Morgan Stanley talks reform

FinanceAsia: Is Singapore over 50% of your FIG business?

Harrison Young: No, it's not more than 50%, but it might be around 50% on a revenue basis.

Is that a number which is a short-term blip?

A lot has been going on in Singapore. But in the greater scheme of things, while it is an important market, it's only 3 million people, in a region with 2.5 billion.

It takes Asia's top 75 banks to reach an equal market capitalization to HSBC. What does that say about Asian banks?

It says it's a developing region. Most people look at bank market caps as a function of bank capital. And capital is function of risk assets (loans), and loans are a function of GDP. The GDP in Asia relative to developed markets will thus produce smaller banks. But they're going to get bigger.

In the case of say, Hong Kong, which is still a small place, you have Hang Seng which has a market cap of $20 billion. Why should Hong Kong produce banks of bigger market cap scale than Korea, for example?

Hong Kong has produced the Hongkong Bank, and to some extent, Standard Chartered. Hongkong Bank has been an enormously successful bank. Hong Kong has been an international financial centre and banking centre. And Hongkong Bank has had some extraordinarily successful people in its management. So it's a nice mixture of culture and location, the growth of the region, and the fact that Hong Kong was a banking centre.

Do you think the fact that Hongkong Bank had no controlling shareholder was a factor in its success?

Yes. Family-controlled banks have a little more trouble capitalizing on all the opportunities that are available to them. Partly because of a decision making process that may make it hard for them to get beyond a certain size, and partly because families don't want to see their ownership position diluted.

As part of the Malaysian financial masterplan, they have said they don't want families or individuals controlling banks. Is that a good trend?

It depends on the family, but generally yes. The right way for a banking system to work, is for banks to concentrate solely on providing financial services. Banking and commerce should not be in the same enterprise. It is better if the bank is controlled by a broad range of investors whose primary interest is maximizing shareholder wealth, as opposed to other factors that owners of banks sometimes care about.

Do you see consolidation being driven in the Taiwan market by the insurance companies (bringing the banks into holding companies)?

There are some strong insurance companies in Taiwan, which is, in general, not the case in any of the other Asian markets. The government has significant ownership in almost all the major banks. It will thus be a politically centric decision-making process, as in Japan and Korea. I don't think the insurance companies are going to play a dominant role in that process, although there are some good insurance companies.

Do you think the correct model for reforming a financial system is the one being pursued in Malaysia where they are saying, 'this is the size of the economy, this is how many banks we need'. Or should it be driven by market forces?

Talking generally across the region, I believe that both the market and government have a role to play in shaping the financial services sector. It can't be left solely to the free market. A bank is a public trust and you cannot allow the sort of chaos that would happen in a totally unregulated market. So both government and markets have something to say. By itself, either one leads to bad outcomes.

A number of governments around the region seem to have focused much attention on reducing the number of banks, and sometimes that is seen as a solution for more problems than that alone can be a solution for. If a government feels they would like to professionalise their banks and reduce the level of family ownership, one of the ways they can do it, is to say 'we don't want 25 little banks, we want six bigger banks'. In the United States, for instance, people sometimes do mergers as a way to do something else – for example, change the culture of your company. You may need a transforming event to do that.

When people talk about consolidation, they often talk about efficiency and cost saving and there are sometimes discussions where people get confused and think the cost efficiencies will deal with the embedded losses in a bad loan portfolio. If bad loans are one-and-a-half times your capital, reducing your cost structure will help, but it won't solve the problem. Of course, the political process makes it difficult to tell taxpayers that they will eventually have to absorb losses, but governments want to be seen to be doing something by creating financial services holding companies.

I don't think the fundamental problems are the size structures; the fundamental problems have to do with governance and professionalism. And when I say governance I don't just mean how you choose your board of directors. I mean, who is able to influence the credit granting process? Having control of this is a way to get very rich, so there's a political struggle for control of it.

You don't think that process has changed since the crisis?

I think there has been a good deal less reform than people expected.

The Lex column in the Financial Times spoke about Citigroup's second quarter earnings, and said Citi was a "model of stability". Is Citigroup a model for Asian banks to aspire to?

No. It's too big, it's too complicated and the product of a whole variety of franchises that have been created over 100 years. The managerial and credit discipline of the Hongkong Bank is probably a better model for Asian banks to aspire to.

Do you think Asia will move to a bancassurance model?

You think it should, but it's amazing how hard it is to make it work. Life insurance is a very tax-dependent product. One of the reasons it is so successful in France is because of tax implications.

Is there reason to be optimistic that the Singaporeans will be able to create regional banks in Asia?

Yes. Look at Singapore, which is itself a creation. I would hate to bet against Lee Kuan Yew and his successors achieving anything they set out to achieve based on their record over the last 40 years. Because it is a small country, it has had to think about its place in the region as opposed to being complacent. So I am inclined to believe its banks will be successful in being outward-looking in the years ahead.

You used to run CICC, so you may have a view on this: Over the next 10 years do you think the Chinese banks will attain a regional presence in Asia?

The Chinese will focus mostly on China. China is a continent of itself. The opportunities there are enormous and they have a certain amount of competitive advantage.

How has the bank capital management issue been evolving in Asia?

The capital management discipline has been coming to Asia. Three years ago, you could go to a bank in Singapore or Hong Kong that had a 17% tier-one ratio, and say 'Don't you think there could be a more efficient way to run your company and they'd say 'Well, that's fine in theory, but what would I do with the money?' That's been changing.

What has been the catalyst for the change?

I don't think there has been one magic catalyst. People read financial magazines that talk about it and at some point say 'I wonder if I should know more about this?'. OCBC hired Chris Matten, a world expert in bank capital, so others knew that OCBC was going to be more efficient in managing its capital. Inevitably, if they start doing transactions others will be watching. I suspect that regulators have not played an enormous part in this process, because regulators almost never do. I was once a regulator and I never had a colleague that thought a bank had more capital than they liked.

Have Hong Kong and Singaporean banks always had the highest capital adequacy ratios in the world?

In my memory they have. Part of the reason is you have family controlled institutions that say 'Where else am I going to put the money?'. Part of it can be a desire to be extremely safe – Hong Kong doesn't have deposit insurance. Also there is no particular tax pressure, which can be an issue in some jurisdictions.

Do international investors understand the issues relating to Asian banks? One investment bank said when they took a bank on a sub-debt roadshow, most people had never been told the story of a bank like this before.

Most people outside of Asia don't know much about Asia, starting with the fact that they think Asia is a place, as opposed to an incredible diverse collection of countries and markets. All Asian-based banks have an extra burden of explanation because it's a faster growing more dynamic region.

Showing quality management to international investors is very important. Unfortunately, as investing becomes more globalized, that will put those banks from smaller markets at a disadvantage. Investors will increasingly question whether it is worthwhile to invest the resources in understanding each market. That's one of the factors that will drive regionalization.

Does it make a difference when you have senior expatriate professionals like Chris Matten going on roadshows? Does that make London and New York investors more comfortable?

What investors want to see is a commitment to worldscale best practice, and one of the ways you can achieve this is by recruiting on an international basis. This does not necessarily mean expatriates; it may mean people from the country in question who have experience in other markets. I would also say that investors will also want to see people from the bank's home country who are very good. If all you saw were non-Koreans coming to talk about a Korean bank, you'd scratch your head and say, 'I'm not sure this is a sustainable personnel strategy'.

You got a very good price in the sale of Dao Heng to DBS. Will this slow down the pace of Hong Kong consolidation, because other families will want similar prices?

We didn't get that multiple. Quek Leng Hai got that price. The reason the deal occurred on the terms it did had to do with his skill as a negotiator and his sense of timing as an investor. It was also a strategic matter to DBS. Most people in this market recognize that was an exceptional transaction, and I don't think there are any bankers or owners of banks in Hong Kong saying 'I want 3.3 times book'. They may be saying they want 2.5 times book when 2 times book is more realistic. That was such an exceptional transaction that it didn't spoil the market.

However, I would also say that the outlook for profitability of Hong Kong banks has weakened. It's going to be a tough market and I don't know of a long list of foreign banks that want to come and buy a bank in Hong Kong.