LONDON, 23 May — In a soon to be published report by Gulf Banking Consultants (Top 25 banks: Financial Performance and Future Challenges), more than one-third of the top 25 banks in the GCC were found to have depleted, rather than enhanced, economic value for their shareholders during 2001. This category included five out of the top 10 banks confirming the fact that big is not necessarily beautiful, according to a Gulf Banking Consultants’ press release yesterday.
Another one-third of the top banks created marginal economic value for their shareholders. The report argues that if the cost of capital of these banks is computed in a more demanding manner, some of them may find themselves creating almost no economic value for their shareholders. The remaining one-third of the top banks created adequate economic value for their shareholders. In fact, financial performance of the more successful GCC banks could make international banks become envious.
Gulf Banking Consultants’ report emphasize the fact that banks are accountable first and foremost for efficiently managing the capital they are given by their shareholders. Shareholders expect a return on their capital commensurate with the risk they are taking by investing in the bank. Based on a comparison of the shareholders’ expected return with the returns posted by the Top 25 banks, the report identified banks that created economic value for their shareholders during 2001 and the banks that did not.
The report suggests that it is more than just an academic exercise to measure economic value created by banks. Financial analysts believe that market price of the shares of banks to a large degree is influenced by the extent these banks are able to create economic value on a sustainable basis. To test the validity of this hypothesis, Gulf Banking Consultants compared the market-to-book value of the Top 25 banks with their performance in creating economic value during 2001. Although evaluation of one year’s performance cannot provide a conclusive answer, the analysis suggests that market capitalization of banks that created substantial economic value during 2001 was significantly higher than their book value.
Similarly, banks that substantially depleted economic value had a market value below their book value.
The report concludes that when banks create economic value, their shareholders are rewarded in the form of higher share price and market capitalization. For large banks, the difference between a good and a mediocre performance in creating economic value could very easily become a $1 billion question in terms of market value.
It highlights that board of directors and senior management of banks have a fiduciary responsibility to maximize shareholder value. To enable them to carry out this fiduciary responsibility, the report recommends that banks should put in place a process that measures and reports the extent to which their bank is able to create economic value for their shareholders. While this shareholder value driven measurement and reporting process is well established in most international banks, it is not very common in the Middle Eastern banks.
The report concludes that implementation of shareholder value driven measurement and reporting process would result in alignment of management decision making with the interests of the banks’ shareholders. Identifying four categories and listing banks belonging to each category, it highlights future challenges for the Top 25 banks:
* The challenge for banking stars is one of significant diversification in terms of lines of business or geography to continue enhancing shareholder value;
* For bulge bracket under-performers, the challenge is to introduce a significant change and business restructuring within their organization to stop depleting shareholder value;
* Banks in lean and mean category would have to focus most of their efforts on new business development;
* the banks classified as stuck in the mud may have to find a niche in which they could compete effectively or consider merging with other banks to gain scale benefits/competitive business franchise to create value for their shareholders.
