Blinkered Policy

In la-la land, there are two banks “Mean and Lean (M&L)” and “Fat and Profligate (F&P)” who had similar balance sheets and profitability figures five years ago. Over the last five years, the two banks have focused on completely different strategies. While F&P has been more aggressive and often reckless in seeking growth, M&L has focused on prudent banking practices.

Over the last five years, the total asset of M&L has grown at a cumulative average growth rate (CAGR) of 15 percent. The top management, including the chief executive officer (CEO) of M&L has focused on quality over quantity while pursuing growth. M&L has maintained excellent lending standards, with rigorous credit analysis, while providing loans to its clients. Their credit analysis not only involves determining the client’s “ability” to pay but also their “willingness” to pay. Often, M&L has rejected loan requests because of either dodgy business proposals or because of the client’s past track record. Moreover, M&L has worked

on maintaining a diversified

lending portfolio.

In line with its prudent strategy, M&L has focused on growing its deposit mix judiciously focusing on both current and savings accounts (CASA) to lower its cost of funds and time deposits to address a potential asset-liability mismatch.

To maintain its rigorous banking standards, M&L has concentrated on retaining and hiring experienced staff; however, it has not indulged in a hiring spree to push its loan products. M&L’s perks and benefits for its staff are on a par with the average industry standards, and its Human Resource (HR) department has devised new and innovative, yet cost effective, ways of retaining quality manpower. Moreover, because of a large number of experienced and long serving staff, the top management of M&L has been able to seamlessly convey its strategic vision to middle and lower level management, which has resulted in operational synergies.

Over the last couple of years, lots of new banks and financial institutions have emerged in la-la land, and, as a result, staff attrition in the banking sector has increased rapidly. However, because of M&L’s focus on quality over quantity, flexible working hours and a not so strenuous job schedule, it has been able to minimize the employee turnover level. Experienced staff coupled with a motivating work environment has increased M&L’s staff productivity, helping to increase its bottom line.

M&L’s focus on quality over quantity in their loan portfolio has helped it to keep its non-performing loans (NPL) to a bare minimum level. Its judicious deposit mobilization has helped it to maintain its interest spread. As a result, the net profit of M&L has increased at a CAGR of 25 percent over the last five years. Shareholders of the

bank have been satisfied with the management’s ability to grow profit and deliver above average returns on equity.

Compared to M&L, F&P’s total asset has grown at a CAGR of 30 percent over the last five years. In order to purse this high growth, F&P has pursued a different strategy to that of M&L. The lending practice of F&P has been lax at best; and often, loan requests have been approved without proper due diligence. While seeking high growth, the top management of F&P has ignored maintaining a diversified loan portfolio. As a result, its portfolio is highly concentrated among a few vulnerable sectors (such as real estate).

In order to pursue rapid growth, F&P has poached a lot of staff from other banks by offering them a higher salary, which has resulted in higher than average salary expenses. However, the top management of F&P has not been able to properly convey its strategic vision to middle and lower level management resulting in lack of organizational coherence. Moreover, long working hours and a demanding schedule have taken their toll among F&P’s staff, reducing their productivity.

Recently, because of a sudden slowdown in the real estate sector, a few major loans of F&P have come under scrutiny. This, coupled with higher staff compensation, has severely undermined F&P’s bottom line. As a result, the net profit of F&P, after growing at a CAGR of 30 percent for the first three years, has decreased at a CAGR of 17 percent over the last two years.

Ignoring other financial information, for comparative purposes, the total asset of F&P is approximately 2.5 times that of M&L currently, while the total staff expense of F&P is two times that of M&L. However, the total profit of F&P is only half that of M&L.

Now, why on earth does Nepal Rastra Bank (NRB), given the above mentioned hypothetical yet plausible scenario, want to have the CEO of F&P earn a higher salary than that of M&L? To put it more bluntly, why does NRB want to have more F&P-like banks and less M&L-like banks in the future? Because by linking the CEO’s compensation to the total asset and average salary expense, NRB has paved the way for formation of bloated financial institutions with the management’s mandate to seek total asset growth irrespective of other factors.

This article was first published on 20th December 2010. Permanent Link:

http://www.ekantipur.com/2010/12/20/business/blinkered-policy/326772/