Universal Banking Post Crisis: Past and Future of International Corporate and Personal Banking

This paper reviews the characteristics of the international incursions by banks since the early 1990s, examines the implications of the US subprime meltdown crisis and ensuing credit crunch for the pursuit of international banking activities, and provides a prospective view on how banks will tend to make decisions regarding the scope of their international operations in the years to come. We conclude that banks will tend to remain loyal to a universal banking model in terms of scope of activities. But they will most likely also be forced to combine domestic leadership in a first set of financial service activities, regional or international leadership in a second, and global leadership in a third, accepting secondary market shares only temporarily, as a step towards the goal of a leading position for that service in that market.


I. INTRODUCTION
The 1990s were a period of fast expansion and re-invention for the banking industry globally. Three main factors affecting the fundamentals of financial intermediation contributed to this: major regulatory changes, an extraordinary acceleration in the use of digital technology, and the explosive growth of the securities markets.
On the regulatory front, substantial changes in favor of financial liberalization came about almost simultaneously on both sides of the Atlantic. In Europe, the Financial Services Action Plan (1999) formalized a series of measures towards a single wholesale financial market and a more open retail market in the European Union, completing a process of gradual reduction of barriers to cross-border financial intermediation initiated ten years prior with the EU Second 2 Banking Directive of 1989 (Dermine, 2002). In the U.S., over six decades of regulatory obstacles to, both, interstate banking and universal banking were removed. In 1994, The Riegel-Neal Interstate Banking Act revoked the restrictions to interstate mergers among banks which had been put in place by the McFadden Act in 1927; and The Gramm-Leach-Bliley Act (or The Bank Holding Company Act) completed the elimination of regulatory constraints to securities underwriting activities by commercial banks originally set in place by The Glass-Steagall Act in 1933 (Bodie, 2005).
On the technological front, a substantial acceleration of a paper-to-digital trend revolutionized how financial information is assembled and disseminated, how credit risk is assessed, priced and provisioned against, how large volumes of loans could be classified, bundled and securitized, how contractual obligations are established and monitored, and how trades are conducted and settled.
Finally, and very much facilitated by the above -there was an explosive growth of the securities markets, putting downward pressure on the spreads commercial banks could earn on better known credit risks and pushing them, particularly over the past two decades, towards the pursuit of, both, the capital markets activities and higher margin consumer finance endeavors, at home and abroad.
This long period of a purely market driven broadening of scope and geographic reach of activities by leading banks around the globe came to a halt in 2008. The U.S. subprime meltdown crisis and the ensuing global credit crunch triggered, both, a process of government assisted financial industry consolidation in many countries around the world and a reexamination of bank regulation globally towards significantly tighter minimum capital and liquidity requirements for banks in the years to come.

3
In the following sections, this paper revisits the nature of gains of scale and scope that have driven international corporate and personal banking incursions by leading banks globally over the past twenty years, examine how the recent U.S. subprime meltdown and global credit crunch have affected banks' pursuit of universal banking strategies globally, and conclude with the outline of a strategic framework for decision making by banks regarding the scope and reach of their international operations.

II. FROM CORPORATE COMMERCIAL TO WHOLESALE BANKING
Other things equal, increased competition for a certain asset class by institutional investors (such as pension funds, insurance companies, asset managers, and hedge funds) puts a downward pressure on the spread banks can charge for taking that credit risk (Crosse et al, 1973). As credit opportunities in one country become also of interest and available to lenders and investors from other countries, credit spreads tend to narrow further (Marshall et al, 1994).
The extraordinary reduction in the costs associated with bridging the information asymmetry between savers and borrowers, brought about by the rapid processes of technological change, financial liberalization and growth of securities markets, had the effect of increasing the competition for the best credit risks. Balance sheet carry of institutional credit risk -the core source of revenues for the traditional corporate commercial bank -gradually became less and less financially rewarding.
The response by most leading corporate commercial lenders was to seek to lever on their access to -and understanding of the credit risk of -institutional clients to pursue the investment banking activities of securities underwriting.
4 Some banks, such as JPMorgan (JPMorgan, 2012) decided to build the most critical missing piece, access to investors -or securities sales and distribution -from within. Others chose to pursue the acquisition of investment banks, as amply illustrated in Exhibit 1 below.  Fargo and Co., 2011) or, simply, Investment Bank (JPMorgan Chase, e.g. JPMorgan Chase and Co., 2011).

III. FROM DOMESTIC TO INTERNATIONAL PERSONAL BANKING
Until the early 1980's banks tended to divide the coverage of their individual customer base in, essentially, two major groups: the consumer bank, serving the public-at-large; and the private bank, offering the more personalized attention of specialized banking executives to high networth individuals and families (Sinkey, 1998).
Regardless of income level, net worth, or any other cultural and/or geographic consideration, an individual's need for financial services will always combine the demands for payment services (such as checking accounts and debit cards), credit products (such as overdraft accounts, personal, auto, mortgage and home equity loans, credit card facilities), investment products (such as savings accounts, brokerage services, investment funds), and insurance (such as auto, home, health and retirement). The challenge for the financial institution is to establish and effectively manage the mix of personal banking products that can most efficiently capture the profit potential from its serving of constituencies with different characteristics and priorities (DiVanna, 2004).
In response to this challenge, banks around the world have continuously sought to refine their personal banking segmentation strategies (Venzin, 2009). In consumer banking, subsegmentation tends to be guided by the customers' income level, as a proxy for their likely demand for credit and ability to borrow. In private banking, sub-segmentation is primarily determined by the customers' net-worth, as a proxy for their likely demand for wealth management assistance and willingness to invest.
The explosive growth of the securities markets globally over the past two decades has had the effect of making global wealth management an absolute priority for the private bank. At the same time, rich profit margins from domestic consumer lending led several banks to aggressively pursue the establishment of potentially even more profitable consumer finance abroad franchises overseas.
An examination of the key drivers of and challenges associated with each of these two distinct international personal banking strategies follows.

INTERNATIONAL PRIVATE BANKING
Until the late 1980s, high net-worth individuals had sought international private banking relationships with the primary objective of protection of their wealth from domestic turmoil and/or regulatory scrutiny. The fundamental change that occurred over the past two decades in the nature of international private banking was the shift in priorities by high net-worth individuals away from the safe heavens of low yielding deposits with a reliable international bank towards yield and globally diversified portfolios.
This shift, in large part due to the same reasons that transformed corporate and investment banking -lowering of barriers to international capital flows, technological change, and explosive growth of the securities markets -has been further stimulated by specific actions taken by governments around the world to enact and enforce stricter laws and tighter bank regulations against tax evasion and avoidance mechanisms (Croft, 2010, Nov 9).
Today, a private bank's offering must combine the institution's own convenience, credit, and investment management products with those of third party providers of asset management and insurance services. Client coverage is typically organized along two main dimensions, region of origin and size of net-worth (Maude, 2005). Other criteria, more directly related to potential revenues to be generated -such as account size and amount of investable assets -help the 7 financial institution to further sub-segment further (e.g. high, ultra-high and mega-high), typically allocating a smaller number of customers of higher revenue potential to its more seasoned private bankers.
Competition for wealth management services is fierce as very much engaged in it are not only the world's most well known international banks and non-bank providers of investment advice and brokerage services but also leading regional private sector banks, such as Nordea Bank (Nordic countries) and Itaú-Unibanco (Latin America). In addition, tighter regulationsincluding the requirement for banks to ascertain the legitimacy of clients' funds, with criminal implications for bankers and severe penalties for the institution for failure to doing so -have also contributed to put downward pressure on volumes and margins in private banking.
The main obstacle for a bank considering entry into a foreign consumer banking market is the existence of well entrenched financial institutions that may already enjoy the advantages of significant distribution networks, already well entrenched and trusted brands, and cultural integration with the customer base.
Differently from, both, wholesale and private banking -where the customer perceives the foreign bank as a passport to the world -going abroad in consumer banking requires from the incoming financial institution to become operationally domestic overseas. Not surprisingly, entry by a consumer bank institution into a new market typically takes place through the acquisition of a local franchise.
Three major factors have contributed to a more aggressive international stance by certain banks towards consumer banking abroad: (i) technological breakthroughs, which have facilitated automated contracting, settlement and control of financial transactions, therefore allowing for much lower distribution cost of retail banking services; (ii) the combination of attractive margins with the apparent reliability of consumer behavior and credit models (Mays, 2004); and (iii) the lowering in many countries of regulatory restrictions to the acquisition of major domestic consumer banking franchises by foreign banks, therefore facilitating entry at economically viable scale of operations.
This balancing act between the attractiveness of margins versus the challenge associated with the establishment of viable scale operations overseas has led most banks to take regional approaches (Fiordelini, 2009) to international consumer banking (such as Commerzbank from Germany and UniCredit from Italy towards Central European countries or BBVA/Spain and Itau-Unibanco/Brazil towards Latin America). 9 The few banks that have chosen to pursue a more global approach to consumer banking have typically begun to move aggressively into a new region only after consolidating viable scales of operation in previous ones. These were the cases of HSBC/UK (Patil et al, 2007) towards the Americas from the late 1990s onwards, after having achieved strong competitive positions in many countries in Asia, of Banco Santander/Spain (Ghemawat et al, 2006)

IMMEDIATE RESPONSE (2008-2009)
The immediate response by governments around the world to avoid the collapse of their

REGULATORY DEVELOPMENTS (2009-current)
Recognition globally that excessive leverage, over-reliance on short-term funding and inadequate supervision by bank regulators had been at the root of the quasi collapse of the financial system led to a major revamping -not yet fully concluded -of bank regulation. (iv) obligation for SIFIs to develop and maintain a living wills that provide regulators with a roadmap of how the bank's management perceives the company could be orderly liquidated without disruption to the financial system; (v) establishment of specific legislation empowering regulators to unilaterally place a SIFI in orderly liquidation and to conduct this process, beginning with the ousting of the company's management and board and the wiping out of its equity holders.
While final rule making on several of these measures is still under debate, the consequences for SIFIS are clear: substantially higher capital requirements overall and for securities trading and off-balance sheet exposures in particular; severally regulatory restrictions to proprietary trading; and, last but not least, much closer regulatory scrutiny and supervision.

V. PRIVATE SECTOR RESPONSE TO THE CRISIS
The private sector banking industry response to-date to the crisis has been characterized by two distinct waves. (to Barclays), the latter also driven by target capital adequacy commitments made by ING to the Dutch treasury upon the granting of government support in 2008.
Bank valuations have to-date pushed banks to prioritize balance sheet de-risking coupled with low dividend pay-out ratios over shareholders' dilution via equity offerings. Still, when viable the opportunity to tap the public has not been missed, as evidenced by Banco Santander's listings of its Brazilian (Reuters, 2009) and Mexican subsidiaries (Merced, 2012). Through these well timed offerings, which involved double listings in the NYSE and in the domestic stock exchange of each subsidiary, Banco Santander (Spain) managed to raise over US$ 12 billion in fresh equity without loss of ownership control of these operations.

VI. PROSPECTIVE VIEW
The combination of government and private sector responses to-date to the crisis has resulted in an acceleration of the purely market driven process of concentration of the banking industry globally.
It has also reinforced the trend for banks of different jurisdictions around the world towards universal banking -including the U.S. where leading independent mortgage lenders and investment banks have been absorbed by universal banks, exception made to-date to Goldman Sachs and Morgan Stanley -now bank holding companies but not (yet?) also commercial banks.
Looking forward, the combination of new regulatory restrictions and lessons learned from the crisis should push SIFIs' and D-SIFIs' managements and boards of directors to have their companies pursue much more carefully assessed and selective value driven business strategies in terms of, both, scope of activities and geographic presence.
In the Eurozone, once surpassed the ongoing sovereign debt turmoil, we should expect international mergers to accelerate, as stronger banks in one country begin to more aggressively pursue beyond their borders, both, gains of scale and stability of funding in Euros.
Greater internationalization is also likely via acquisitions by leading banks from countries less affected by the 2008 global financial crisis, such as financial institutions from Japan, China, Australia, Canada and Brazil that have seen their relative valuations vis-à-vis European and U.S.
banks improve materially since 2008.
Generally speaking, the years ahead should be characterized by the obsessive pursuit by banks of reliable revenue growth at maximum efficiency, with renewed focus on client -personal and institutional retention and share of wallet maximization. The challenge before the boards of directors of banks around the world is to properly assess their companies' strengths and weaknesses across the full spectrum of their institutions' financial services offerings vis-à-vis those of their stronger competitors in each geographic arena under consideration, so that market shares can be achieved that ensure acceptable and sustainable returns on thoroughly determined economic capital allocated for each initiative at each jurisdiction. In other words -and as illustrated in Exhibit 2 -to be capable of putting in place and sustaining, an organization that can successfully achieve strong market positions -with virtually assured acceptable profitability -in all it chooses to do.
For major banks of countries around the world, this will most likely imply in continued domestic pursuit of leading positions across the spectrum of financial services to individual and institutional clients in their home jurisdictions; but international ambition in a narrower second, and global reach only in an even narrower third set of financial service activities.

Retail Banking
Commercial Consumer Finance Domestic

Corporate Commercial Significant
Transaction Services Multi-regional On the other hand, lessons learned by banks' boards of directors and significantly tighter regulations will force banks to pursue much more carefully assessed and selective value driven business strategies in terms of, both, scope of activities and geographic presence).

Investment Banking
The challenge for banks around the world is to properly assess their companies' strengths and weaknesses across the full spectrum of their institutions' financial services offerings vis-àvis those of the stronger competitors in each geographic arena under consideration, so that economically viable market shares can be achieved. In other words, to be capable of putting in place and sustaining an organization that can successfully pursue strong market positions -with virtually assured acceptable profitability -in all it chooses to do.
For major banks of countries around the world, this will most likely imply in continued domestic pursuit of leading positions across the spectrum of financial services to individual and institutional clients in their home jurisdictions; but international ambition in a narrower second, and global reach only in an even narrower third set of financial service activities.