Developing An Endgame - What Drove Profitability in 3Q and Why Strategy Matters

What Drives Bank Profitability

In case your sports calendar was full this weekend, you might have missed the 2013 FIDE World Chess Championship. This is the most anticipated chess match in decades and, so far it is been a classic duel giving bankers insight into both strategy and tactics. The Championship pits The Tiger of Madras, Viswanathan Anand against Norway’s Magnus Carlsen. Anand is representing the old guard at 43 and is India’s first Grandmaster, not to mention chess’ undisputed champ since 2007.  Carlsen, at 22 years of age, is the young buck, but has been the sport’s highest ranked player since 2011. A win, which we are expecting, would make Carlsen the second youngest champion in history behind Garry Kasparov.

 

The series is the first to 6.5 points out of 12 games, and as the first two games ended in a draw the score is tied up 1-1. While we wait for the next game today, we want to point out that just as both players employed a strategically simple opening really designed to gather information about their opponent, both players were setting themselves up for a complex endgame.

 

In banking these days, it is much the same way. With thin margins, low growth and some lingering credit problems, it is difficult to advance. However, like the first two games of the Championship, testing and setting yourself up for future success is the key. Many chess players master the opening and intermediate part of the game, but what separates a Grandmaster is their ability to keep the endgame in mind,  In analyzing third quarter data, the four largest influences on top performing banks are (in order):

 

  • The ability to generate fee income,
  • Efficiency,
  • The ability to maintain above average risk-adjusted margins and
  • Controlling unanticipated credit losses. 

 

While we will explore each one over the coming weeks, the key strategic takeaway here is to notice the order and the magnitude that each factor has on performance. It is important to notice what is not here, which is mainly size and growth. While we will explore these factors as well, despite what the media headlines and M&A analysts say, the data suggest that you can have a 2% ROA or better at almost any size bank.

 

The overarching point here is that strategy really matters in banking. There are many ways to get a 2% plus ROA, but it all starts with strategic alignment of a bank’s business model. In other words, a bank must know its endgame.  It is difficult to have sub-50% efficiency if you are trying to be both retail and a business bank at the same time. It is difficult to generate consistent risk-adjusted performance without domain expertise in certain lending categories. Finally, there are many banks out there that place a strategic imperative on growth and end up sacrificing the very elements that really matter to performance.

 

 As difficult and complex as chess is, banking is even harder. There are at least two other dimensions (space and time) to manage for, not to mention multiple competitors.  The data shows that the best investment that a bank can make is to figure out ways to generate more fee income. However, before banks add a wealth management division or jump overdraft fees, a set of goals need to be defined to clearly articulate the path and timing to get to where management wants to be. Banks would be well served to take another look at their endgame, then review their business model and then pick a set of strategy and tactics. Almost all 400 top performing banks have a clearly defined strategy that is very different than the common community banking model. Like in chess, winning is about a sound strategy and great execution. 

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