by Rene T. Domingo (email comments to rtd@aim.edu)

Two external events, the ongoing Asian financial crisis and the internet boom, are putting pressure on the conservative banking industry to redefine itself. Both events are challenging banks to shift from custodianship to entrepreneurship. This paradigm shift is not going to be easy, for most banks systems and policies are still firmly anchored on what is obviously tried and tested. Will traditional banking be an anachronism, sooner and not later?

A Lesson from The Asian Financial Crisis

The Asian financial crisis has taught many Asian banks the perils of bandwagon lending and the traditional collateral-based lending. With real estate prices and infrastructure soaring to new heights prior to 1997, banks further fueled the frenzy with aggressive marketing and massive lending to the booming real estate and construction sectors. This thrust by the banking industry was by no means entrepreneurial in nature, but revealed its entrenched conservative mindset that says: “follow the crowd.” Even those which gave out unsecured real estate loans were not taking entrepreneurial risks since given the reassuring trends and times, they thought the real estate sector has transformed from speculative to blue chip. Ironically, the more cautions and conservative of banks which opted to give out only collateralized loans were not spared by the crisis. The reason is simple: the collateral they were holding were mostly in real estate, “the traditionally preferred collateral”, the very sector which suffered a direct hit. Most of these loans have in effect become under-secured. But the real disaster, whether the banks are in secured, under-secured, or unsecured positions, was most of these loans, real estate or not, became sour and non-performing. Those secured may seem to have suffered less damage, but in reality, they gained practically nothing, for the assets and collateral foreclosed are not marketable and cashable at least in the short and medium term. Moreover, these assets are expensive and difficult to manage while in the bank’s possession. Even with the popular “dacion en pago” solution, while it may clean (window dress) the bank’s balance sheet of NPL’s, the banks have become more and more saddled with real estate property they cannot dispose, liquidate and manage.

A entrepreneurial bank would have easily seen and avoided the incoming train at the end of the tunnel, given the real estate bubble already bursting in Thailand and Japan at that time. An entrepreneur is not one who takes any risks, but one who knows how to take the right risks and avoid the wrong ones. The Asian financial crisis, has shown at least by hindsight, that given a bandwagon boom that is leading to a cliff, the most entrepreneurial and prudent of all moves was to do nothing. Bandwagon lending is not entrepreneurial, but conservatism at its most subtle and dangerous form. The unfinished and abandoned buildings jutting out of the skyline of Asia’s major capitals are grim reminders to the banking industry to think and act entrepreneurially.

The Internet Boom – A new lesson from the new economy

While the Asian financial crisis has shown how conservatism has led banks to jump into the wrong risks, the internet boom has demonstrated again the conservatism of most banks, this time from the other end of the spectrum. Banks have practically avoided financing new economy ventures and internet-based upstarts. Financing and investing in these new and maverick companies are mostly the entrepreneurial venture capitalists (VC’s). It is easy to find out why banks would rather touch internet companies with a ten-foot pole. They do not fit the banker’s paradigms:

Banks need collateral to secure loans, and look for the bricks-and-mortars in potential borrowers. Internet companies have no assets, except probably a rented garage and an empty wooden crate that serves as the CEO’s chair.
Banks need history of past successful and profitable performance to support loan application. The borrower has to prove that it doesn’t need money, as the old saying goes. Internet companies have currently no past, no history, no performance, no success, and no profits.
Banks need the credentials and glowing references of the project proponent or borrower. The founders and entrepreneurs behind internet companies have no experience (especially in the business they are in), no friends, and are not part of traditional business and social circles. Many of them are college drop-outs, uncouth, unknown mavericks and rebels in their fields. Only their mothers know them and can vouch for them.

Unless there are drastic changes in these banking paradigms, the banks will remain onlookers and would continue to prefer and cater to the brick-and-mortar, flesh and blood accounts. In short, they will miss the vast opportunities carried by the coming wave of global technology-driven economic revolution

In contrast to the banking industry, the securities industry has looked more kindly and pragmatically at the new economy companies, many of which are profitless. For instance, since these companies have no earnings, the stock market has shifted its yardsticks from Price/Earnings (P/E) ratio to another type of P/E ratio -- the Price/Eyeball ratio, where eyeball represent and measure the number of website hits or customers who browse the companies’ websites. While banks would like to track the cash flow of borrowers, the stock market tracks website guest flow and other indicators of actual and potential market dominance. Using new and appropriate yardsticks, the stock market has rewarded many internet and technology companies with soaring market capitalization that can easily dwarf those of the world’s major banks.

Inventing the entrepreneurial bank

The two events described above have taught the banking industry that conservative policies are not shields from financial ruin. They not only can lead to problems but more importantly, they can also hide opportunities. A new kind bank in the new millennium has to be invented – the entrepreneurial bank or “entrebank” as I would call it - a bank that would withstand future global and regional economic crises and be at the forefront of advancing the technological revolutions. Like the venture capitalists, entrebanks will be forward looking and not backward looking. They will know how to discern and take the right risks.

Entrebanks will be less cash flow and less collateral oriented. They will give more importance to the quality of the business of the borrower than to the quality of its collateral. They can look beyond the obvious, the tangible, and the past. Rather than invest in systems and people to track and manage the borrowers’ credentials, cash flows, and collateral, the entrebank will use these resources to develop industry specific expertise so that it can correctly evaluate the business potential of its clients and guide them accordingly. Enterbanks will serve as proactive business consultants rather than overly protective custodians of public money. They will know and understand the businesses of their clients. Paradoxically, the more a bank think and act entrepreneurially, the more it can safeguard the money entrusted to it.

The management of entrebanks will behave like businessmen rather than bankers. They will be result oriented rather than cost oriented. Consequently, entrebanks will have the flexibility to provide services at cost, at a loss, or for free, whichever is appropriate, in order to retain and/or expand the core business of its clients. For instance, for premium clients – borrowers or depositors -, the entrebank will waive the annual membership fees of their credit cards or safety deposit box fees. Similarly, in case of service failures, entrebanks will compensate the client for his inconvenience, just like what hotels and airline do to appease and retain displeased and angry customers. We have heard of stories of fine restaurants and hotels that do not charge the customer for services and food if case he complains of long waits, discourteous personnel, or wrong bills. I have not seen a bank that compensates clients for failed ATM transactions, like the common case of no-cash dispensed but the account is debited. To add insult to injury, the offended client is even asked to file a written complaint if he wants his account corrected and get his money back. Entrebanks will look at these service problems as opportunities to create loyal customers, rather than as reasons to lose them.

Entrebanks will be organized according to clients’ total needs rather than according to products or functions. Like the modern consumer marketing companies, entrebanks will shift from managing brands to managing categories of customer services. They will have a total approach to clients needs by developing customized total solutions- covering loans, deposits, credit cards, securities, treasury bills, and other financial instruments and services. In short, the enterbank will look at the client as the profit center and not the specific products. Maximizing total profits generated by a client will be the goal rather than maximizing the total profits of a bank product, service, or business unit. With this set up, entrebanks can easily and naturally do cross-selling of products to clients. Entrebanks can resort to flexible product pricing and loss leader strategies to optimize total profit per account. Entrebanks will make full use of information technologies like data mining and data warehousing to discover hidden patterns in customer behavior. This knowledge will allow them to bundle and package the right combination of products and services that will truly appeal to and delight the target market segment.

There are no pricing rules for the entrebank. Employing the techniques of revenue management, the enterbank can dynamically price its products, including interest rate levels, according to customer, time, place, and competitive situation. It can charge below cost if need be, or it can charge a fee for a service that is traditionally free of charge. A service may also be created or innovated such that it satisfies a specific need customers are willing to pay for. The entrebank can create new businesses from home delivery services, much like fast food and video rental shops. It can for instance, pick up a check from a client for encashment, and then hand carry the cash to him – for a very reasonable fee that is much less than the cost to the client in doing the chore himself. With the right systems in place, an entrebank representative can possibly encash the check right in the client’s office or home. These “out of box thinking” will be second nature to entrebanks, in sharp contrast to traditional banks which always have 101 reasons “Why it cannot be done in banking.”

A lot of reengineering and automation are going on in banking, but unfortunately most of these initiatives are not entrepreneurial in nature. We have ATMs, bank on wheels, bank on boats, bank on malls, electronic banking, call centers, and phone and cell phone banking. These programs are just delivering traditional products faster and more efficiently. The rules and policies in deposit taking, lending, and client selection and screening, in spite of the high-tech automation going on, remain conservative and mired in the old economy. To survive in the new millennium, banks will have to reinvent and reengineer not only their processes and products, but also their policies and business philosophies.