PORTUGAL INDUSTRY MAGAZINE This was the opinion of the Portuguese-born Chief Executive of Lloyds Bank, António Horta-Osório, who addressed members of the British-Portuguese Chamber of Commerce and British embassy officials at the British Ambassador’s Residence in Lisbon on Friday. Trust, in turn, was also a prerequisite for a strong banking sector with a clear alignment of incentives. Customers, banks and regulators all need a strong economy. “It is up to the industry to change and establish the conditions in which trust can be rebuilt,” he told business leaders at the BPCC Board of Directors/Embassy organised event. Despite economic differences in the past, Portugal and the UK faced similar challenges today, he said, “How can we put ourselves back on the path to a strong recovery? How can we create the conditions for a more stable, more balanced path to growth?” asked the banker. In the short term, the key to restoring growth was by reducing uncertainty and restoring confidence so that the private sector could expand and offset deleveraging in the public sector. “The banking sector cannot change this by itself. Banks cannot force households or businesses to borrow in order to prop up demand in the short run. Nor should they” he warned in a veiled reply to criticism that banks weren’t doing enough to support cash-strapped SMEs. But just as banks played a key role in the causes of the crisis, they could and had to play a key role in supporting the recovery Horta-Osório admitt This meant looking after the deposits of households and businesses, and using this funding prudently to support investment and growth, especially to SMEs, the “life blood” of any country’s industry, and to first time house buyers given the key role of the construction sector in creating employment and growth. “The biggest challenge that households and businesses face is that they no longer trust banks to carry out these responsibilities,” he admitted. “Without the trust of our customers banks are effectively unable to carry out their role in supporting the recovery and building a stronger economy,” he said. Therefore, just as the external environment had changed, banks also needed to change. The key to restoring this trust came in three parts: changing the culture, improving stability, and supporting growth through prudent lending. A culture based on longer-term returns and sustainable growth was key to ensuring banks improved in their medium-term growth prospects. Pay had to be linked to the long-term performance of a bank not short-term gain. It needed to be aligned with the long-term interests of shareholders and managers and transparently linked to success. Rewards also needed be tied in with customer service, effective controls on risk, and better outcomes for customers, with less emphasis on sales targets. The same principles had to apply to the senior management of the banks. While pay should be linked to the long-term performance of the bank, it must be capable of being clawed back where bad decisions adversely affected the banks performance and costs. This was in stark contrast to the culture that existed in the banking sector in the lead up to the crisis where the interest of shareholders and customers were seen as conflicting. “The business model that puts the customer at its core and delivers sustainable returns over time is the one that completely aligns the bank with the interests of investors. Cultural change will take time, but in the short term we must seek to build customer trust in banks by ensuring that no bank is in a position to threaten the safety of their deposits,” said Horta-Osório. Recent events in Cyprus had made this task more difficult. But the considerable efforts made in enhancing the stability of the industry over the past few years also needed to be recognised. Since the crisis capital ratios at European banks had steadily risen despite the weak economic backdrop and difficulty of raising capital in the markets. Between 2008 and the first half of 2012, Core Tier 1 capital ratios of UK banks rose from 8.6% to over 13%, Portuguese banks have increased Core Tier 1 ratios from 7.5% to over 11%...more than the Spanish banks had done. “At Lloyds we set out our strategy to reduce the risk on our balance sheets in June 2011 by reducing wholesale funding, lowering operational leverage, and increasing capital ratios. However building stability was also about structural change. Retail and commercial banks should be “simple and boring”. That is why Lloyds was supporting the initiative in the UK to ‘ring fence’ the commercial and retail activities of banks. “I believe this will help engender trust among our customers as they know exactly what activities the banks undertakes and what it does not,” he said. “We also need to build and maintain better relationships with regulators; both should want a financial system which enables a strong and healthy economy,” he added. “Ultimately we need to create the conditions for banks to allocate funds to the most productive areas of the economy which requires a regulatory framework that allows banks to do this but also safeguard the stability of the system at all times.” On the FCS Deposit Guarantee Scheme in off-shores, this could vary from the off-shore in question. In the Isle of Man, for example it was not the UK government’s guarantee that was in place but that of the bank and the authorities in the Isle of Man. If someone places their deposits in Gibraltar, for example, with a bank, they will have the guarantee of the Gibraltar authorities and the parent bank company in the UK. In what was overall a talk about the similarities between Britain and Portugal he showed how the banking sector could help the economies of both countries. It was an “understatement” to say that the environment under which banks and businesses were operating remained “challenging”. Across the advanced economies the processes of deleveraging in both the private and public sectors was taking longer and having a more depressing impact on growth than many had thought when the worst of the 2008 financial crisis and associated recessions happened. The Euro zone, as a whole, and the so-called periphery economies remained in a deep recession today. The UK economy with its close trade and financial links to the Euro zone had not been immune, with flat growth over the past 18 months but despite the weakness in the main economic outlook, the actions of the ECB and other central banks had brought relative calm to financial markets over the past six months. This had provided policy makers with a breathing space to make progress on the longer term reforms to economic and financial policy required to deliver lasting stability. But it remained vital that they did so to reduce uncertainty in the economy and to reduce the negative impact on business confidence and investment decisions. Horta-Osório pointed out that while this was a difficult environment for businesses to operate in; it also provided a unique opportunity for change. An opportunity to assess business models and practices, for their appropriateness for the new environment. One thing that was clear from the past five years was that the external environment in which business operated had changed “dramatically and for the long-term”. Nowhere had that proved truer than in the banking sector. The health of the banking sector and the health of the economy were inextricably linked. The differing experience of the UK and Portuguese economies over the past decade provided a “useful case study”. On a GDP per capita basis, Portugal had experienced flat growth for a decade. The UK economy had outperformed most advanced economies, even the United States. Although there were a number of reasons for this contrasting performance, a key difference has been the allocation of capital via the banking sector. On joining the Euro Portugal enjoyed an influx of capital. But while this should have found its way into the most productive areas of the economy to drive growth, it didn’t. Instead productivity growth fell - despite the abundance of capital, low interest rates and the closer trading ties that membership of a unitary trading union brought. At the same time the UK also saw significant capital inflows. While it was a popular perception that UK growth prior to the crisis was driven by increases in financial sector output, this was not borne out by the data. The key drivers of UK growth came from business services, distribution, manufacturing and telecommunications – not necessarily the financial services and banking sectors. This was not to say that there wasn’t a misallocation of capital to certain sectors. The UK experienced an unsustainable boom in both residential and commercial property markets, and an emphasis on domestic demand growth despite globalisation. There was a culture in the banking sector of complaisance towards risk management, a loss of customer focus, and an emphasis on creating ever higher revenues to outpace rapidly rising costs. In effect core banking practices were progressively being relaxed in favour of short-term financial gains. “To me this demonstrates the importance of an efficient banking sector, to build a strong economy which delivers a significant improvement in living standards over time and sustainable returns for banks,” he said. Across the whole of Europe a spiral of weak consumer confidence leading to lower demand and lack of appetite to invest and create jobs was pushing the economy further into recession and further delaying any prospect of recovery. Households were worried about the outlook for the economy and their own job prospects, so they cut back on spending today. Companies saw the weak environment and they cut back their workforces and postpone investments. It was a vicious cycle. To ensure that this time the lessons of the past will not be repeated, he said there were substantial structural changes underway in the way that the sector would operate in the future. Given the trend of ‘laisser faire laisser passer’ that started in London in the 1980s, in which there was a belief that the markets correct themselves and the animal spirits work for the common good, all those trends had been called into question, and as a consequence people were now concerned about balancing the interests of society with a properly functioning bank sector.
Posted on: Sun, 16 Jun 2013 22:25:23 +0000