value of global trade, but the world still needs international banks to finance cross-border trade and capital flows.
The CEOs of the two banks appear to share one thing in common: a conservatism that borders almost on risk aversion. This was most obvious at Lloyds in the surrender of some share in mortgages last year and at HSBC in its funding profile, with advances standing at just 68% of deposits. Both men have seen the damage of paying compensation for previous misdeeds. They know how to face down pressure to boost short-term returns by taking on more day-to-day business risk.
In some ways more impressive than the business transformations both have led has been capital preservation and accumulation. The biggest danger, if banking revolves in some great super-cycle of capital destruction and creation, will come if their successors, rather than sticking to the daily grind of wringing out utility-like returns, are tempted to bet this bounty on a visionary new dash for growth.