In my previous article I suggested, using scenes from the film A Beautiful Mind that game theory could explain why more than 50 banks exist in an economy too small to commercially need such business. The idea is basically that banks choose to be mediocre because competition would harm them to the benefit of customers.
The feedback was tremendous, and I would like to expand on some of the points made. The first is the concern that I might antagonise people in the banking system. I believe that transparency and open dialogue fosters a healthy commercial environment and that most people will listen if your intent is positive. The few people who have a closed mind might react negatively to new or open ideas. One just needs to accept that this exists and hope that the greater good outweighs any personal backlash.
The second point raised is that the simpler explanation for bank behaviour is incompetence. Although possible, I find it hard to believe. First, incompetence leads to bad service, not mediocre service. Second is that I have dealt with a large number of executives and most seem quite competent to me. This seems to be more of a strategy, albeit a possibly unconscious one.
Finally there is the question of what could be done. There needs to be a trigger to change such a cosy situation. The banks have no incentive to change; the customers have no power if the banks do not compete – that leaves the shareholders. A potential catalyst could be a plummeting return on equity as the banks deleverage in a contracting economy.
The shareholders of the global foreign banks are unlikely to pay attention to the behaviour of local operations. That leaves local banks, which are mostly owned by a diverse shareholder base and if there is a large shareholder it is usually a government entity. In the case of no large shareholder, it is usually impossible for the shareholders to act collectively to effect change. In the case that the government is the main shareholder it would seem that policy issues could be challenging to overcome. Could you imagine the government forcing commercial improvements that lead to job losses or to loan defaults?
The answer in both cases is the activist asset manager. An activist investor acquires a large number of a company’s shares with the aim of garnering board seats so as to effect major change that would increase shareholder value. An activist asset manager simply does this on behalf of shareholders.
The idea here would be for an activist asset manager to find banks, or even other listed companies, that are not performing at their full potential because of ineffective or inefficient management and to then acquire shares to influence the board and unlock this potential.
The government and regulators can help to foster an environment supportive of activist investors in a number of ways. Strengthening corporate governance regulations and transparency would help investors in understanding where the potential value lies. Similarly, strengthening shareholder rights, particularly their ability to remove board members, could help to open the door for activist investors.
Moving from the regulatory side to the commercial side, there are two main ways that governments can help to improve effectiveness. The first concerns their shareholding, which can dwarf other shareholders and in some cases constitutes a majority. Ideas include refraining from voting on board members, giving other shareholders the ability to vote a majority of the board or even placing the government shareholding with an activist asset manager.
The second commercial facet is the business, in terms of deposits as well as loans, that the government gives to banks. I do not know if banks owned by the government get preferential treatment, but a transparent and equitable policy could remove the maverick risk for banks that want to try something new.
The benefits of such changes are not simply to the shareholders and customers of banks. It creates a market culture that becomes attractive for foreign investors and can help to substantially increase inward foreign investment.
Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at Al-binali.com