Consider this remarkable comment from a recent Lex Column of the The Financial Times: “There is little proof that a bank needs the best talent anyway. This latest financial crisis showed that it was a bank’s business mix, rather than its skills, that determined whether it copped big writedowns. The most talented CDO desks lost money, while ordinary banks without investment banking divisions did not.”

We all know that investment banks house the brightest financial people available. We know this because they constantly tell the rest of us (yes, consultants included) that they are a different breed, deserving of enormous comp. However, this most recent disaster (as well as others before it) resulted from the rocket scientists at the investment banks creating a monster that boomeranged and blew themselves up, a bit like the errant torpedo in the 1950’s movie Run Silent, Run Deep.

The Lex columnist is making the good point that the very nature of the business these bankers were focusing on dramatically increased risk and, perhaps inevitably, resulted in the pain being felt by Citibank, WAMU, Wachovia, Bear Sterns, Lehman Brothers, and so many others.

Avoid the Obscure
At its best, banking operates as a relatively simple and straightforward business. Despite all the “gee whiz” technology, CRM vendors, and increasingly sophisticated managers, most banks make most of their profits from deposits or deposit-related activities. What is more straightforward than obtaining and maintaining deposits? How much time do banks focus on this area versus other initiatives? With every bank we have worked with, the answer is “not enough.”

Of course, lending is important, but smart lending requires that the banker truly understands the deal and can clearly point to the repayment path. When I was a commercial banker many years ago, my team leader insisted that I be able to articulate three ways of repayment, to include cash-flow, an actionable personal guaranty, and hard assets against which we had a lien. He even had me call up a borrower to ask him why he was requesting a draw down on an approved facility. Basically, his approach was to be all over the credit and take nothing for granted. He was very much a fact-based lender.

Years later, at a different bank, I made one loan that, in retrospect, was unarguably stupid. Over a period of years, the manufacturer, Baldwin Piano, developed into Baldwin United, a finance company with a significant emphasis on single premium deferred annuities. To make a long and painful story short, when my bank made its loan commitment the company’s stock was at or near its all time high, and lenders were anxious to get involved with the company. Did I understand the deal structure? No. Did my boss? No. Did his boss? No. Why did we do the deal? We thought we were getting into a relationship with an industry leader, a company led by a man whom many viewed as a financial genius. Making a classic error, we also we relied on the capabilities of the premier bank group of which we would become a part. The old J.P. Morgan was a leader as were Bankers Trust, Chemical, Continental, Crocker, Mellon, and Bank of New York. (Perhaps it is no surprise that many of these players are now gone.) On reflection, it is fair to suggest that none of these bankers, among the smartest imaginable, understood the deal. In effect, the “business mix” that we decided to pursue put our banks in harm’s way.

KISS (Keep it Simple, Stupid) as a Management Philosophy.
Back to basics seems an unexciting approach, but unexciting is a good thing in banking. Too many bankers go off in new directions (for example, I have to admit some skepticism about Green Banking) without significant knowledge, investment, or economic certainty. Even worse, frequently, an emphasis on the new results in a de-emphasis on more traditional businesses. Certainly, that has impacted the SME space (small and mid-sized businesses) at many banks. Citibank, among many others, took its eye off the SME space in the U.S., apparently preferring to bet the bank in more exotic areas. It should be a giant in a business that offers consistent earnings and good growth to many others; today, it is not.

Despite the economic cycle, consumer, small, and mid-sized businesses remain strong. In our recent blog entry we cite data from Paynet, a company that works with multiple lenders on developing predictive credit and risk tools. Their analysis of 50+ lenders indicates that while losses are accelerating, even at their worse they should remain manageable, particularly for those lenders that chose a selective business mix within the small business segment.

(Note: Our BankBlog is a new addition to a revamped website. Please feel free to add your comments on issues related to SME banking, Wealth management, Retail, or other areas of interest.)

Concluding Thought
Today, no bank is too big to fail or at least too big to be consumed by another. Financial service company stock prices drop like rocks as investors and analysts run from what they view as landmines, whether detonated or suspected. One of the lessons of this era may be that really focusing on the business you select to be in with an emphasis on “sticking to the knitting” remains a winning management strategy. Of course, good employees will always be important, but even a great employee will never overcome an inappropriate decision related to business mix.