Ask David Conner, chief executive officer of Singapore’s Oversea-Chinese Banking Corp., what makes a world-class bank and he smiles and tells the story of how he was hired. It was April 2002, and Singapore’s banks faced a struggling economy, poor demand for credit and rising competition from foreign lenders that had just won greater access to the Singaporean market.
Conner, then 53, had taken charge of OCBC after 25 years as an executive at Citigroup Inc. divisions in Singapore, India and Japan. When Conner -- who grew up in St. Louis -- sat down with OCBC’s top directors, they told him they wanted him to make the lender a world-class bank, Bloomberg Markets magazine reports in its June issue.
“What is a world-class bank to you?” Conner asked.
One board member responded, “You tell us.”
Conner worked up a presentation outlining his goals. Among the high points: focus on the customer, establish a strong capital base and minimize risks. He appears to have achieved those goals. Based on its performance for the 2010 fiscal year, OCBC, founded in 1932, ranks as the world’s strongest bank, according to data compiled by Bloomberg.
OCBC is one of three Singaporean banks that make the top six in the Bloomberg Markets ranking. The other country that’s prominent on the list is Canada. National Bank of Canada is No. 3, and the country has five banks in the top 20.
No. 2 is Svenska Handelsbanken AB of Sweden.
Canada’s performance in the ranking “shows that size is not everything in financial services,” says Louis Vachon, CEO of National Bank.
Just three U.S. banks -- Fifth Third Bancorp (No. 7), JPMorgan Chase & Co. (No. 14) and Citigroup (No. 16) -- make the top 20.
The ranking includes banks with at least $100 billion in assets. It weighs and combines five criteria, including Tier 1 capital compared with risk-weighted assets; nonperforming assets compared with total assets; and efficiency, a comparison of costs against revenues.
Tier 1 capital includes a bank’s cash reserves, outstanding common stock and some classes of preferred stock, all of which combine to act as a shock absorber against losses when the economy hits a rough patch.
“Singapore banks would score very high here largely because, historically, the Monetary Authority of Singapore has always required Singapore banks to keep more Tier 1 capital than other banks,” Conner says.
DBS, UOB Also on List
The MAS is both the central bank and chief regulator of Singapore’s financial system.
Singapore’s DBS Group Holdings Ltd. ranks No. 5, while United Overseas Bank Ltd. is No. 6. OCBC and UOB shares led Singapore’s benchmark Straits Times Index’s 0.6 percent advance today. OCBC shares rose almost 1 percent to S$9.39 and UOB shares gained 2.1 percent to S$19.38.
OCBC has operations in 15 countries, including a strong presence in China, Hong Kong, Indonesia, Malaysia and Taiwan. It was founded by the Lee family, and their descendants are still the biggest shareholders.
Billionaire Lee Seng Wee, 80, is a former chairman of the bank and still sits on its board. His son, Lee Tih Shih, 47, is also a board member.
Hugh Young is a Singapore-based managing director of Aberdeen Asset Management Asia Ltd. Aberdeen owns about 6 percent of OCBC and more than 4 percent of UOB. Young says he’s not surprised that Singaporean banks score so highly on a global ranking.
“We are big holders of OCBC and UOB and have been for a long time simply because they don’t do the stupid things Western banks do,” says Young, who helps manage $70 billion in Asian equities. “They don’t do things like lending 120 percent of the value of a property to people without a job, and they don’t do stupid things in the derivatives markets and proprietary trading.”
Not all of the strongest banks are exemplars of smart banking practices. No. 16 Citigroup was rescued by $45 billion in U.S. Treasury loans and investments in 2008 after it was deemed by the Federal Reserve, the Federal Deposit Insurance Corp. and the Treasury to be “systemically important.” Its stock has quadrupled since it hit its all-time low on March 5, 2009. At the end of last week Citi did a reverse split of its shares, which raised the price ten-fold, to $44.16 at the close of trading May 9.
“Citi is a much underappreciated recovery story,” says Kevin Conn, an equities analyst and co-head of the financial services research team at Boston-based MFS Investment Management. “They overmedicated the balance sheet, raising too much equity and setting up massive reserves. It’s a very strong balance sheet at this point.”
All major banks march to the tune of the Basel Committee on Banking Supervision, an arm of the Bank for International Settlements, based in Basel, Switzerland. The committee issued its first internationally agreed upon capital guidelines, known as Basel I, in 1988. The early rules focused narrowly on banks’ credit risk: the possibility that borrowers might not pay back their bank loans. The committee recommended that banks’ cash reserves, common and preferred stock total at least 4 percent of assets.
The rules changed in 2004 with the adoption by regulators of Basel II, which set more-sophisticated guidelines for how to assess and quantify the risk of a bank’s assets, much as a modern blood test breaks down cholesterol into good HDL and worrisome LDL.
Under the standard Basel II guidelines, just 35 percent of a mortgage issued to a family with an excellent credit history would be counted as a risk-weighted asset, while an investment in a hedge fund would get counted for risk purposes at 400 percent of the amount invested.
Bank managements aim to keep their risk-weighted assets -- the bad cholesterol -- low because regulators insist that banks hold precious capital, such as retained earnings, against it.
The 2008 to 2009 financial breakdown sent regulators hurrying back to Basel to rewrite the rules one more time. Basel III, whose basic outlines were approved in November, raises requirements for Tier 1 capital to 6 percent starting in 2015. Basel III also phases in extra capital cushions for very large banks, which could take the total capital requirement north of 10 percent.
Full implementation of Basel III will be phased in over six years to assuage fears by both bankers and regulators that the new capital rules would suppress lending if implemented too quickly.
“Broad-brush-stroke regulatory changes should come with a warning label and with sufficient time for informative exchanges between affected parties,” wrote Donna Alexander, CEO of BAFT-IFSA, a banking-industry trade group, in a September note to members.
Although Asian banks have fared better than their Western counterparts in the downturn, Conner also worries about the impact of Basel III’s capital requirements.
“Keeping the capital ratio high all the time makes it potentially difficult to expand,” he says. “We are operating under considerable uncertainty, and as a result, we’ve added significant amounts of capital.”
Some banks cruise far ahead of regulators.
“For Canadian banks, having higher capital ratios than anyone else in the world is a source of pride,” says Mario Mendonca, a financial services analyst at investment firm Canaccord Genuity in Toronto. Canada’s banks held average Tier 1 capital of 9.8 percent in 2008, as the financial crisis set in.
No Crisis at Canada Banks
The extra cushion paid off when U.S. banks teetered on the edge of failure in the fall of 2008 and had to be bailed out with $700 billion from the Treasury.
“We all went into the downturn with very strong quality of capital,” says Edmund Clark, CEO of Canada’s Toronto-Dominion Bank, No. 12 on the strongest-bank list. Canada also suffered a much milder housing downturn than the U.S.
U.S. banks, meanwhile, are still working to implement the 2004 Basel II accords.
“Currently, in the U.S., none of the banks are calculating their capital requirements based on the Basel II numbers,” says Hugh Carney, senior counsel at the American Bankers Association.
The banks, Carney says, are in a transitional phase called a parallel run, which means they are still operating under Basel I and are testing and calibrating the risk sensitivity of their loans and investments under Basel II. U.S. banks will only shift to Basel II risk assessments once the Fed approves their risk-weighting methodology, Carney says.
Jamie Dimon, CEO of JPMorgan Chase, has emerged as a spokesman for what he regards as beleaguered U.S. financial institutions. He told the Council of Institutional Investors in early April that Basel III was unnecessarily harsh and could crimp global growth.
Most large U.S. banks emerged from the Federal Reserve’s March stress test, the Comprehensive Capital Analysis and Review, with passing grades. The Fed approved the plans of a group of banks, including Citigroup, Fifth Third, JPMorgan Chase and Wells Fargo & Co., to raise dividends or do share buybacks.
Yet, the shares of commercial banks have lagged behind the Standard & Poor’s 500 Index from the day before the report’s release date, March 18, through May 6. Bank stocks fell 1.6 percent on average in the period, compared with a 5.2 percent gain for the S&P 500.
Richard Ramsden, a bank analyst at Goldman, sees no mystery in the bank share slump. In an April 7 note to clients, he attributed the poor performance to the weak housing market, banks’ shrinking loan books and uncertainty on bank capital standards.
The Fed may require institutions such as Citigroup and JPMorgan to hold two extra dollops of capital -- one for being “systemically important” and another as a buffer against economic downturns. As capital requirements go up, banks’ return on equity goes down, Ramsden says. He predicts the ROE of the big U.S. banks would fall 350 basis points if strict rules were imposed. (A basis point is 0.01 percentage point.)
Europe had four banks on the strong-bank list, including Switzerland’s UBS AG at No. 9; Credit Suisse Group AG, No. 13; and the U.K.’s Standard Chartered Plc, No. 15. In mid-April, the European banking industry was undergoing a new round of stress tests being administered by the European Banking Authority. Currency traders gave a quick thumbs down to the last round.
“There’s a lack of credibility,” Brian Dolan, chief strategist at Forex.com, told Bloomberg News last July. In September, just two months after the results were released, two Irish banks that had passed needed a 50 billion euro ($72 billion) bailout from the European Union and the International Monetary Fund to stay solvent.
New Europe Test
MFS analyst Conn says the new test will be a truer measure of bank strength.
“They are making it tougher and taking more account of exposure to sovereign-debt holdings,” he says.
OCBC’s Conner proclaims that his bank can pass anyone’s test. “This bank can meet all the Basel III requirements today, given our capital base, so we are ready,” he says.