On the face of it, banks are providing their customers with an ever-increasing welter of financial information. For example, in the recent reporting season, they regaled their various constituencies with 20-plus page documents crammed with P&L and balance sheet data. But how much does a large corporate client or major shareholder really know about what is going on in the banks that provide them with financial services and manage their money?
Not nearly enough, in the opinion of organisations including PricewaterhouseCoopers and International Financial Risk Institute (IFCI), the Geneva-based think tank. A recent report by PwC confirms long-held suspicions that the market is dissatisfied with the banks” financial reporting, and most of the criticism focuses on the opaque area of risk disclosure. However, the lack of information does not stop outside the dealing room.
‘Risk is not the only area where greater disclosure is required,’ says Richard Barfield, PwC”s director, banking practice. ‘The financial information banks give to the market is generally well covered, but we would like to see more disclosure at the business unit level, particularly on economic profit and return on risk-adjusted capital, as well as strategy and IT spending and investment. Other areas where the level of disclosure is insufficient are customer retention, penetration, and risk management practices.’
In its annual report, Barclays goes on at length about bold initiatives that will raise performance levels, double economic profit every four years, and implement a rigorous, value-based management framework. But beyond the platitudes there is precious little information about what each of the reorganised business units is doing. Where, for instance, are the graphs showing the daily trading position of Barclays Capital? We are only given a few parameters showing how much was earned by this ‘important component of the overall group’.
However, it is logical to expect an improvement in the level of the bank”s disclosure under the leadership of Barclays” flamboyant new chief executive Matthew Barrett. He comes to Barclays from Bank of Montreal, one of the highest scorers in the PwC report. ‘Bank of Montreal has recognised the benefits of greater disclosure, which can reduce the cost of capital and increases the share price,’ says Barfield. ‘Banks pay a market premium for opacity.’
The IFCI report, which was compiled in conjunction with Arthur Andersen says, ‘The quality of risk disclosure by the financial industry is disappointingly poor.’ The review established a template for scoring, with a maximum score of 100 if a firm provided good quality information. With regard to trading and non-trading disclosure, not a single one of the 42 international banks surveyed scored above 50, and the large majority scored below 25.
‘Disclosure by British banks is generally more comprehensive than in continental Europe,’ says John Leonard, banking analyst at Salomon Smith Barney. He says this applies particularly to banks that have listed their shares in the US and are pushed by regulators to greater disclosure.
Of course, there is a good reason why banks are reluctant to disclose their risk positions. At worst, the complex data could be misinterpreted by shareholders. The more common fear is that by releasing trading information, banks would give away a competitive edge. If, for instance, it were revealed that Deutsche Bank was pouring a lot of capital into German equity derivatives the market might interpret it as a signal to pile into this area.
‘One of the most important policy disclosures that a bank could state in terms of derivatives exposures is the use of collateral and the policy framework supporting it,’ says the IFCI. ‘Virtually none of the banks has given any disclosures in this area or quantified its impact on the accounts.’
One of the dangers for corporate clients is that a bank with an undisclosed trading risk position might not be able to provide the financial services a company needs in a period of distress. The black hole tends to appear without warning: witness NatWest, which, within a few hours of releasing its 1997 half-year results, discovered a £90m hole in its interest-rate options book.
Relying on the regulators to minimise risk is of limited value – they are not primarily concerned with risk, and in many cases they would prefer to have volatile trading positions and problem loans kept quiet. That said, there is now a degree of pressure from Basle, which will be asking the banks to provide more information about the quality of their assets and risk management as part of its new capital adequacy framework.
In the final analysis, though, pressure for disclosure will come from shareholders, because improving their understanding of a bank”s business position will lead to higher market valuations and enhanced returns.
Jules Stewart is a freelance journalist.
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