The immediate cause for the turmoil in the US banking industry is the subprime losses that many have suffered. The estimates of how much money American banks could lose because of soured loans made to those with poor credit scores are climbing very fast. A new Goldman Sachs report says that subprime losses could touch $400 billion (Rs15.72 trillion), around four times more than what was initially assumed by most bankers and analysts. There are even more damaging estimates being tossed around.
Unfortunately, less attention has been paid to another debate that is raging over these past few weeks—on the business model of the large banks in the US. And since some of our own banks have consciously tried to ape this business model, the debates on the future of American banking should resonate here in India as well. But they do not.
Most of the world’s leading banks are diversified conglomerates that give out loans, buy and sell securities for clients, manage mutual funds, offer credit cards, dabble in private equity and have insurance businesses. A few have kept out of one area or the other, but the general tendency has been to have vast and diversified portfolios of financial products. Some banks like to think of themselves as financial supermarkets.
The business logic is appealing. A customer who walks into a bank branch has several financial needs. She needs a bank account, wants to insure herself and the family, needs a credit card, etc. A bank can grab this customer and sell her a variety of products at little extra cost. So, ideally, a financial conglomerate should be able to earn higher margins than its smaller high-street competitor.
That, alas, has not happened. Operating revenues have not grown dramatically faster than operating costs, which the conglomerate model would lead us to expect—at least in the case of a few banking giants.
What is happening at Citigroup serves as an interesting example. It grew to its present size thanks to early efforts by people such as John Reed and then the aggressive acquisitions by Sandy Weil. In a way, Citigroup is the classic financial conglomerate, and till now, a very successful one. Yet, there are growing chorus es asking for its break-up into smaller pieces.
Former CEO Charles Prince, who recently stepped down from his post after the bank’s subprime losses mounted, had already sold some businesses under the Citi umbrella. He had also tried to cut costs many months before the bank found itself bang in the middle of the subprime mess. But there are now demands for even more dramatic change, though some of the large investors in the bank—such as the Saudi prince Alwaleed Bin Talal—disagree.
It is not clear what will happen at Citigroup. But there are lessons here for Indian banks. The best and biggest of them are aggressively pursuing the conglomerate model that seems to have run into a spot of trouble in the US. The top Indian banks today have pushed into new areas such as insurance and are also trying to grow other businesses such as credit cards and broking. The Reserve Bank of India, too, is trying to figure out how it can regulate banks that do so much more than banking.
It could be argued that India’s realities are in stark contrast to America’s—a growing and under-serviced market for financial products will ensure that conglomerates will continue to prosper here.
It’s possible. But we also need to pay attention to what is happening in organizations such as Citigroup. Managing a complex and sprawling financial services group is not as easy as it looks on paper. At this juncture, there are not enough questions being asked about the validity of the financial conglomerate model. This is something that Indian banks and their regulators would do well to recognize.
Are financial conglomerates the future of Indian banking? Write to us at email@example.com