And how IROs can use that information to their advantage
Imagine you are on the short list to become the head of investor relations at a bank. The interview is going well and it looks like you’re going to get the job. But then the conversation turns to rewards.
The recruiter explains that the CEO is rewarded for increasing the bank’s price/book value. He or she gives you a blank sheet of paper and asks you to write down how you would increase the bank’s price book ratio. What would you focus on? Return on equity (ROE)? If so, you’ve failed the interview. ROE as a measure has completely lost credibility, given that some very high ROE banks failed during the banking crisis.
In fact, there is an inverse correlation between historic ROE and bank failure. Many of the lower ROE banks came through the banking crisis better. They had more conservative equity/total asset funding, while higher ROE banks did not reward shareholders because their business models were too risky.
ROE does not equal shareholder value. So what does? The Bank of England and the Max Planck Institute for Human Development in Berlin have done a detailed study on this, titled ‘Taking uncertainty seriously’, looking at the simple rules of thumb that helped predict which banks would come through the crisis and which wouldn’t. Inspired by this, we decided to look at successful banks across the world, to see what they are doing right. We then formalized this into a kind of Piotroski Score for banks that we have just launched called Lafferty Bank Quality Ratings.
The 15 criteria used to determine a bank’s quality rating are both quantitative and qualitative and were arrived at after extensive interviews with senior bankers, regulators and investors around the world. These include return on assets, equity capital and deposit funding as well as strategy, culture, customer satisfaction and management experience. Banks’ annual reports were then mined for our ratings, with the resulting score translated into star ratings that range from five for the best banks to one for those at the other end of the scale.
The results of our first 100 ratings of the largest banks by market capitalization across the globe are fascinating, offering such insights as:
– There are many different successful banking models, but unfocused universal banking is not one of them
– The best banks are focused on retail or corporate banking, or a combination of the two
– Most of the best banks come from emerging markets like South Africa, Malaysia or India – and many are relatively young
– High-rating European and US banks are few but include Handelsbanken and Swedbank from Sweden, TSB from the UK and Discover from the US.
How does this help your position as potential head of IR at the bank, however? Rather than talking about ROE, tell the interviewer the CEO must concentrate on building sustainable earnings. The price/book value will then take care of itself.
A former Financial Times journalist, Michael Lafferty is chairman of the Lafferty Group
