ALM Partners organised a large seminar in Helsinki today 2.10.2018 to present some recent developments in banking and insurance asset liability management. The theme is relevant 10 years after the last financial crisis where taxpayers in many countries have been on the hook for banking losses and bankruptcies.
The main speaker was Pentti Hakkarainen from the ECB who is a senior member of the banking supervision there. He dealt with the question “Banks in shackles – myth or reality?”
He reported on the sharp increase in banking regulation but underlined that this was designed to stop taxpayers from footing the next round of losses. Banks are now subject to stronger regulation, must have much larger equity capital and they must have adequate liquidity. Far from shackling banks the new regulations stop unfair competition from undercapitalised banks that are poorly managed. A strong, well-managed bank will always innovate and move with market demands or cease to operate, according to Mr. Hakkarainen.
He admitted that the benefits of these regulations has been offset by lower profitability at first. The return on equity for large banks in the euro area in 2016 was as low as 3.2%, but in Q4 2017 it stood at 6%. He made the chilling remark:“Nonetheless, many euro area banks don’t expect their return on equity to match their cost of equity by 2020. Further, many publicly listed banks still trade at price-to-book ratios below one – which indicates that banks need to improve further to meet investors’ expectations.”
He explained that this average return is not evenly spread and that some banks are doing well by bringing down costs and generate stronger revenues. He explained the success of some banks: “It is the way they are managed and governed. Those that more effectively steer the bank towards a well-specified set of long-term objectives end up doing better. This means keeping a close eye on the detailed drivers of income and costs – and to use sophisticated ways of pricing products in a sustainable but competitive way.”
He sees that regulation should be dynamic and take into account new market realities, but hoped that the present calm can be used to reflect on better strategies for which he sees 3 key fundamentals:
- First, bank balance sheets need to be sufficiently loss-absorbing to safeguard citizens and taxpayers from the potentially excessive costs associated with bank failures. Studies show societal benefits from bank capital peaking at a Tier 1 risk-weighted capital ratio between 16-19%.
- Second, our regulatory structure must continually set the right incentives for banks to manage their risks in a manner that is consistent with societal costs and benefits.
- Third, and most importantly – banks need to govern themselves and their risks in an adequate way. Even very robust regulatory ratios cannot rescue a bank if governance is weak.
The other speakers confirmed these views saying that banks must manage their business well with good banking practices and this means that the asset liability management must become the central core of financial management where both sides of the balance sheet are placed together to create natural hedging under the control and responsibility of an Asset Liability Management Committee that reports directly to the board and is effectively at the same level as the executive board.
This above comment was made by another key speaker, Professor Moorad Choudhry from Kent Business School, and active ALM banker, who saw that supervision is not the key to safe and successful banking but just the minimum. Banks can only thrive by ensuring the true importance of the ALM Committee within a bank and by ensuring that the activities of the asset and liability managers/staff understand the importance of strategic thinking to find cost effective solution to maximise what he calls “natural hedging”.
His reflections are backed up by the organiser, ALM Partners, an interesting company that is the result of a bank’s decision to spin off its ALM division to a company owned in part by the ALM management team. This company now offer their ALM services to other banks and financial institutions. Their success in finding bank clients in Finland and now in other Nordic countries, is an inspiring innovative solution for this rather compact company of 50 employees that work now with much larger banking clients. Since the regulation is the same for all banks and financial companies, it makes sense to work with a smart service provider that can advise and assist with regular supervisory and management reports in a secure manner. It cuts costs and clearly improves efficiency.