Lloyds have embraced the ‘boring banking model’ but whether they are a trailblazer for the other major British banks or simply an outlier remains unclear.
Renowned economics Professor and Financial Times columnist John Kay recently argued that the global financial crisis of 2008 had presented banks with an opportunity for reform and to shift the focus of their business. In his article Professor Kay argued that in order to ensure their future stability, and the safety of the financial system as a whole, banks need to return to the ‘boring’ yet safer retail banking model which had predated the ‘Big Bang’ deregulation of the City of London.
Banks continue to play a crucial role in our society acting as the default financial intermediary through which vast and multiple exchanges take place every day. However, they are also vulnerable to economic shocks, shocks which can quickly and easily spread to the real economy. A shift towards the kind of boring banking suggested by Professor Kay could help to mitigate the effects of these shocks by reducing the degree of systemic risk built-up within the banking sector.
In this post I consider the example of Lloyds Banking Group to explore what a turn towards the boring banking model looks like and what this could mean for the future stability of the UK economy. Indeed, I ask the question: is Lloyds Britain’s most boring bank?
While Lloyds had for the most part avoided the lucrative yet devastating pre-crisis world of investment banking and US sub-prime lending the bank was not without their problems. For example, upon their recapitalisation in 2009 the group had a pro-forma leverage ratio of 29:1, the highest of any UK bank. This lack of savings deposits also meant that the bank had become over reliant upon wholesale funding. Lloyds were also increasingly trading in securitisation instruments, lacked sufficient internal oversight and had a remuneration structure which fostered a culture of short-termism predicated upon high risk/high reward bonuses.
Since the financial crisis Lloyds appear to have significantly changed. The group has reduced its leverage ratio from 29:1 to approximately 5:1. Likewise, customer deposits have increased by 20 per cent resulting in an 8 per cent decrease in short-term wholesale funding. Total regulatory capital now stands at approximately 168 per cent above minimum requirements and the group’s core business has been retrenched on UK domestic retail markets. Furthermore, gross loans as a percentage of total funding have also decreased by over £200 billion or approximately 20 per cent.
From these figures we begin to see an emerging picture of a much more conservative and risk averse balance sheet. However, the structure and composition of the group’s key financial metrics is not the only facet of the business to be overhauled post-crisis, internal governance and oversight has also been shored-up and strengthened.
For example, the authority within the bank to make strategic decisions is now devolved equally between three separate units. Internal governance has been further enhanced by the introduction of additional sub-committees who advise on a number of specialist issues. Moreover, these new sub-committees have also been endowed with special powers which allow them to make direct challenges to the bank’s Board, the Audit Committee, the Board Risk Committee and the Group Chief Executive. This has given Lloyds a much ‘flatter’ management structure which is able to respond to emerging risks in a much timelier manner.
While Lloyds, like many British banks, have continued to make headlines in relation to a series of governance failures, we should note that many of these regulatory breaches pertain to historical legacy issues which in many cases predate the financial crisis. Indeed, it was Lloyds who in 2011 conceded their legal battle over the mis-selling of PPI, thereby setting a precedent which compelled others banks to follow suit, with the Group’s Chief Executive António Horta-Osório telling reporters that it was the ‘right thing to do’.
Moreover, the way in which Lloyds reward their employees has also changed significantly post-2008. Annual cash bonuses, which are widely accepted as being a key contributor to the crisis encouraging short-term risk taking, have been capped at a maximum of £2000 for all employees across the Group with share options replacing cash alternatives. Furthermore, variable remuneration for all Executive Directors is now payable exclusively in shares. As such, bonuses for employees have taken on a distinctly long-term outlook tying employee incentives to the sustainable economic welfare of the Bank and its shareholders.
Despite a myriad of issues, such as the mis-handling of PPI claims and the rigging of both Libor and the REPO Rate Benchmark, which continue to plague the bank, Lloyds do appear to have turned a corner and I would argue that they have begun the long journey towards becoming Britain’s most boring bank. This is important, not least because the balance sheets of Britain’s ‘big four’ banks remain enormous and individually, as well as collectively, continue to pose a huge threat to the domestic economy.
However, while Lloyds appear to be a more risk averse institution post-financial crisis, we cannot ignore the human cost of this restructuring which has resulted in some 57,000 redundancies as the group looks to make ‘cost efficiency savings’. These job cuts, and the effects of unemployment felt by staff and their families, have come against a backdrop which has seen Lloyds continue to make exuberant bonus payments and which has made Horta-Osorio Britain’s best paid banker.
Despite this, Lloyds appear to remain an outlier rather a trailblazer for boring banking. While Royal Bank of Scotland, like Lloyds, have made some impressive progress on the structure and composition of their balance sheet; diversifying their funding base and reducing reliance upon wholesale markets, the group have also increased the percentage of total funding being dedicated towards lending activities. However, this increase in lending has also witnessed an upward trend in the number of impaired loans since 2008. RBS have also been embroiled in series of governance failures which point towards a breakdown of internal checks and balances.
Likewise, HSBC, Britain’s largest bank, have also failed to embrace the boring banking model exemplified by Lloyds. Indeed, while HSBC have shed a number of assets across North and South America the group continues to operate an enormous balance sheet. Rather than retrenching their business on domestic retail markets, as advocated by Professor Kay, the bank have instead recently announced a so-called ‘pivot in to Asia’ suggesting that HSBC, like RBS, are not yet ready to embrace the boring banking model.
Barclays too appear to be shunning the boring banking model. While the bank now operates a much smaller balance sheet than in 2008 and has begun the run-down of their investment bank, trading liabilities as a percentage of group assets have increased. Barclays has also largely failed to reduce their reliance upon wholesale markets and they have been plagued by a series of governance failures relating to money laundering, tax avoidance, the rigging of Libor, so-called ‘Dark Pool’ trading and the manipulation of gold prices.
Were Britain’s other big banks to follow the more traditional ‘boring banking model’ that Lloyds appear to have embraced then I suggest that the potential risk posed to the domestic economy by these systemically important institutions would be mitigated and lessened. This could therefore lead to a more stable and robust financial sector and domestic economy. However, at present Lloyds appear to be an outlier rather than a trailblazer.