Friday, August 24, 2012

Elementary Banking Essentials


A successful banker is composed of about one-fifth accountant, two-fifths lawyer, three-fifths political economist, and four-fifths gentleman and scholar – total ten-fifths – double size. Any smaller person may be a pawnbroker or promoter, but not a banker.”

George E. Allen

In 1918, J.F. Ebersole has published his textbook “Elementary Banking”. This textbook mainly explains the regulation and functioning of the financial instruments of that time, such as contracts, drafts and acceptances, promissory notes, and bills of laden.

In addition, the author has written a first chapter on elementary banking essentials in which he explains the general skills that he deems necessary for a banker to succeed in his career. It is quite interesting to read about those skills almost 100 years later. Some of them seem to be perfectly up to date, others could, in my view, not easily apply today.

In his book, the author continuously addresses himself to a messenger. This messenger is a person to which “all bank men will do well to study the work of such beginners and to learn of their problems”. In today's language, this would probably be a leader.

General characteristics

According to J.F. Ebersole, a banker ultimately needs to meet the following characteristics:

  • sufficient knowledge of commercial documents and banking practice;

  • best principles of personal conduct;

  • proper attitude or view of the own job.

This type of broad principles probably still applies today. However, we would rather say “You must develop your hard- and soft skills.” instead of the above language.

The messenger's first week

In his first week a messenger should develop

  • a desire to make the business men of the city like the bank”;

  • a desire to secure merited personal advancement in his own bank”;

  • a certain amount of definite information concerning adding machines and the duties of messengers on routes”.

All this in one week? Today, we probably need at least one week just to get the computer systems running. Very curious is the first point: Should the business mirror the bank or the bank mirror the business? After all, banking is a service industry and, as such, should provide services that its clients need.

Making a good impression

  • The first essential in making a good impression is cleanliness. A clean collar, with regular brushing of the clothes and shoes, is more important than the quality, style or expensiveness of one's attire. Customers consider smoking as questionable in a young man.” However, “so much of modern business is carried on over the telephone that the customers of a bank may very easily form their opinion of the bank from the way in which they are treated in a telephone conversation. The fact a person with whom you are talking over the telephone cannot see your face makes it especially important that your words be selected carefully and that your general attitude be that of persuasive kindliness.”

  • The second essential is courtesy and politeness. The essence of courtesy is to treat every individual with equal kindness and consideration.”

  • A third essential is never to give out any information concerning the affairs of the bank. Business men do not like to have their affairs known in great detail by their competitors or by other business men.”

In my view, all this still applies today. Only the clothing habits (in today's trading rooms) might have changed in the meantime. In addition, the banking secrecy is today thoroughly regulated in many jurisdictions.

General advice

  • A good banker should begin at the bottom in the banking business. (It is only by beginning at the bottom that a man can become familiar with all the details of the business.)”

The argument is comprehensible. However, I tend to think that many aspects of today's banking business are getting more and more complex. This means that you can probably study the bottom of your banking business the whole life without ever finishing such studies. It probably also depends on the business in question.

  • It is equally important to make good impression when collecting as when lending.”

In modern marketing language you write “Our firm emphasizes a long-term relationship with our clients.” The idea that a bank not only sticks by its clients in good times but also in difficult times should also apply today.

  • Employees who are working for banks are being watched every day to see if they are going to develop into men of character and capacity. Every day is a judgment day.”

Besides the language that seems a little bit declamatory, why should this only apply in the banking business?

  • The beginner in banking must not make the mistake of believing that his work is unimportant.”

This is good advice. Given the number of departments and people involved in many banking businesses, people obviously can sometimes wonder how their own work participates in the ultimate results.

  • The importance of the work must not be judged by the amount of the salary. As soon as [the messenger] is prepared for advancement his salary is increased.”

That seems a little bit idealistic doesn't it?

  • Punctuality (“The work of many may depend upon the work of one or two.”) and accuracy (“in order to avoid unnecessary labor for others who are compelled to balance with you”) are particularly important.

  • The beginner in banking should master routine, but should not let routine master him.”

I will definitely use this quote in one of my next power point presentations...

  • Messengers should understand that their time belongs to the bank from the time when they arrive in the morning until they leave at night.”

There was no Internet at that time!

  • Take nothing for granted. Investigate anything that you do not thoroughly understand.”

Today, I would put this advice definitely on top of the list. People much too often take things for granted, referring simply to a “standard market practice” instead of understanding what such practice is about. In addition, it often needs some courage to admit that you haven't understood something, just to discover later on that nobody actually understood it!

  • Above all else, it is necessary for the ambitious bank man to assume responsibility.” In the author's view, taking responsibility is necessary because it “prepares oneself for the job just above one's present job”, because it means that one “never relies on some superior officer to see that a thing is correct”, and because it helps learning “the art of concentration”.

This is definitely true still today.

  • The ambition to do better and greater things, however, must not lead to the mistake of neglecting routine work. Banking is a business of infinite detail, and accuracy and promptness in minor matters are essential to any complete and logical system of administration.”

I assume that nobody would question this principle today. The problem is, however, to apply it in practice. The advice reminds me the current discussions in the banking industry about how much effort, recognition, and remuneration to be put into back-office work.

Career development in banking

To advance in a banking career, the most important qualities are

  • honesty (“[Honesty] is an absolute requisite in getting people to entrust the bank.”) including truthfulness, sincerity, and an absence of every pretension to appear what on is not,

  • team play (“Unless each member of the team does his duty the whole team cannot win the game.”) which, according to Ebersole, includes “intelligent obedience and willingness to take orders”, and

  • development of individual capacity, including “the importance of clean living” (“The way to secure good health is to avoid late hours and to secure adequate exercise outside of banking hours.”) and the study of banking and the business world (“Knowledge is power.”).

If you are interested in Ebersole's book, you can download it here.


  • J.F. Ebersole, Elementary Banking

Thursday, August 16, 2012

Leadership Lessons of Steve Jobs in the Banking Business?

In April of this year, the Harvard Business Review has published an article written by the biographer of Steve Jobs, Walter Isaacson. This article pretends giving us the “real leadership lessons of Steve Jobs”. I must admit that neither have I read Isaacson's book nor am I a particular fan or specialist of Steve Jobs and his career at Apple.

The article was, therefore, the chance to fill my knowledge gap by reading 10 pages instead of hundreds of pages in Isaacson's book. The commercial logic of Isaacson's HBR article is probably not to replace his book but, to the contrary, to lead people reading his book in addition to the 10 HBR pages.

Be that as it may, when reading about Jobs' leadership principles, I was wondering if and how they can apply to the banking business.

1. Focus

Deciding on what not to do is as important as deciding what to do”

It might be right that people tend to overlook this in their every-day life. However, it still remains a self-evident principle and, as such, applies to any business or personal situation. Consequently, it also holds true in the banking business.

2. Simplify

Zero in on the essence of things and eliminate all unnecessary components.”

Conquer rather than merely ignoring complexity.”

To be truly simple, you have to go really deep.”

Being able to get to whatever you want in three clicks.”

You may like the above quotations or not. The principle however, fully applies to the legal and finance business as I experience it. As a matter of fact, finance contracts become longer and longer and ever more complex. Everybody who deals with ISDA or LMA contracts knows what I am talking about.

I sometimes wonder where this complexity comes from. It seems that people often try to cover any possible business situation contractually instead of caring about the business relationship itself. I strongly believe that this is wrong. I am convinced that the future will always be different from what you expect it to be. (Otherwise, life would be boring, wouldn't it?) Therefore, any attempt to cover all possible future scenarios must necessarily fail.

In such a situation, you should get the basics right and be specific and extensive on the underlying principles and interests guiding your business relationship. It's like buying a car: Decide on the main issues such as performance, design, and price but forget about questions such as “Can I connect a USB stick to the HIFI system?”.

The obvious and most important problem here is to differentiate the big points from an unimportant negligibility. How can you do that when it comes to legal issues? Unfortunately, there is no answer to this question. In my view, only experience can help you here. In addition, you need the right specialist because, the more big points there are, the more your lawyer can charge...

3. Take responsibility end to end

Make sure that hardware, software, and peripheral devices are seamlessly integrated.”

This is very difficult in banking as responsibility is usually shared among many participants such as front office, risk department, back office, tax department, legal department, compliance, and numerous external advisors.

However, the idea is right when it comes to a bank's relationship with its clients. The client is obviously only interested in the final product and not in assignments of guilt among a bank's departments.

4. When behind, leapfrog

Instead of merely catching up by upgrading and imitating, create something radically new.”

If you don't cannibalize yourself, someone else will.”

Definitely yes! This should apply to any industry.

5. Put products before profits

Don't compromise on this maxim.”

Focus on making the product great and the profits will follow.”

Profits are there to allow you making great products, not vice versa.”

Products, not the profits, must be the motivation.”

Were sub-prime mortgages good products for retail clients? Were sub-prime mortgage backed notes issued by securitization vehicles good products for investors?

6. Don't be a slave to focus groups

Don't ask customers because they don't know what they want until you have shown them.”

Caring deeply about what customers want is much different from continually asking them what they want. It requires intuition and instinct about desires that have not yet formed.”

Again, this should apply to any industry.

7. Bend reality

Do something that takes months in days.”

Life's ordinary rules don't apply to you.”

You can do the impossible if you don't know that it is impossible.”

In don't think that this is good advice in finance. If you don't take the necessary time, you will not understand your product. In addition, if you don't face reality, you may disregard existing and threatening risks.

8. Impute

People judge a product or company on the basis of how it is presented and packaged.”

The design of your product must impute a signal rather than be merely functional.”

In my view, marketing and public relations activities of financial institutions are usually well done. If only the never ending scandals (Sub-primes, LIBOR, etc.) could stop...

9. Push for perfection

Delay your product's release until it is perfect.”

Even if nobody will ever see your product's insights, make them nevertheless as beautiful as possible.”

I refer to my above comment under No. 2. The basic principles should be perfect.

10. Tolerate only A Players

Don't be so polite that mediocre people feel comfortable sticking around. If something sucks, tell people to their face.”

If you have really good people, you don't have to baby them.”

By expecting people to do great things, you can get them to do great things.”

By definition, any company in the world pretends having the best employees. The only question is who defines what “best” means!

11. Engage face-to-face

There is a temptation in our networked age to think that ideas can be developed by e-mail and chat. That's crazy.”

Make people mingle with people they might not otherwise see.”

Jobs hated formal presentations, but he loved freewheeling face-to-face meetings.”

This is definitely missing in the banking business, above all in financial markets. Too much telephone and email and not enough face-to-face meetings! However, face-to-face meetings are difficult to promote when people don't work close to each-other and company budgets are tight.

12. Know both the big picture and the details

Common sense and self-evident! The question is how to apply this in practice if time is money and, at the same time, deals become ever more complex.

13. Combine the humanities with the sciences

Difficult in finance!

14. Stay hungry, stay foolish

I didn't know that Jobs was a HR consultant!


  • Walter Isaacson, The Real Leadership Lessons of Steve Jobs, Harvard Business Review 2012, pages 93 et seq.

Wednesday, August 8, 2012

US Money Fund Exposure to European Banks and the “Originate to Distribute” Business Model

On July 26, 2012, Fitch Ratings has published an interesting report on the US money fund exposure to European banks.

Sharp decline in US money market fund exposure to French Banks

The report shows that, since end of May 2011, the exposure of US prime money market funds towards Euro-zone banks has decreased by 78 %. In the case of France, the decrease attains even 88 %.

As you can see on the graph below, the exposure to French banks is in line with the overall exposure to Europe, even though Germany and the UK are less impacted by the US investors' distrust.

The divestment trend is still ongoing today. As Fitch Ratings mentions in its report, the exposure to Euro-zone banks since the end of May 2012 has decreased by further 33 %. Over the same period of time, the exposure to French banks has decreased by further 28 %.

According to Fitch, “the declining MMF allocations to Euro-zone banks are at least partly a reflection of ongoing investor concern about the region”.

Stock price evolution of French banks

Let's now compare the divestment trend of US money markets since last summer with the stock prices of the major French banks BNP Paribas, Crédit Agricole, and Société Générale.

As you can see, the divestment of US money market funds has, amongst other things, triggered a tremendous decline of the stock prices of BNP Paribas and Société Générale.

Strategic response of French banks

How do the French banks respond to the mistrust of US investors and the decline of their stock price?

A first response lies in a sale of US assets, amounting to 65 bn USD in case of BNP Paribas and 55 bn USD in case of Société Générale. Compared to total assets, the intended sales represent roughly 3 % for BNP Paribas and roughly 4 % for Société Générale.

The second response relates to a return to the so-called “Originate to Distribute” (OTD) business model. The basic idea here is that the banks reduce their funding needs in USD by reducing / stopping the issue of USD denominated loans to clients. Instead, the banks will carry out advisory activity and coordinate the direct relationship between their clients and third party investors.

As you can see, Crédit Agricole is especially innovative as it distributes first and then originates... Errare humanum est! There are simply too many presentations to be prepared and held today!

More specifically, the French banks intend to focus on
  • origination and structuring of financing,
  • bond solutions,
  • syndication and securitization, and
  • early-stage partnerships with investors.

Originate to Distribute (OTD) Model

In my view, the term “originate to distribute” does not seem entirely appropriate for the strategic shift that the above banks intend to carry out.

As the name indicates, the OTD model refers to a business model according to which banks do not hold the credit assets they originate until maturity, but distribute them to different types of investors through the issuance of structured finance products (e.g. securitization) or simply through syndication.

The simple advisory activity involves no origination at all and, therefore, the model as such does not apply to this business situation.

The naming of this strategy is all the more surprising as the OTD model has not enjoyed a good reputation in the recent subprime crisis. In this regard, the European Central Bank has carried out, in 2008 an interesting stakeholder analysis from an agency theory perspective.

Principal / Agent Relationships in the OTD Model

Expanding on the ECB's findings in the subprime mortgage context, the main stakeholders, incentives, and interests in the OTD model envisaged by French banks are the following:

To address the above described conflict of interest between the banks and the other stakeholders, the following measures can be put in place:

  • Banks should retain an ownership stake in the deal, leading ultimately to a certain degree of re-intermediation of the banks. However, as no USD refinancing is currently available, this stake must necessarily consist of an off balance sheet item such as a (partial) performance guarantee on the clients' repayment obligations towards investors or a backup liquidity line for the benefit of investors. To protect the general public, the risk management of the off balance sheet items would obviously need to be carried out and monitored properly.
  • To align the clients’ and investors’ goal of a successful finance transaction with the banks’ interests, it could be wise for the latter to perform additional tasks during the entire financing period. As USD financing is currently not available to French banks, this must necessarily consist in additional services. Examples include payment and other commercial banking services, loan administration and, if necessary, future restructuring of the financing transaction.
  • The banks' reputation should be engaged in the deal. This is obviously a win-win situation as the bank benefits from such public exposure in terms of advertisement and the client receives a “pledge” for the success of the transaction in the form of the banks' long-term engagement and reputation.
  • Redesign of remuneration schemes: The idea here would be to spread the fees paid to banks over the entire financing period. Besides ongoing services provided during the financing project, a kind of “success fee”, payable during / at the end of the financing period, might be envisaged.
  • Transparency and adequate flow of information: From the agent theory’s perspective, this is the most important and most efficient instrument to manage conflicts of interest among principals and agents. Only if all participants know exactly what the banks’ role in the respective transaction is (anything from pure advisory to complete bank financing via loans), potential conflicts of interest become apparent and, thus, manageable. This transparency can be enhanced by improving either the legal documentation or the corporate governance mechanisms of potential SPV’s and their shareholders involved in the financing scheme.


  • Fitch Ratings, “U.S. Money Fund Exposure and European Banks: Eurozone Hits Fresh Low”, July 26, 2012
  • BNP Paribas Presentation – Goldman Sachs Conference – June 14, 2012
  • Société Générale – Morgan Stanley European Financials Conference – March 28, 2012
  • Société Générale – Goldman Sachs Conference – June 15, 2012
  • Crédit Agricole – Credit Update February 2012
  • ECB Report – The Incentive Structure of the “Originate and Distribute” Model – December 2008

Wednesday, August 1, 2012

IFRS and US GAAP - Towards global accounting standards?

On July 13, 2007, the SEC Office of the Chief Accountant has published a staff report on the incorporation of IFRS standards into the financial reporting system for US issuers.

This report has been received negatively by the financial press. On July 15, the Financial Times wrote:

“SEC staff issued a non-committal paper on the subject on Friday that gave no clue as to when an already-delayed decision on possible IFRS incorporation would be taken by the US markets regulator.”

Michel Prada, chairman of IFRS Foundation, is cited as follows:

“While recognizing the right of the SEC to determine the method and timing for incorporation of IFRS in the United States, we regret that the staff report is not accompanied by a recommended action plan for the SEC.”

What is the the report about? As will be explained below, the report contains interesting information about the differences between IFRS and US GAAP and the consequences of an IFRS adoption in the US. However, it does not define what the intentions of the SEC in this matter are and what it intends to do about it in the future.

The report starts off by saying what it is not about:

  • The staff report does not imply that the SEC has taken a political decision about a possible incorporation of IFRS accounting rules in the US financial reporting system.
  • It is also not about the question of how to incorporate IFRS into GAAP.

Criticisms of IFRS

In the report, the SEC staff raises the following main criticisms against the IFRS accounting system that might cause problem when implementing it in the US:

  • As of today, the US internal support for the IFRS standard seems to be low as regards domestic reporting purposes.
  • The IFRS Interpretations Committee should carry out adequate and timely maintenance of its accounting standards in form of providing faster interpretation support and authoritative guidance.
  • The IASB should consider greater reliance on national standard setters.
  • To allow a comparable financial analysis in different jurisdictions, the IFRS accounting standards must be applied and enforced on a consistent basis which is not entirely the case today.
  • As a private not-for-profit organization, the IFRS foundation might have problems to ensure its financing. The SEC staff mostly criticizes IASB's continued reliance on funding by the large public accounting firms.
  • Investor education on IFRS accounting issues and changes in the accounting standards are not uniform and, all too often, investors rely on the large public accounting firms to understand recent changes to accounting standards.
  • The SEC staff has reviewed financial statements prepared under IFRS and observed that, although being overall compliant with IFRS, the issuers could enhance the quality of their application of the IFRS rules namely regarding transparency and clarity of the financial statements. In addition, the diversity in the application of IFRS can present challenges to the comparability of financial statements across countries and industries.
  • IFRS provides only limited guidance for certain topical areas, such as accounting for several common control transactions, recapitalization transactions, reorganizations, acquisitions of minority shares not resulting in a change of control and similar transactions, and the push down of a new accounting basis in an entity’s separate financial statements.
  • In addition, IFRS lacks regulation of specific industries, such as those related to utilities, insurance, extractive activities, and investment companies.
  • The application of IFRS accounting principles should be more transparent.
  • Compared to US GAAP, the IFRS accounting guidance is less detailed and prescriptive.
  • Large accounting organizations are structured as networks of independent member firms. As a consequence, individual firms develop viewpoints on IFRS interpretation issues that might lack internal coordination. Thus, there is a possibility of those firms reaching differing conclusions.
  • Each IFRS jurisdiction might contain different managers’ reporting incentives, regulatory enforcement environment, and auditing regulation that can significantly affect the comparability of financial reports under IFRS.

To achieve a more consistent enforcement of IFRS financial statements, the SEC staff suggests installing the following mechanisms:

  • Database of previous IFRS member decisions;
  • Periodic conference calls with IFRS members;
  • Implication of members in the IFRS legislative process through consultative joint comment letters.

In addition to the above criticisms, the SEC staff sticks to some additional issues that might conflict with an IFRS adoption in the US:

  • Countries usually adopt IFRS only indirectly by incorporating it into local legislation. This can trigger inconsistencies in the adoption and subsequent application of IFRS.
  • Full adoption of IFRS may cause significant costs for US companies as well as confusion for investors in US securities.
  • An adoption of IFRS would need substantial legal work on the existing US GAAP regulation and, therefore, lead to substantial legal costs.
  • Sufficient time must be given to US investors for a transition from US GAAP to IFRS as they have not developed sufficient IFRS knowledge yet.
  • Even though they are not legally bound to prepare financial statement under US GAAP, many private US firms use US GAAP in practice. Those rather small companies will be particularly hit by a possible introduction of IFRS as they usually don't have the internal capacities to deal with such exceptional project work.
  • Current contracts of US companies refer extensively to US GAAP provisions. Therefore, an introduction of IFRS would lead to high legal costs for reviewing and renegotiating existing contracts.


A very interesting part of the report is the SEC staff's comparative analysis of IFRS / US GAAP fundamental and minor differences:

Fundamental differences:

The SEC staff has observed fundamental differences in the following areas:

Minor differences

Somewhat minor differences have been identified in the following areas:

  • Business combinations: Certain differences exist in the recognition and measurement of specific transactions (non-controlling interests, contingent consideration, and common control transactions).
  • Accounting for debt in specific industries is more precisely regulated under US GAAP than it is under IFRS.
  • Share-based compensation: The scope of application of the standards differ and, in addition, US GAAP contains more illustrative and application guidance than IFRS does.
  • Compensation components other than share-based compensation
  • Earnings per share

IASB’s Governance Structure

The SEC staff report goes on describing IASB's three-tier governance structure:

  • The IASB is a private standard-setting body that is responsible for the development of IFRS.
  • The IFRS Foundation oversees the IASB.
  • The Monitoring Board oversees the IFRS Foundation.

Overall, the staff report acknowledges that the current IFRS regulation setting standard serves the organization pretty well and achieves a good balance between the needs of public accountability and the independence of IASB’s standard-setting process.

Some isolated criticisms of the governance structure pertain to

  • the need for greater clarification and definition of the respective roles of the IFRS governmental institutions;
  • removal of any confusion to ensure greater transparency;
  • the reporting structure for post-implementation reviews of IFRS which should involve IFRS Foundation Trustees directly.

The section on the IASB governance structure is very detailed. However, I am missing more concrete conclusions in this section as well as an appraisal as to how this governance structure could fit / not fit adoption criteria from an US GAAP standpoint.

IFRS Funding Approach

In the staff report, the SEC outlines the major IFRS funding maxims, e.g. broad-based, compelling, open-ended, and country- or jurisdiction-specific.

These characteristics seem to be met: As a matter of fact, IFRS funding relies on

  • the donor’s long-term commitment;
  • public sponsorship, excluding any direct or implicit governmental or regulatory support;
  • flexibility of funding schemes from one jurisdiction to the next;
  • proportional commitments of the major economies of the world depending on the individual GDP level;
  • publicly accountable funding schemes.

The SEC only criticizes the fact that the IFRS Foundation continues to rely significantly on voluntary contributions from the large accounting firms.

IASB Standard-Setting Process

In its report, the SEC staff focused on the following 3 components of IASB’s standard-setting process:

Impact of IFRS on the US regulatory environment

The SEC staff analyzes the impact of an IFRS introduction in the US in great detail. In summary, it holds that

  • the impact would be significant;
  • , unless IFRS would be introduced in the US indirectly through incorporation in US GAAP, its introduction would lead to significant work (and costs) for amending references in state laws and regulations;
  • the US GAAP industry-specific standards are important for specific US regulators;
  • ongoing changes in US GAAP could cross the introduction of IFRS, leading to investors' confusion.

As a general comment, I think that the SEC staff report is very informative as regards the major differences between IFRS and US GAAP as well as the practical consequences of an IFRS introduction in the US. However, I miss a genuine debate on the question whether to implement or not to implement IFRS in the US. As a matter of fact, the SEC writes a lot about the consequences and costs of the introduction. However, I cannot find any substantial argument of the SEC against the adoption itself. The question then remains: Why is there no specific time table for the introduction of IFRS in the US?


  • SEC Office of the Chief Accountant – Final Staff Report on the Incorporation of IFRS into GAAP dated July 13, 2012
  • “IASB hits out at SEC stance on rules” in FT dated July 15, 2012