Published: March 01, 2010
The recent financial crisis has changed the financial markets – and the players within them – dramatically and irreversibly. Unlike previous economic downturns, the effect of the crisis was synchronised across all of the world’s major economies. Even countries that did not sink into negative growth, such as China and India, saw significant government intervention to shore up the financial community. The start of 2010 has seen positive economic signs continue in most regions, but uncertainty remains, particularly relating to the speed and sustainability of growth, and the regulatory response to the crisis. This article considers the economic outlook, which although brighter than a year ago remains fragile, and explores what financial institutions require from their UK banking partner in this environment.
Although many of us can remember previous economic downturns, such as 1975-76, 1981-2 and 2002, the most recent crisis is unique in both the depth of recession (Figure 1) and the synchronicity across markets. The UK experienced negative growth of 6.1%, around the mid-point compared with other major economies, with Ireland at one end of the spectrum -12.3% and France -3.5% at the other (Figure 2).
We saw unprecedented LIBOR-OIS spreads in October 2008, and although these narrowed relatively quickly, it was almost a year before liquidity in inter-bank markets returned to normal levels. This has been accompanied by a return to flat or positive growth in most countries, although this has been slower in some markets than others, including the UK.[[[PAGE]]]
In the UK, banks and regulators are working with a variety of different hypotheses and scenarios with respect to economic recovery, from a ‘base case’ of steady recovery from 1.8% in 2010 to 2.9% in 2012, with sustained business and consumer confidence and slow deleveraging. However, this scenario does not take into account the impact of any shocks either to the markets or to confidence levels which could trigger restrictions in credit in the wholesale funding market, further tightening in public finances and reduced spending, all of which would contribute to a prolonged negative impact. This downside scenario would have a considerable impact on financial institutions, not least the need to shrink balance sheets and the potential for further consolidation in the banking sector. Changes to regulation, particularly the demands for higher liquidity standards, may require financial institutions to increase borrowings further, reduce assets and/or lower customer lending.
Although the situation remains fragile, however, the signs are positive both in the UK and on a global basis for organisations that have robust balance sheet funding and a strong capital position. To emerge strongly from this vulnerable period, financial institutions need the right business partners with whom they share a trusted relationship, and who have a commitment to excellence in execution, and a detailed understanding of their needs and constraints.[[[PAGE]]]
Like many banks, Lloyds Banking Group has experienced challenge and change over the past 18 months, but 2009 was a year of major progress and the group has been recapitalised, positioning itself for growth. Lloyds is now considered a UK bank of choice for overseas financial institutions that need to access the UK to provide transaction services to their customers, or to access the UK investor base. We are able to add significant value to these clients in a variety of ways, such as giving access to our branch network, delivering customer convenience and robust processing capability. Our strategic objective when working with our financial institution clients is to understand and respond to their current needs and to support their ongoing objectives.
We know from our own experiences and those of our clients that funding and capital adequacy are amongst the most significant considerations of financial institutions today. Addressing these areas in a way that satisfies both investor and regulatory requirements is a key way in which financial institutions can position themselves to survive this period of ongoing market fragility and to flourish as economic conditions strengthen. Financial institutions today are looking to extend the tenor of funding and diversifying their sources of finance, whilst managing the new liquidity rulings the banks and financial institutions are about to have introduced. This requires a combination of innovation and conservatism. The days of highly complex financing structures with embedded derivatives and opaque terms are arguably over; however, there remains considerable scope for innovation in order that an investment is attractive to investors and regulators while still achieving the firm’s objectives.
To be successful in this, a banking partner needs to have a clear understanding of the client’s needs, constraints and future strategy, and to form a close and balanced relationship. In addition, the bank needs a detailed awareness of the needs of investors and regulators in order that a financing structure receives support from these key groups. Lloyds has a unique insight and experience in bridging the requirements of clients, investors and regulators, and is a proven partner of choice for those seeking financing in the UK.[[[PAGE]]]
Building relationships with financial institutions usually requires a local presence in clients’ home country, backed by strong processing capabilities at home. Lloyds has adopted a proactive approach in new markets, leveraging our expertise and execution capability to add greater value to client relationships. Maintaining a local presence enables us to establish close relationships at a senior level, recognise risk factors and maintain an awareness of local issues that influence our clients’ needs. In Asia, for example, we support a large number of clients in China, Hong Kong, Singapore, Japan, Korea, Australia and New Zealand, and consequently we have established local support for these countries. In China, clients’ current needs differ somewhat from those in western Europe. Liquidity in domestic currency is less of an issue, but sourcing USD is a greater challenge and dealing with onshore markets is even more time-consuming. Access to capital and maintaining an appropriate size of balance sheet are key requirements, particularly as in China, and also Japan, regulators have indicated that banks need to increase the level of capitalisation. Furthermore, banks are seeking overseas investment products that local banks may not be able to deliver, and as the financial markets mature, Lloyds’ best practice expertise in setting up and managing financial entities is proving invaluable - an example of which is in the distribution of structured investment products. The Lloyds name is considered attractive in these markets as people recognise the quality of the brand, synonymous with banking in the UK.
Financial institutions seeking to establish and execute a clear strategy in a still uncertain market need business partners who combine a conservative approach to risk with the ability to develop innovative financing structures and excellence in execution. As market fragility continues, it is important that banking partners are in regular dialogue with both investors and regulators to ensure that solutions meet both sets of requirements. The innovative nature of our own liquidity management exercise, as well as our experiences with all client types, means that we have a unique insight into funding the balance sheet, market and pricing intelligence which we can bring to our clients combined with excellence of execution.
It is an exciting time ahead of us despite recent market trends, however financial institutions like Lloyds have to be able to evolve to become increasingly agile and with the desire to be successful as we progress in the future!
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