HSBC SHOWS THE DIMINISHED VALUE OF GLOBAL BANKS / THE WALL STREET JOURNAL

Heard on the Street

HSBC Shows the Diminished Value of Global Banks

Is size worth the diseconomies of capital and funding, legal risks and other costs?

By Paul J. Davies

Feb. 23, 2015 8:41 a.m. ET
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    HSBC Chief Executive Stuart Gulliver Photo: Agence France-Presse/Getty Images


For HSBC , the bad news just keeps coming.

The bank abandoned targets for return on equity and costs when announcing full-year results on Monday. But put alongside revelations over client tax evasion in Switzerland and the recent fines in Mexico and related to foreign exchange trading, it is further reason to ask whether the structure of such a large, global bank is working against it.

Even if HSBC’s Swiss business has been entirely overhauled since the bad behavior that got the bank in trouble, there remains a legitimate question whether the group is too big to manage.

Executives can never hope to know what every single employee is up to. And Stuart Gulliver , chief executive, argues banks are being held to higher standards than any other private or public institution.

HSBC’s old culture of country heads being “king” has been replaced, he adds, with regular peer-review by other group executives. That sounds better but hardly bulletproof. Risks of legal problems will remain.

Meanwhile, there is a painful symmetry in the higher capital HSBC says it needs and its lower expected returns. The bank hopes for a return of greater than 10% in the medium term instead of the previous 12%-15% target. This is mainly because it has lifted its goal for core equity capital from greater than 10% to 12%-14%.

It no longer has a cost target: where it aimed for a cost-to-income percentage ratio in the mid-50s, it now simply wants to grow revenues faster than costs.

Expectations for HSBC’s earnings and dividends will have to be pared back. But the real question for investors is whether there is value in such a globally systemic institution existing in its current form.

There may now be such diseconomies of banking scale that the answer is no.

HSBC has one of the highest capital needs of any bank because it is one the biggest and most complex. And yet rules designed to ensure each part of a very large bank can be wound down separately in the event of big losses mean that each subsidiary must have its own capital at hand. In future, subsidiaries will also likely need their own bonds that can be written off or converted to equity.

Ultimately, a bank like HSBC will increasingly look like a collection of individual banks. Each must have at least the capital it would as stand-alone bank but with an added buffer at group level and its own bonds to meet total loss absorbing capital, not required at stand-alone rivals.

Covering those additional costs means, for example, running a single IT services unit for the group or churning out financial products that are as similar as possible globally. HSBC says 40%-50% of its commercial banking revenues depend on it having a global network. That may be true, but that business won’t cease to exist should all banks become smaller and simpler.

Ultimately, it is increasingly difficult to believe that the benefits available to the biggest global banks are enough to make the diseconomies of capital and funding, legal risks and other compliance costs worth bearing.