Bad loans: A sperate affairs<\/p>\n
By Andrew Cainey & Andrew Clark<\/p>\n
JAKARTA (JP): Banks need to separate their current operations
\nfrom the resolution of problem loans. Without this clarity,
\nongoing business will be neglected and a work out will suffer
\nfrom lack of concentrated effort appropriate expertise. Clear
\nseparation is important because the objectives, pace, type of
\npersonnel required and measures of success are all so different.<\/p>\n
Speed is of the essence in the work out: success rates in
\nrecovery drop off steeply as every week goes by. Believing that
\nyou will get 100 cents on the dollar is unproductive, which is
\nwhy you need different people working on the bad credits. Those
\nwho were involved in extending the original loan are less willing
\nto settle quickly and move on to the next case.<\/p>\n
\"Bad bank\" executives must be given clear negotiating
\nauthority, and staff should be added up to where marginal cost
\ncan no longer drive marginal revenue. It is also advantageous
\nthat customers view this group as separate from their regular
\naccount executives. On the other hand, prudence must be the
\nwatchword for the ongoing \"good bank\" operations; credit
\ndecisions must be carefully studied, costs controlled and
\ncustomer service delivered to a high standard.<\/p>\n
Over the past few months, the Boston Consulting Group has seen
\na number of Asian banks involve every one of their talented
\nexecutives in bad loan resolution, which soaks up all their time
\nand leaves none for maintaining ongoing business. The risk of
\nthis approach is that there is no underlying business to return
\nto when the nonperforming loans are resolved.<\/p>\n
To further protect the ongoing business, banks that have not
\ndone so already, need to revamp their credit processes and tools,
\nmoving from asset-based to cash-flow lending. In addition, they
\nneed to free themselves of the type of top-level relationship --
\nor government -- directed lending demonstrated across Asia.<\/p>\n
An effective recovery process is the biggest lever a bank has
\nin a crisis economy. Once bad loans have been reserved, any
\nincremental recovery goes directly to the bottom line. Even the
\nhealthiest Mexican banks, which sold U$19 billion of bad loans to
\nthe government, are still focusing on the recovery process; under
\nthe terms of the bailout, banks continue to hold a 25 percent
\nstake in all loans they have sold.<\/p>\n
To deal with profit pressure, banks need to reengineer and
\nrestructure to reduce costs. Banamex and Bancomer, two of the
\nmost profitable banks in Mexico, have such programs underway.
\nBanamex is preparing to lay off 10,000 of its 31,383 workforce.
\nBancomer has announced an additional 8 percent reduction in its
\nworkforce in 1998. Bital has sacked nearly 4,000 of the 4,389
\nemployees that came with its acquisition of Banco Altantico.<\/p>\n
While many Asian banks have undertaken similar efforts, they
\nhave not usually included cost cutting. Staff lay offs, typically
\nthe major source of cost reduction, are anathema in this region
\ngiven the absence of social safety nets and have been avoided by
\nleveraging rapid growth instead.<\/p>\n
Most Indonesian banks have not actively played the key roles
\nof a banking system: the filtering and selection of investment
\nopportunities, attracting customers and profitable lending
\nactivities.<\/p>\n
In the future, Indonesian banks need to aggressively build the
\ncapability to filter the good risks from the bad risks. This
\nmeans better collection and analysis of customer information. It
\nmeans banks need to conduct probing industry analysis. As the
\njudgment and experience is scarce today, banks will initially
\nneed to centralize loan decisions in the hands of those with the
\nmost experience. As capabilities grow, branches can play a more
\nactive role again.<\/p>\n
Above all, success requires a new mind-set and the courage and
\nability to say \"no\" to unattractive but large lending
\nopportunities.<\/p>\n
Banking crises usually create a high interest rate
\nenvironment. In Sweden, the interbank overnight rates went as
\nhigh as 500 percent, while in Mexico, the interbank overnight
\nrate leapt to 109 percent at one stage. Similar developments have
\noccurred in Indonesia, where the interbank overnight rate reached
\n150 percent for some smaller banks.<\/p>\n
This causes problems for banks without local deposit bases.
\nForeign-sourced funds dry up due to risk aversion and the central
\nbank becomes the primary source of liquidity. But increased cost
\nof funds often cannot be passed on, either due to preagreed loan
\npricing or client inability to pay. Thus, banks that fund
\nthemselves on a wholesale basis find their margins dramatically
\nsqueezed, if not negative. In Mexico, all lending businesses were
\npushed into the red, even before considering bad debt losses
\nbecause banks were unable to reprice loans fast enough to keep up
\nwith the increasing cost of funds.<\/p>\n
Banks that already have strong retail networks in the right
\nlocations can leverage these with higher rates and focused
\nmarketing. Banks with poorly placed branches or few branches at
\nall should consider strengthening their retail network through
\nacquisition.<\/p>\n
According to the Boston Consulting Group, there are two areas
\nfor domestic mergers and acquisitions. Banks need to think beyond
\nprice\/value and consider complementarity or overlap. In the
\nfirst, a bank with a strong presence in Jakarta may want to
\ncapture a nationwide retail operation by acquiring banks which
\nfocus on other regions.<\/p>\n
In the second, a merger of two banks creates opportunities for
\ncost reduction and branch closure. For foreign capital
\ninjections, domestic banks can benefit from thinking through
\ntheir preferred source of capital and positioning themselves
\nappropriately. Foreign players will typically want to invest in
\nthe stronger banks, not the weaker ones.<\/p>\n
In Mexico, Bital has emerged successful from the crisis. While
\nrelatively small, it is considered to be one of the leading
\nbanks, particularly in terms of new product innovation and
\nmarketing. With the marketing experience of its international
\npartners, Banco Central Hispano and Banco Commercial Portugues,
\nit has created a small revolution in the retail banking segment.<\/p>\n
It was the first bank to open afternoons and weekends, forcing
\nthe rest of the sector to follow to defend their share. It rolled
\nout an impressive array of new products for the consumer, ranging
\nfrom credit for small appliances (BitaBonos) to innovative
\nsavings products modeled on the informal economy (Tandas). Bital
\nalso leads the sector in new branch openings, going from 450 in
\n1994 to 1,218 in 1997. All of this has been supported by an
\naggressive advertising campaign poking fun at the rest of the
\ntraditionally staid banks.<\/p>\n
Finally, whatever merger and acquisition decisions are made,
\nthey must be executed well. To realize the benefits -- greater
\nmarket penetration, increased scale in asset management, cost
\nreduction -- integration must be handled as a discrete, explicit
\nprocess. Strategic objectives must be clear and decisions must be
\nmade quickly, communicated openly and executed relentlessly. Many
\nmergers actually destroy value because they are not properly
\nintegrated.<\/p>\n
Banks that waver, risk losing key personnel, high-value
\ncustomers and the momentum to make drastic cost reductions.<\/p>\n
The main value of in-market mergers comes from growing the
\ncustomer base while reducing costs. If, however, customer
\nattrition is not carefully managed, the value is lost. In one
\nrecent Mexican example, the acquiring bank should have boosted
\ndeposits by 30 percent, yet one year later, its market share was
\nactually below the premerger level. In a different Mexican
\nexample, disgruntled former employees of an acquired institution
\nwho felt they were treated unfairly took their customer lists to
\ncompetitors.<\/p>\n
Times are hard, and there are many urgent issues to distract
\nsenior managements. Only the institutions that focus on the five
\nkey success factors will emerge as strong competitors in the new
\nenvironment; banks which can honestly say that:<\/p>\n
* their ongoing business and work out problems are being run
\nseparately by focused groups of experts,<\/p>\n
* intensive cost restructuring is underway,<\/p>\n
* they have a program to build risk management capabilities,<\/p>\n
* they have a secure and expanding deposit base, and<\/p>\n
* senior management has clear views on complementary mergers and
\nacquisitions, as well as concrete plans for execution<\/p>\n
Should be comfortable that they are on the right path.<\/p>\n
Andrew Cainey is a vice president of the Boston Consulting
\nGroup and Andrew Clark is a manager of PT Boston Consulting
\nIndonesia.<\/p>\n
Window: Most Indonesian banks have not actively played the key
\nroles of a banking system: the filtering and selection of
\ninvestment opportunities, attracting customers and profitable
\nlending activities.<\/p>",
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