EuroMedProceedings_Salerno_Oct2009 1 - SSRN papers

2nd Annual EuroMed Conference of the EuroMed Academy of Business

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FINANCIAL CRISIS: ITS EFFECT ON EXISTING BANK-SME RELATIONSHIPS Ioannou, Myria1; Mihai-Yiannaki, Simona2 1European University Cyprus- Laureate International Universities (EUC), 6 Diogenes, Street, Engomi, Nicosia, 1516, P.O. Box: 22006, Cyprus, . 2Ph.D., M.B.A., Affiliation : European University Cyprus- Laureate International Universities (EUC), 6 Diogenes, Street, Engomi, Nicosia,1516, P.O. Box: 22006, Cyprus.

Purpose: The value of relationship building is well documented in the literature, where a number of benefits seem to accrue for both interacting parties. This is also the case for Bank-SME relationships. However, the recent financial crisis is expected to have a significant impact on the underlying dynamics of such relationships and as such, this paper models the expected effect and proposes a number of recommendations to reduce the crisis potential effect. Approach: The paper utilises literature from both banking and finance and relational studies, on the basis of which a conceptual framework is developed and recommendations are proposed. Findings: Some particular recommendations are discussed relating to various aspects of the relationship itself, including changes in the communication mode as well as changes relating to strategic aspects such as reformulating facets of HRM to enhance the relationship. Originality/value: The paper addresses a hot topic, in both academic and managerial circles, and offers insights on both the expected effect of the recent crisis on Bank-SME relationships and on actual ways of dealing with the problem. To this end, it integrates different cross-functional management aspects and is therefore expected to be of interest to both academics and practitioners. Keywords: Bank-SME Relationship, Financial crisis, Retention, Multipurpose teams Paper classification: Conceptual Paper

INTRODUCTION Business-to-business relationships unfold within a wider environment and from the interaction of two active parties (Hakansson, 1982; Moller and Halinen, 2000). Consequently, any change in this wider environment, such as the recent financial crisis, is expected to influence the underlying dynamics of existing relationships. In particular, the banking crisis started by weak and un–uniformly spread regulation in risk management in the derivatives and housing markets. At the same time the lack of liquidity in refinancing deals and the default fear pushed towards a chain reaction in the system creating thus a global scale economic deterioration. In order to redress the situation most banks looked for capital injection, bailouts or restructuring or selling off part of their units together with complementary redundancy schemes. But very few banks looked also inside their relationship with their customers to boost support to households and SMEs. Many banks reacted in different ways, some wanting to keep corporate customers and get rid of the subprime portfolio. Hence, how has the recent financial crisis affected the market? There is a possible threefold approach: 1.

It affected banks first, through both bankruptcy and liquidations

2.

It made many industrial facilities bankrupt

3.

It made a large number of SMEs and individuals bankrupt or redundant

Therefore, instead of increasing attention on SMEs as a means of coping with the crisis, the above changes resulted in increased pressure for both the financial institutions and their SME customers, which at many instances, endangered existing relationships. Given, however, the considerable value that exchange relationships can yield for the interacting parties, such an approach can be seen as detrimental to their longterm success.

Managerial and Entrepreneurial Developments in the Mediterranean Area

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Consequently, this paper aims to model the impact of the recent financial crisis on the relationship between banks and SMEs, with application to Cyprus and other Euro-Mediterranean countries and to propose a number of recommendations to reduce the potentially adverse effect of the crisis on the exchange relationship. This is largely driven by the acknowledgement of the centrality of exchange relationships on the long-term success of the interacting parties (Wilson, 1995; Christopher et al., 2002), where a plethora of benefits accrue for the dyad. In fact, banking is considered conducive to relationship development (Lovelock et al., 1999), and relationship banking can yield considerable benefits for both the financial institution and the SME; benefits which are exemplified in the case of a financial crisis. Specifically, on the bank’s side, relationships ease the collection of customer information, help in understanding customers better and facilitate loyalty building. That is, reliable information on small and medium-sized enterprises (SMEs) is rare and costly for banks. To compensate for this, relationship banking is often considered as the appropriate lending technique (Baas and Schrooten, 2005). As such, holding a strong portfolio of SMEs can help in achieving scale and scope economies, ultimately enhancing long-term profitability (Reichheld and Sasser, 1990). This is why banks perceive SMEs as a core and strategic business and seem well positioned to expand their involvement with SMEs (de la Torre et al., 2008). On the other hand, for the SME which is more financially constrained than large firms (Schiffer and Weder, 2001; IADB, 2004; Beck et al., 2005; Beck et al., 2006) and hence, in a worse position to ask for financing during a financial crisis, a positive relationship with their financial institution can reduce perceived risk and uncertainty (Sheth and Parvartiyar, 1995) because the Bank-SME relationship will provide greater assurance that funding will be available even in times of duress (Holland, 1994). As such, the objective of this paper is to identify the crisis’ impact on the Bank-SME relationship and to propose ways to redress the crisis’ negative effects - with application to Cyprus and other EuroMediterranean countries. To this end, the paper reviews and utilizes literature from two research areas: relational studies and banking theory and finance, and draws a conceptual framework which maps the effect of the recent financial crisis on existing Bank-SME relationships. In conclusion, the paper discusses a number of recommendations, which can potentially reduce the crisis’ adverse effect on existing Bank-SME relationships. LITERATURE REVIEW - CONCEPTUAL FRAMEWORK The recent financial crisis is postulated to have a profound effect on the interaction pattern of existing Bank-SME relationships, and as such, our conceptual framework models this effect. The present section discusses the literature employed in designing the conceptual framework. It is divided in three areas: the first explains the potential effect of the crisis on the interaction environment and on each of the interaction parties in isolation, the second maps the effect that the financial crisis creates for the interacting dyad and the section concludes with a discussion of the effect on existing Bank-SME relationships. Exchange relationships are seen to develop within a wider environment (Hakansson, 1982, Kumar and Nti, 1998). In the proposed framework, the environment is conceptualised to include such aspects as Culture, the Economic environment, the Legal and Regulatory framework (e.g. Central Bank regulations) and the Technological environment (Ioannou and Zolkiewski, 2007). As such, the recent financial crisis has reshaped the environment within which Bank-SME relationships develop and is, therefore, expected to have influenced the underlying dynamics of the particular relationships. Specifically, it is suggested that environmental changes have affected both parties of the dyad. The extent that the crisis has affected each party is as follows: The crisis’ influence on the bank is subject to a number of parameters, such as the philosophy and strategy of the bank, the structure of the institution as well as its financial position. In particular, the underlying strategy of the financial institution and hence, the extent of its customer-orientation affect the pattern of interaction (Hakansson, 1982; Odekerken-Schroder et al., 2003) and in periods of economic crisis they are expected to assume a vital role in reformulating the bank’s policies. Managerial and Entrepreneurial Developments in the Mediterranean Area

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Put differently, a bank’s philosophy and strategic planning should grasp the relational concept and debate its medium to long-term strategies as well as the short-term tactics in applying it. This results in an improved relationship which leads to better financial positions and reputation, one of the most important traits in the service. Supporting this strategy, the new Relationship Management (RM) concept should be released towards all stakeholders, with strong emphasis to the employees. Such apprehension is an essential part of building personnel’s knowledge and bank behaviour as well as strengthening the bank’s mission and vision. In this line of thought, the so-called opaqueness of SMEs[145], becomes virtually redundant. Within the umbrella of the bank’s philosophy, one needs to also consider the Corporate Social Responsibility (CSR) of the financial institution. Some may look at CSR as "the policy and practice of a corporation’s social involvement over and beyond its legal obligations for the benefit of the society at large" (Enderle and Tavis, 1998), while others (Lerner and Fryxell, 1988) suggest that CSR describes the extent to which organizational outcomes are consistent with societal values and expectations. But for simpler people and for the retail business, as an extension, being socially responsible identifies very much with the rationale that businesses are more likely to do well in a prosperous society rather than in a crisis affected one (McIntosh et al., 1998). There are so many words associated to or replacing CSR, such as: corporate philanthropy, social disclosure, company’s environmental record, workforce diversity, financial health and tendency to grow, community involvement, ethical lending, all depending on cross-cultural differences. What it is interesting is that when defining CSR as ‘financial health and tendency to grow’, Stanwick and Stanwick (1998) provide evidence that profitability of the firm encourages managers to implement programs that enhance the level of CSR. Apart from the value-significance perspective, the financial perspective is not sufficient to evaluate the level of neither CSR nor any other perspective individually. A company may have outstanding employee benefits but if they go into financial distress, those benefits become null. Instead, strong banks are alleged as more pro-social as they can offer employees more advancement chances (Fombrun, 1998). Considering this normative facet of CSR, it becomes obvious that this concept is of ‘no single value state’ (Frederick, 1991) in bank RM as well. Moreover, it becomes redundant to consider it a cause or an effect of failing relationship management within financial crises. It could, however, be suggested that during a financial crisis banks have a ‘moral and social obligation’ to support SMEs, since SMEs provide the highest employment level and uphold economic well-being. Therefore, under times of duress, an important aspect of their CSR is the need to nurture Bank-SME relationships. Further, the crisis effect on the bank is conditioned by its shareholder base. Mergers and Acquisitions have played an active role within the banking market during the past years. For instance, in the Cypriot banking market most banks have a large business exposure to CEE and SEE, hence they work with these markets’ local SMEs, and the cultural factor becomes an important ingredient to success. At SME level in Cyprus, there is still a high involvement of RM instead of an arm's length finance or of firm-like organization by market exchange. Hughes et al. (2003) studying financial consolidation found elements of managerial entrenchment among banks with higher levels of insider ownership, more valuable growth opportunities, poorer financial performance, and smaller asset size. When managers are entrenched, acquisitions are associated with greater inefficiency. For example, following the M&A of Marfin Popular Bank (MPB), it is relocating post-merger its headquarters, downsizing and rethinking its strategies in Cyprus to escape merger diversification (De Long, 2001) to compensate for efficiency loss. Thus teams’ combinations do play a key role in keeping RM optimum with their clients, by allocating time and people to service. Another efficiency model is the one of managerial utility maximization (Koetter, 2006) and the associated measure of risk-return efficiency developed in Hughes et al. (1996, 1999, 2000) of the measure of return efficiency with cost and profit efficiency and found that efficient banks using a low-risk investment strategy

145

i.e. unstable economic feasibility – capacity to pay as well as un-appraisable willingness to pay- due to moral hazard. Managerial and Entrepreneurial Developments in the Mediterranean Area

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are less profitable, since they also expect lower profit. Then, would the adventuring into higher risk bearing relationships with the SMEs, trigger higher risks-higher profit profile of the bank during financial crises? On the other hand, the crisis’ effect on the SME is seen as a function of the nature of the SME’s business, its market share and customer composition, its financial position as well as its shareholder’s base. Specifically, the economic crisis had a greater impact on certain industries (e.g. automotive, food and beverage, tourism, manufacturing, trading, chemicals & pharmaceuticals) and hence, those SMEs operating in the said markets may encounter bigger financial problems and may require more support from their financial institution. In turn, this affects their interaction with the banks, since on the one hand, they become riskier customers[146] but on the other, the SMEs expectations vis-à-vis bank performance may rise. In fact, existing literature suggests that small business customers are more relationship-focused than corporate customers (Istock, 1996 in Colgate and Lang, 2005) and hence, are more likely to expect the financial institution to reciprocate in periods of duress. In addition, the economic crisis has had an effect on consumer behaviour, where a number of retail customers have either withdrawn from the usage of certain products or have switched to lower-priced alternatives. That is, the crisis’ impact is distinct for different customers and thus, the profile of the SMEs customers, manifested in such ways as who the target market(s) is/are and the degree of customer loyalty (cf. Reichheld and Sasser, 1990) become critical variables. Consequently, coupled with the SMEs nature of business (i.e. type of products traded), the SMEs customer composition and market share have a significant effect on its operational performance and interaction pattern with the bank. The factors outlined above, will ultimate shape the financial position of the SME. That is, the above parameters have a direct impact on the SMEs’ operational performance and are likely to cause cash flow shortages. This would essentially translate into increased pressure on behalf of the SME for working capital on the one hand, and on the other, a higher perceived risk and uncertainty level for the bank. Further, if the market is mature or emerging and if the bank went through M&A (e.g. MPB in Cyprus), then the RM can affect both the SMEs activity as well as the bank’s structure and efficiency. In such a case, though, it proves interesting to deal with the following factors at the same time:

146 Where the risk level of customers is a determinant attribute when the Cypriot banks assess SME customers (Ioannou and Zolkiewski, 2007).


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Local SMEs

Foreign SMEs

Fears of default

Strong

Strong

Reactions to hard (financial) information

Weak

Strong

Reactions to and soft (managerial or informal) information

Strong

Weak

Industry independence degree

Weak

Strong

Attitude change

Strong

Strong

Opportunities and Threats impact

Medium

Medium

Strong

Strong

What is the level of adaptability?

Strong

Weak

What is the response during financial crisis?

Strong

Strong

What is the compatibility/match?

level

of

cultural

Mature Markets vs. Emerging Markets

Factor/Connotation

TABLE 1. Factors and Connotations in RM approach to SMEs (authors’evaluation)

Consequently, at a first level, the financial crisis affects each of the interacting parties and, in turn, the above factors determine the effect that the crisis has on the dyadic interaction. Specifically, the Bank fears that the customer might not be in a position to promptly and consistently meet its financial obligations and may even eventually default; as such, the bank aims to secure itself. Therefore, the extent of pressure that may be exerted by the bank to the SME will depend upon: 1.

The buying centre of the SME and the Bank employees

The interaction pattern of the dyad is conditioned by their characteristics (Hakansson, 1982). Specifically, the SME’s management team and in particular the SME’s buying centre on the one hand, and the capabilities and experience of the bank employee(s), on the other, influence the exchange procedure and the communication mode. That is, the profiles of the dyad affect both the content and the quality of the information exchanged (Wilson and Moller, 1998). This is a particularly important consideration since in turbulent periods communication assumes an even more important role in RM. 2.

Interdependence and Power balance

These are also important elements in relationship development (Dwyer et al, 1987; Wilson, 1995). The conceptual framework postulates that the resulting power balance and interdependence amongst the interacting parties will be conditioned by (a) how important a particular SME is to the bank and (b) whether the bank is the sole financier of the particular SME. These parameters become especially important in periods of duress, where financial institutions could reassess the value of their customers. In other words, the SME’s profile, including such aspects as soft elements, cash flow, risk assessment/credit scoring and group affiliation, determine, to a great extent, the attractiveness of the particular customer to the bank (Gronroos, 2000) and hence, the latter’s willingness to maintain the relationship. Specifically, customer creditworthiness is key in any kind of transaction with SMEs. Most of the time, the credit scoring becomes a strong instrument in assessing it. Yet, there are many pitfalls that can show in many mature markets, even companies that look great on paper, but which are a “nightmare” in reality, due to their group affiliation or else. Much information does not reside in the shareholding structure, but in the “supply-side” partners. Other deficiencies often relate to rating SMEs as per Basel II Accord when calculating the bank’s capital adequacy ratio as per the Standardised Approach. This method, mostly used by smaller banks, allows the bank have their customers rated by international rating agencies. These agencies cannot yet mark to market their clients while having different valuation methods for default Managerial and Entrepreneurial Developments in the Mediterranean Area

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probability. Here is when the banks start the “rating shopping”, should the SME be a strategic target of the bank (Mihai-Yiannaki, 2009). Moreover, the attractiveness of the SME to the bank is influenced by the industry in which the SME operates. In terms of risk diversification, the bank may try to get customers outside its areas of concentrated exposure (either geographical or industrial or transaction related). Yet, there are cases where concentration on temporary healthy business is recommended rather than on diversified losers, even it contradicts some local legislations. The power balance and interdependence level is also affected by whether the bank is the sole financier of the SME or not. Where the SME patronises more than one bank, its comparison level of alternatives[147], CLalt, (cf. Hakansson, 1982; Anderson and Narus, 1984) may be higher than that of other SMEs which bank only with one institution. Consequently, perceived switching and termination costs (cf. Jackson, 1985) may be greater for SMEs that have a single financier. Thus, on the whole, as Anderson and Narus (1984) suggest, the CLalt has an impact on Power/Dependence. Conversely, the bank may value more an SME which patronises it on an exclusive basis, and the bank would be more committed in maintaining the particular relationship. Therefore, in periods of duress the bank’s attitude and behaviour may be more favourable for its exclusive SMEs customers. 1.

The type of the existing relationship

Blois (1998) stresses that what matters is not whether an exchange relationship exists, but what form that relationship takes. In fact, a number of academics (see for example Turnbull et al., 1996; Wilkinson and Young, 1998), argue that there are different relationships in different situations and thus, it is important to understand the form that the relationship assumes in each situation. The conceptual framework postulates that the financial crisis can affect the existing form of the relationship; in effect, existing Bank-SME relationships may reshape as a consequence of changes in their underlying dynamics. Specifically, changes in the adaptation level and in the increasing need for communication between the dyad, affect relationship variables [148]. The effect on the existing Bank-SME relationship may emanate from the bank’s fears of customer default and the pressing need to further secure itself. As such, the bank may engage in one or a combination of the following: (a)

The bank may either impose more rigorous lending terms and conditions or may impose lending restrictions; either way making it more difficult for the SME to borrow funds. However, given the possible liquidity problems of SMEs during such periods, this may undermine relational efforts.

(b)

The bank may require more securities, so as to further decrease its exposure. This may be perceived by the SME as a sign of lack of trust on behalf of the bank, which adversely influences their relationship.

(c)

The bank may also pressurise SMEs for savings, which may serve both in improving the bank’s liquidity and in reducing its exposure. Again, such an action may negatively impact the existing relationship.

(d)

Increased pricing at periods of duress: Financial deterioration has had an impact on the asset quality of many European Banks, while their interest income has been hurt by falling interest rates set off by the European Central Bank. Specifically, Baas and Schrooten (2005) show that lack of reliable information leads to comparably high interest rates even in the long-term relationship between borrower

147 Defined as a standard which represents the quality of outcomes available from the best available relationship partner (Thibault and Kelley, 1959). 148 Relationship variables influence success or failure of relationships (Anderson and Narus, 1984; Anderson and Weitz, 1990; Wilson and Moller, 1991; Morgan and Hunt, 1994).


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and bank. This is also one of the short-term tactics utilized by Cypriot banks during the financial crisis. The reason is retaining larger, more important corporate clients in the detriment of potentially financially distressed SMEs. Here, the banks will reduce their dependencies to potential losses in favour of getting exposure to corporations. At their turn, those corporations depend on SME’s activities, yet the latter’s bargaining power diminishes during financial crises. What we experience then, is a negative chain reaction at the liquidity level: banks reduce SMEs financing, but keep financing corporations, which ousts from the market many SMEs putting them in financial distress, while themselves cannot cope with the demand drop in the market. The outcome is twofold: either both the banks and corporations get bailout by government, or everyone is drifting away. Consequently, communication becomes integral, where the bank needs to clearly and sincerely explain to the SME the underlying changes in their relationship. Hence, a further relationship dimension, i.e. openness, becomes critical. In fact the importance of openness in a business-to-business banking context has been revealed by the work of Moriarty et al. (1983) and its importance is enhanced in periods of duress. Moreover, the outlined changes may essentially alter the adaptation level in the relationship. Adaptation is an instrumental factor in relationship building (Axelsson and Easton, 1992 cited in Zineldin and Jonsson, 2000), since "adaptations are the way in which a company shows that it can be trusted to respond to a counterpart's requirements" (Ford et al., 1998) and signal that a supplier is willing to co-operate and make sacrifices. Even though there is as yet no generally accepted definition for adaptation (Brennan et al., 2003), adaptation encompasses investment of tangible and intangible resources by both parties. Investment may be in the form of human resources, development of or alterations in goods/services, production processes and procedures or even investing in transaction-specific investments (Anderson and Narus, 1991). More specifically, in the present context, adaptations refer to such dimensions as flexibility, speed and understanding. Ultimately, as Ford et al. (1998) and Zineldin and Jonsson (2000) suggest, adaptation affects trust and commitment. Trust is a gateway to a successful relationship (Wilson and Jantrania, 1996); it is the building block of a business-to-business relationship (Wilson, 1995) and it creates the conditions under which commitment develops (Wilson, 1995). Commitment, which is the most commonly used relationship determinant, is the enduring desire to maintain a valued relationship (Moorman et al., 1992). Therefore, in view of the overriding role of trust and commitment in RM (Morgan and Hunt, 1994), it becomes vital to safeguard them, even in periods of economic distress. Failure to do so may prove detrimental to any relational efforts.


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E N V I R O N M E N T

Bank

SME

Philosophy & Strategy Shareholder Base Financial position

Nature of SME business Customer Base Financial position Shareholders

814

INTERACTION

Extent of pressure exerted depends on:

SME’s Buying center & Bank Employee(s) Power/Dependence (a) Importance of Customer (b) CLalt Effect on bank-SME relationship: Bank strives to secure itself Form of existing relationship Effect of communication - openness Potential change in the level of Adaptations made Possible effect on Trust & Commitment FIGURE 1: Conceptual Framework

RECOMMENDATIONS The proposed conceptual framework suggests that the financial crisis can alter the underlying dynamics of the Bank-SME relationship. As such, a number of recommendations are discussed below, so as to ensure that the crisis’ effect on the said relationships will be the lowest possible. Firstly, upon specialized knowledge and job description it is possible to see the level of integration of the RM concept within the bank’s top-down strategy and identify team and individual motivational tools for driving responsibility and sustainability in relationships with SMEs during the financial crisis. Then utilising HRM concepts, certain tools become key in improving RM: •

Maintain a professional attitude in line with the bank’s strategy, i.e. keep the SME connected to the bank, recognize the SME’s efforts during the financial crisis, put value to RM. This can be obtained through: i.

Bonuses, LTI (long-term incentive) and pay-to-performance

ii.

Build dedicated teams

iii. Budget reorientation and constraints (creating the best team combination and allocating time in this respect) •

Client retention (through superior employee performance)

Bank Relationship matrix on PAY (employee)-PRICE (product) affects the relationship with the SMEs by improving the selection of companies according to optimum risk-taking appraisal. In such cases, inputs from teams can better evaluate not only risk but also the bank’s behaviour towards the SME. In terms of compensation, during financial crisis, it is necessary to fit a more exceptional case rather than a threshold case:


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FIGURE 2: Market value measure Trends in shape, size and scope (Cornish and Dell, 2009)

We could analyze base salary; total cash compensation (TCC); total long-term incentive (LTI) values as well as a breakdown by vehicle; total direct compensation (TDC); LTI mix; and TDC mix. In the relationship with SMEs it becomes very difficult to extract the cost/income components in team works though. Such quantifications have improved results on the SME- bank relationship, profitability and durability. Yet, on a whole, the participating team must match the need for calibrating pay to performance, aiming at the top right quadrant.

FIGURE 3: Calibrating pay to performance on RM objectives (Cornish and Dell, 2009)

The link between them is the high individual and team motivation. Hence, choice of performance measure is critical. If not thought through carefully, and "audited" regularly, an organisation may be paying the bonus but not rewarding the right business performance. When considering risk taking as part of the pricing-efficiency model in the context of Bank-SME relationships, building a visible dedicated team to serve SMEs asks for a set of requirements. Requirements assembly

for

team

Cross-knowledge of culture/language

Team key competences Language development, behaviour analysis, case studies

Team minimum composition Customer Service Desk Loan Officer

Information identification

Explore various information sources/channels

Treasurer

Inside information exchange

Build up trust

Risk Manger

Information processing/ synthesis

Staff training


Legal Officer

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2nd Annual EuroMed Conference of the EuroMed Academy of Business Information adaptation

HRM& IT departments involvement

Information makers

Build up dedicated teams

selling to decision

Price- related information reflection

816 Relationship Manager

IT specialist

Standardisation vs. customization in pricing

TABLE 2. Multipurpose teams serving SMEs

It is important to observe that having good clients makes getting much easier. Yet, clients that are not good enough can improve anytime, yet during financial crisis the chances for “bad” clients to get worse are higher, despite the fact that the market can bounce back. Using confidential regulatory data on small, closely- held commercial banks, DeYoung et al. (2001) find that banks that hire a manager from outside the group of controlling shareholders perform better than those with owner-managers; however, this result depends on motivating the hired managers with sufficient holdings of stock. Higher levels of insider holdings lead to entrenchment and lower profitability. Therefore, the bank needs to be proactive: it should educate the SMEs, understand their current situation, including analysing their zone of tolerance (Zeithaml and Bitner, 1996) as well as determining their propensity to default. That is, through the enhanced communication channels, the bank should establish whether, under the new regime, the SME has a positive, cooperative behaviour towards finding mutually beneficial solutions to enhance the relationship (Wilkinson and Young, 1998), or whether it is likely to behave in an opportunistic way (Williamson, 1985 in Zineldin, and Jonsson, 2000), Put differently, for an RM success strategy in times of financial crisis, there are seven fundamentals of RM development: LEARNER Leverage: leverage current SME clients to get new ones Expand: Expand the products and services each client uses, but add and drop products and services in line with the portfolio strategy and keep reassessing clients constantly (client reshuffling). Assets: Get all of your clients’ assets Retain: Retain your clients by providing extraordinary service Niche: Develop your niche and natural markets and build a marketing process around them (an RM Tool) Educate: Educate your client to work with you and the financial products and Regulate: regulate at both an internal and external level your SME, i.e. create a control and supervision system within the SME department and share your experience with the regulators, the Central Banks. Out of these fundamentals, one is key in times of financial crisis: Retention. Some general factors affecting customer retention are: •

Portfolio performance consistent with client goals and expectations - a certain degree of satisfaction that can be immediately measured and data stocked and interpreted in time. A combination of client education by the bank on such factors as performance and contact frequency or required level of relationship. Understanding goals and risk tolerance levels come prior to expectations and are key in a long-term RM. Then performance satisfaction depends on the allocation, diversification and a disciplined investment process. In the long run, a conservative approach will outperform a less-disciplined, aggressive investment approach.

•

Frequent, proactive contact - not only the clients want to hear from you during this time, but they need your help in the sense of caring, appreciation and actual support. A minimum of two proactive contacts per month is recommended: one for information exchange and another for problem solution.


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•

Crisis communication tips: plan ahead, constant contact, consistency and engagement in each issue, fast response time, no rumours, total coordination.

•

Effective problem resolution-based mainly on communication becomes the most important trait of RM. Any solution should be immediately be released to the client, while any delay should be regularly explained and followed through.

•

A broad relationship - the higher the number of products held with the customer the higher the technical probability of client retention as a vote of confidence from the customer.

•

Ensuring that the new relationship experience is positive - first impression always counts, not only in new client relationships about also in terms of new products offered to existing clients.

•

Team work (specialized on product types, inside and outside from contact-communication and administrative issues, vertical or superstar structure (Mullen, 2008), junior and senior for a succession plan or a mixed team) or reach through someone else system.

•

Final step to Client Associate Programmes - the SMEs can participate to the Bank client retention programmes. In this case, the SMEs benefit from large fee and interest rates reduction (based on their participation level to the Bank’s client retention), while at the same time the bank can suggest possible clients/suppliers or partners to the SME in strengthening each others’ business.

•

Build-up upon the Bank’s strategy, a RM Control and Supervision system (why, by whom, how often, where)

From the bank’s view point, hard information (financial and market ratios analysis) offers a level of probability subsequent to default. For the bank, credit scoring plays an important role in predicting default. Nowadays, many banks incorporate in the internal credit rating, soft information that usually contributes 4050% to assessing credit quality (Kornai 1980). Therefore, in many industries and cultures the soft information component prevails to hard information. Most of the time these areas are associated to emerging markets, but touch mature markets due to globalization. Then, soft information is associated to default especially when the environment allows room for figures manipulations, the timing data procession or delaying procedures, technology or systems, hidden data and attitudes in payment, when there is no repeated relationship or transactions (exception Herstatt Bank case). Hence, often soft information substitutes rather then complements hard information, depending on the depth of the lending relationship. Further, employees directly involved in RM, can benefit from rotational audit and supervision which could be utilised during financial crisis for reducing person dependency. At the same time the cultural aspect should be kept in mind. Change during financial crisis triggers insecurity, yet a frequent presence of a well-known figure could improve a sustainable rhythm of work. These, as an outcome of the relational philosophy of the bank, can have a positive effect on key employee performance when dealing with grievances and difficulties that arise from the financial crisis. In a nutschell, the measures suggested rely on strong commitment on behalf of the bank in nurturing its existing relationships as well as on behalf of the SME. In other words, it is the attitudes of the interacting parties that will determine the future course of their relationship. CONCLUSION AND FUTURE RESEARCH It is well documented in the literature that fostering customer relationships can result in the long-term success of an organisation (Wilson, 1995; Christopher et al, 2002). Nevertheless, the conceptual framework presented here, suggests that the recent financial crisis can adversely affect the existing bank-SME relationships: it undermines adaptation and may eventually hinder trust and commitment, two fundamental pillars of relationship building.


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Consequently, in view of the above, the present paper discusses a number of recommendations so as to undermine the crisis’s effect on the long-term success of such relationships. To this end, it is suggested that special emphasis is placed on the communication mode between the interacting dyad, i.e. communication channels should be improved. In addition, the recommendations draw from the very nature of services, where their unique characteristics (and especially inseparability) make employee performances critical. As such, in periods of crisis HRM becomes even more important, where employees are motivated to enhance performance and retain SMEs. Further, employees are expected to open the eyes and the ears so as to gather soft information on SMEs; this is key in evaluating SME viability. Moreover, the bank’s structure and the design and availability of special programmes to help SMEs are important parameters, but it is recognised that existing bank regulation does not necessarily help SMEs. On the whole, it can be argued that both the conceptual model and the recommendations may be used as a reference point for potentially any European bank involved in RM with SMEs. REFERENCES Anderson, E. and Narus, J. (1984), “A Model of the Distributor's Perspective of Distributor - Manufacturer Working Relationships”, Journal of Marketing, Vol. 48, Fall, pp 62-74. Anderson, E. and Narus, J. (1991), “Partnering as a Focused Market Strategy”, California Management Review, Spring. Anderson, E. and Weitz, B. (1990), “Determinants of Continuity in Conventional Industrial Channel Dyads”, Marketing Science, Vol. 8, Fall, pp310-323. Axelsson, B. and Easton, G. (1992), Industrial Network: A New View of Reality, London, UK: Routledge and Kegan Paul in Zineldin, M. and Jonsson, P. (2000) “An examination of the main factors affecting trust/commitment in supplierdealer relationships: an empirical study of the Swedish wood industry” The TQM Magazine, Vol. 12, No. 4, pp245-265. Baas, T. and Schrooten, M. (2005), “Relationship Banking and SMEs: A Theoretical Analysis (January 2005), “ DIW Discussion Papers No. 469.”, available at: http://ssrn.com/abstract=788344 (accessed 20 June 2009) Beck, T., Demirgüç-Kunt, A., and Maksimovic, V., (2005), “Financial and Legal Constraints to Firm Growth: Does Firm Size Matter?” Journal of Finance Vol.. 60, pp. 137-177. Beck, T., Demirgüç-Kunt, A., Laeven, L., and Maksimovic, V., (2006),” The Determinants of Financing Obstacles”, Journal of International Money and Finance Vol. 25, pp. 932-952. Berger, A.N. and Hannan, T.H. (1998),” The efficiency cost of market power in the banking industry: a test of the ‘quiet life’ and related hypotheses”, Review of Economics and Statistics Vol. 80, pp. 454-465. Blois, K. (1998), “Don’t all firms have relationships?”, Journal of Business and Industrial Marketing, Vol. 13, No. 3, pp 256-270. Brennan, D.R., Turnbull, P.W., and Wilson, D.T. (2003), “Dyadic adaptation in business – to business markets”, European Journal of Marketing, Vol. 37, No. 11/12, pp. 1636-1665. Christopher, M., Payne, A. and Ballantyne, D. (2002), Relationship Marketing. Creating Stakeholder Value, Oxford, UK: Butterworth-Heinemann Ltd. Cornish G. – Dell M.C.E (2009), ”CEO & Senior Exec Remuneration“, available at: http://www.ceoforum.com.au/article-detail.cfm?cid=6158 (accessed 14 June 2009) DeLong, G.L. (2001),”Stockholder gains from focusing versus diversifying bank mergers”, Journal of Financial Economics Vol. 59, pp. 221-252. DeYoung, R., Spong, K. and Sullivan, R.J. (2001), “ Who’s minding the store? Motivating and monitoring hired managers at small, closely held commercial banks”, Journal of Banking and Finance Vol.25, pp. 1209-1243. DeYoung, R.E., Hughes, J.P. and Moon, C.-G. (2001),”Efficient risk-taking and regulatory covenant enforcement in a deregulated banking industry”, Journal of Economics and Business Vol. 53, pp. 255-282. Dwyer, R., Schurr, P. and Oh, S. (1987), “Developing Buyer-Seller Relationships”, Journal of Marketing, Vol. 51, No. 2, pp 11-28. Enderle, G. and Tavis, A. L. (1998), "A balanced concept of the firm and the measurement of its long-term planning and performance", Journal of Business Ethics, Vol. 17, No. 11, 1129-1143. Fombrun, C. J. (1998), "Indices of Corporate reputation: An analysis of media rankings and social monitors", Corporate reputation review, Vol.1, No.4, 327-340. Ford, D, Gadde, L-E., Hakansson, H., Lundgren, A., Snehota, I., Turnbull, P. and Wilson, D, (1998), Managing Business Relationships, New York, USA: John Wiley & Sons. Frederick, W. C. (1991), "The Moral Authority of Transnational Corporate Codes", Journal of Business Ethics, 10, 165-177. Gronroos, C. (2000), Services Management and Marketing. A Customer Relationship Management Approach, 2nd edition, John Wiley & Sons Ltd., Chichester, UK. Managerial and Entrepreneurial Developments in the Mediterranean Area

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Istock, (1996) in Colgate and Lang, (2005), “Positive and negative consequences of a relationship manager strategy: New Zealand banks and their small business customers”, Journal of Business Research, Vol. 58, pp 195-204. Jackson, B. (1985), “Build Customer Relationships That Last”, Harvard Business Review, Vol. 63, No. 6, pp 120-128. Koetter, M. (2006), “The stability of efficiency rankings when risk-preferences and objectives are different”, Discussion Paper 08/2006, Series 2: Banking and Financial Studies, Deutsche Bundesbank. Kornai, J. (1980), Economics of Shortage, Amsterdam: North Holland. Kornai, J.(1992), The Socialist System: The Political Economy of Communism, Oxford: Oxford University Press. Kumar, R. and Nti, K. O. (1998), “Differential learning and interaction in alliance dynamics: a process and outcome discrepancy model” Organization Science, May, Vol. 9, Iss. 3. Lerner, D. L. and Fryxell, E. G. (1988), "An empirical study of the predictors of Corporate Social Performance: a multidimensional analysis", Journal of Business Ethics, Vol. 7, 951-959. McIntosh, M., Leipziger, D., Jones, K. and Coleman, G. (1998), Corporate Citizenship, Successful strategies for responsible companies, Financial Times/Pitman Publishing, London. Mihai-Yiannaki, S. (2009), “Regulatory Failure and the Subprime Credit Crunch - The Importance of Basel II Regulation/Supervision” (October 17, 2008). The Icfai University Journal of Banking Law, Vol 2, April 2009. Moller, K. and Halinen, A. (2000), “Relationship Marketing Theory: its Roots and Direction”, Journal Marketing Management, Vol. 16, pp 29-54. Morgan, R. and Hunt, S. (1994), “The Commitment-Trust Theory of Relationship Marketing”, Journal of Marketing, Vol. 58, July, pp 20-38. Moriarty, R., Kimball, R. and Gay, J. (1983), “The Management of Corporate Banking Relationships”, Sloan Management Review, Spring, pp 3-15. Moorman, C., Zaltman, G. and Deshpandé, R. (1992), “Relationships between Providers and Users of market Research: The Dynamics of Trust Within and Between Organizations”, Journal of Marketing Research, Vol. 29, August, pp 314329. Mullen D. J. Jr, (2008), The Million Dollar Financial Services Practice- A System for Becoming a Top Producer, AMACOM. Odekerken-Schroder, G., De Wulf, K. and Schumacher, P. (2003), “Strengthening outcomes of retailer-consumer relationships. The dual impact of relationship marketing tactics and consumer personality”, Journal of Business Research, Vol. 56, pp 177-190. Reichheld, F. and Sasser, E. (1990), “Zero Defections: Quality Comes to Services”, Harvard Business Review, October. Schiffer, M. and Weder, B., (2001),” Firm Size and the Business Environment: Worldwide Survey Results”, International Finance Corporation Discussion Paper 43. Sheth, J. and Parvatiyar, A. 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http://siteresources.worldbank.org/INTFR/Resources/delaTorreMartinezPeriaSchmukler042208.pdf (accessed 20 June 2009) Thibault, J. and Kelley, H. (1959), The Social Psychology of Groups, New York: John Wiley. Turnbull, P., Ford, D. and Cunningham, M. (1996), “Interaction, relationships and networks in business markets: an evolving perspective”, Journal of Business and Industrial Marketing, Vol. 11, No. 3/4, pp 44-62. Wilkinson, I. and Young, L. (1998), “Business Dancing – the Nature and Role of Interfirm Relations in Business Strategy”, Asia – Australia Marketing Journal, Vol. 2, No. 1, pp 67-79. Williamson, O. (1985), The Economic Institutions of Capitalism, NY: The Free Press in Zineldin, M. and Jonsson, P. (2000) “An examination of the main factors affecting trust/commitment in supplier-dealer relationships: an empirical study of the Swedish wood industry”, The TQM Magazine, Vol. 12, No. 4, pp 245-265 Wilson, D. (1995), “An Integrated Model of Buyer-Seller Relationships”, Journal of the Academy of Marketing Science, Vol. 23, No. 4, pp 335-345. Wilson, David. T. and Jantrania, S. (1996), “Understanding the Value of a Relationship”, Asia – Australia Marketing Journal, Vol. 2, No. 1, pp55-66. Wilson, D. and Moller, K. (1991), “Buyer-Seller Relationships: Alternative Conceptualisations”, in New Perspectives on International Marketing (Eds.) Paliwoda, S. J. New York, USA. Zineldin, M. and Jonsson, P. (2000), “An examination of the main factors affecting trust/commitment in supplierdealer relationships: an empirical study of the Swedish wood industry”, The TQM Magazine, Vol. 12, No. 4, pp245265.


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RECENT BANK BAILOUTS - LESSONS TO LEARN WHEN PATIENCE IS A VIRTUE Mihai-Yiannaki, Simona1 1Ph.D., M.B.A., Affiliation : European University Cyprus- Laureate International Universities (EUC), 6 Diogenes, Street, Engomi, Nicosia,1516, P.O. Box: 22006, Cyprus.

Purpose: Most recent bank bailouts from financial and economic perspective turn to be politicized. This paper frames ten effective implications/lessons of the most recent bank bailouts of 2007-2009 in the Western economy model when analyzing actual shareholders’ value retrenchment or growth opportunities. Design/methodology/approach: Use of literature review and re-conceptualised framework of event study methodology. Secondary data analysis of qualitative and quantitative information. Findings: Recent bank bailouts relate to: global bailout interconnections, economic downturn and liquidity boost, abnormal returns, efficiency recovery, evade social costs, new opportunities for M&A, new risk management applications, opportunistic investors and eventually patience. Some findings recommend shareholders to grasp opportunities for bargains from bailout banks as well as still harvest their existing investments. At the same time economic education and control becomes another important solution. Research limitations/implications: Consequently, as the paper targets most recent bailouts, a still ongoing event, there is a need for extended financial data that could enhance some cause-related solutions after economic recovery. Practical implications: The practicality of the paper refers to guiding management of both government and financial institutions on the choice for reasoning bank bailouts, providing some critical thinking views to investors as well as academics. Originality/value: There has not yet been written research or studies on the most recent financial crises bailouts, due to the process continuation. The novelty of the paper’s resides not in calculating ratios and interpreting them, but rather to looking more into some interesting strategic moves used to boost shareholders’ value. Paper classification: Conceptual paper Key words: shareholders’ value, bank bailout, bank consolidation, M&As, financial crisis, social corporate responsibility

INTRODUCTION AND METHODOLOGICAL REASONING: Bank bailout main theoretical motive Bank bailouts are happening in various cases, some relate to real financial opportunities to save a “too big to fail institution”. Others, (Stern and Feldman, 2003) look upon the perceived growing concern of the moral hazard, for which there is a need for a bailout in the first place. If we revisit to the main stream of motives for which bank bailouts occur, we identify a common denominator: moral hazard, a spinout of information asymmetries in the financial market that lead most of the time to the so called principal – agent problem. This relates simply to a conflict of interests at least on two different levels: the principal- usually the government in this case, and the agent- the lending institutions or the banks in general. Managerial and Entrepreneurial Developments in the Mediterranean Area

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An interesting combination of facts is mirrored in the concept of systemic moral hazard, which transmits a unique dispute in regulatory responses. The argument lies in that the most appropriate response to systemic moral hazard is "preventive prediction." (Okamoto, 2008). It is essentially difficult to reward individuals for producing preventive prediction. Therefore markets fail to produce it at optimal levels, and thus prevent systemic moral hazard and the kind of crisis we are facing. Some may say that managers should look for prosperity without ‘hurting’ their customers or principals again, by secluding or keeping away information. And all this is encouraged as the principal cannot perfectly monitor the agent. Therefore, one of the causes of these financial crises and therefore of the bailouts resides in lack of proper supervision and monitoring and not the business pattern. Since we could see many other banks succeeding in securitisation and lending activities, as well as in keeping their depositors satisfied, while others do not, it becomes simplistic to assume that their long term strategies are wrong. Banks need to take risks through lending, and the rule is the riskiest loans could yield highest returns. A moral hazard appears if banks make risky loans thinking that they that will repay nicely in good conditions. Yet, these banks will not be liable for any loss if their transactions collapse. Thus, such banks keep the profits but will dispose of social costs. During the years, taxpayers, depositors, and creditors have always been in the tragic situation of compensating for the losses made by the banks’ risky financial decisions. This is because they partner in one way or another with them at various stages of their lifetime. Bank bailouts by governments, central banks or other institutions can drag on risky lending in the future, if those that take the risks become “bullet proof “in front of potential losses. It appears that a central bank, by announcing and committing ex-ante to a bailout policy that is reliant on the recognition of certain states of nature (such as an adverse macroeconomic shock incident), creates a risk-reducing "value effect" that more than compensates for the moral hazard component of the policy (Cordella and Levy-Yeyati, 2003). Of course, there are other causes. One can argue that the government can efficiently provide liquidity except when too much liquidity asks for inflationary pressure; it can protect the currency when eroded by lack of confidence and high deficit. In this situation the banks get hurt in their funding costs, while this ruins depositors’ confidence in both safety and liquidity at the same time. Yet, most often history is forgotten and confidence is reestablished slowly through gaining higher yields again for the banks’ customers or by other various rewards (as we would see in the cases analysed in this paper). In terms of methodology used for this paper, the main source of information is based on event study analysis during 2007-2009 in U.S. and Western European markets as to the evolution of the bailed out banks as to their strategies and share prices. This method provides the paper useful information that can be correlated with the secondary data gathered on bailout literature review as well as on the current bailout banks’ strategic analysis. Bank reports and tertiary analyses were interpreted in order to find the correlation with the literature review as the events unfolded.


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LITERATURE REVIEW AND THE PAPER FRAMEWORK This section of the paper displays under a literature review format the author’s suggested lessons from bank bailouts, as they are presented through secondary data analysis and event methodology. Of these lessons, some may interact with each other, while other will stand alone. The table below shows the ten pinpointed lessons their essence. This will facilitate following the paper’s recommendation and conclusions. Lesson No 1

Related to

Lesson Learned

The electorate’s creeping confidence

There is no need for bailout if it deepens financial crisis eventually

through lack of confidence. 2

Too-big-to-fail rule vs. Too- many-

In contrast to the too-big-to-fail problem of the large banks, the too-

to- fail rule

many-to-fail problem affects small banks more by giving them stronger incentives to usher.

3

M&As vs. hidden bailouts

Non-distressed mergers may be motivated by the desire to prevent

bailouts. Bank consolidation may be eligible for bailouts, but the non-banks may line up for M&As. 4

Hijacking the guilty bank

Either government protective schemes or imprudent banking

practices make the”guilty bank” sensitive to takeovers. 5

6

The equality issue and the cultural –

Innovation goes with banking anytime, but its constructive nature

innovation clash

depends on the cultural lens in viewing equality issues

Who to save first

Bailouts cannot be ethically justified because the losers exceed the

winners. Taxpayers seem to be the main concern, but corporations are first. 7

8

The long term perspective of the

Bailout targets eventually fail, due to government favoring

social costs

underperforming public firms, thus increasing social costs.

The grape-vine effect

The banking crisis in a country leads creditors to reexamine

policymakers' willingness to bailouts in other countries. 9

Bank pricing strategies

Higher prices spring everywhere since regulators suffer an

opportunity cost of capital from not receiving any earnings from bank sales or liquidation on short term. 10

Bailout recuperation time-and

The bank can repay its debt when it’s stable enough to fulfill capital

investors ‘money-loop

requirements, so when the bank starts repaying substantially the state is viewed by investors as a sign of strength, no matter the depth of the financial aid allocated per GDP.

Table 1. The ten lessons of bank bailouts (Source: author’s analysis) Managerial and Entrepreneurial Developments in the Mediterranean Area

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1st Lesson (The electorate’s creeping confidence) Bank solvency crises are due to macroeconomic shocks in a model where government is prone to bailout because of cronyism (Vaugirard, 2007). When we transact in a multi-globalised economy or overwhelmingly ‘foreign-ised’, with so many interdependencies, anyone may think of the citizens’ rights to dismiss the government and rule against its decision if they believe that a bailout is not justified. Thus, both political and banks’ balance sheet uncertainties enlarge the set of factors for which a banking crisis occurs and may increase financial instability. Politicofinancial crises may stem from foreign lenders' loss of confidence rather than liquidity issues or lending incapacity. There is no need for bailout if it deepens financial crisis eventually through lack of confidence. There are also cases where money from the bailout went to purchase another bank or bailout money went to CEO’s bonuses or parties (end of the year), and this should be only the less tough part of the story. 2nd Lesson (Too-big-to-fail rule vs. Too- many- to- fail rule) Too-many-to-fail problem happens when the number of bank failures is quite large, the regulator finds it ex-post optimal to bailout some or all failed banks. When the number of bank failures is rather small, failed banks can be acquired by the stronger more protective banks. This could give the industry some incentives to regroup and increases the risk that many banks may fail together at a later stage. The ex-post optimal regulation may thus be time-inconsistent or suboptimal from an ex-ante standpoint (Acharya and Yorulmazer, 2007). In contrast to the too-big-to-fail problem which mainly affects large banks, it is interesting to show that the too-many-to-fail problem affects small banks more by giving them stronger incentives to usher. We may add here that the actual match between the banks, when these merge or get acquired should also be analysed from this perspective. There is the perception that failing banks can be saved by mergers with healthy banks, yet the theory and practice shows how the new merged bank has higher chances of failure then the actual saved by merger bank (Shih, 1999). This is due to the fact that motives of M&A could lead sometimes to the success or failure of the new bank (Mihai Yiannaki, 2007). In this sense, there seems to be many other banks and industries looking at how they will ensure post-merger or acquisition integration success. That is to say that no decisions will be made till the climate is more favorable. 3rdLesson (M&As vs. hidden bailouts) On the same line of thought, most bank merger studies do not account for hidden bailouts, which may lead to biased results. In a study that employed a unique data set of approximately 1000 mergers to analyze the determinants of bank mergers (Koetter et al., 2007), the authors used undisclosed information on banks' regulatory intervention history to distinguish between distressed and non-distressed mergers. Among merging banks, they found that improving financial profiles lower the likelihood of distressed mergers more than the likelihood of nondistressed mergers. The likelihood to acquire a bank is also reduced but less than the probability


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to be acquired. Both distressed and non-distressed mergers have poorer CAMEL profiles than non-merging banks. Therefore in terms of observing regulations, the bank consolidation in the asset management industry is set to intensify as overruling the law and the client demands for independence and force banks to skim off their funding arms. And, since the investment management industry is in early days of consolidation, it seems that this trend is in place for a while and that is around independence. The rate of growth of the independents has been double that of the banks. The reason for it is the increasingly difficulty of a bank to have a top-tier position in institutional investment banking and in institutional investment management. It is interesting to notice then that non-distressed mergers may be motivated by the desire to pre-empt serious future financial distress and prevent regulatory intervention, such as bailouts. 4th Lesson (Hijack the guilty bank) Once Japan got into a cronycal bank system failure after the 1990’s, it had successive government laws backing guarantee schemes for commercial banks deposits, method viewed as an excessive example of encouraging imprudent banking practices, misallocating financial resources and prolonging structural weaknesses (Stern and Feldman, 2003). Across the Ocean, a different extreme, all the major investment banks, Bear Stearns, Lehman Bros, Merril Lynch, Goldman and Sachs, Morgan Stanley, etc. were they essentially wrong? Their core business relied on easy access to credit, and when one of their main “assets” (mortgage backed securities) posed danger to the stakeholders, they suddenly became less valuable in securing their own loans. Without sufficient business to run they became really bankrupt. Hence, are they all to be treated equally in the eye of the regulators when it comes to doing the same mistake to get bailed out? The latest “capital injection” plan of the U.S. is less bound to the fundamental problems of the bailouts, as is just a short run “shock buffer” aimed at reducing volatility and reinstalling investors’ confidence. Whether it can do so without addressing the real problems is not clear (Congleton, 2008). Then, are the bank bailouts really addressing the same problem? Where is the equality and equity stake placed and then where has the difference gone? 5th Lesson (The equality issue and the cultural –innovation clash) Coming back to the social issue of equality, and pinching on “cultural issues”, each country puts in practice its own bailout system depending on the structural problems of their banks gridlock. Following the 3rd Lesson we can identify by logic that there are apparently three types of bailouts: 1.

one done by the state for the simple and untranslatable reason “too big to fail”

2.

one preformed by the private sector through M&A or bank consolidation

3.

one done for the “people we know”


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“These days even with Alan Greenspan admitting that he was wrong to believe that the financial industry could regulate itself, Reaganesque rhetoric about the magic of market place and the evils of government intervention sounds ridiculous” (Paul Krugman, 2008). Is it then safe to just trust the government bailouts, thinking they will keep their promises as not to use taxpayers’ money to refill the loss too soon? And by the way, where do they record this loss and how do they keep track of it? How deep can we look at the abyss if we are let to do so? Then, when are we going to pay for this loss and at what extent and with what types of costs? Many of the ABS (asset based securities) and mortgages have not yet been withdrawn from the market, still. New innovation in this financial intermediation is therefore needed and new solutions can come up from the market to stop the loss. Then, how much innovation can we let in the market and who is to decide its constructive nature? 6thLesson (Who to save first?) Discussing about solutions, recent academic research (Murphy, 2008) implies ways out to this recent crisis that are considered to be far less costly than a bailout of investors who made poor financial decisions with respect to credit analysis. But if we play on who is to blame, then we shall reach no positive ending soon enough. However, it becomes necessary to learn who are the winners and the losers? Utilitarian analysis concludes that bailouts cannot be ethically justified because the losers exceed the winners (McGee, 2008). Applying rights theory, Mc Gee reaches the same conclusion for different reasons. Thus, the emergency legislation for spending $1.5 trillion on purchasing financial firms' troubled assets to address the current financial crisis, also suggests a superior alternative (Bebchuk, 2008) for achieving the two goals of the proposed legislation: 1.

restoring stability to the financial markets and

2.

protecting taxpayers and especially the sub-prime borrowers, but these are not ethically interconnected.

So where does ethics and social corporate responsibility come in? To see these results now lets have a look at the 2008 fall’s injection of trillions of dollars of federal money into the rehabilitation of the U.S. financial system. Also, all recent efforts by lending institutions and government sponsored agencies have failed to arrest the ruthless climb in foreclosures. Rather, little has been spent to the easing of home foreclosures. 7th Lesson (The long term perspective of the social costs) Governments in the E.U. do often bail out firms in distress by granting state aid. Data from 86 cases during the years 1995-2003 (Glowicka, 2006) addressed two issues: the impact of bailouts on bankruptcy probability and the determinants of bailout policy. There are some interesting results that require attention: 1.

First, the estimated discrete-time hazard rate increases during the first four years after the subsidy and drops after that, suggesting that some bailouts only delayed exit instead of preventing it. The number of failing bailouts could be reduced if European control was tougher.


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2.

Second, governments’ bailout decisions favoured public firms, even though public firms did not outperform private ones in the survival chances.

3.

Third, subsidy choice is an endogenous variable in the analysis of the hazard rate. Treating it as exogenous underestimates its impact on the bankruptcy probability.

We would conclude on this issue with a question: What if private banks act like public firms, will the bailout still be in use? Could it actually provide increased consumer satisfaction and less social costs in the long run? 8th Lesson (The grape-vine effect) Policymakers choose whether to rescue failing banking systems by weighing the previous lesson’s social costs of crises against the costs associated with raising taxes to finance bailouts. They are the only ones who can appraise those social costs of bank liquidation. In this scenario, financial crises may result from the public's self-fulfilling prophecies about equilibrium outcomes, as lenders' expectations impinge on the taxation cost of bailouts. The lesson shows that a banking crisis in a country leads creditors to reexamine policymakers' willingness to bailouts in other countries, which eventually makes their banks more vulnerable to self-confirming depositors' runs (Vaugirard, 2005).This can be approximated to the effect of the American bank bailout announcing on the UK and other E.U. countries bailing out their distressed banks. 9th Lesson (Bank pricing strategies) Bank customers benefit fully from higher loan interest rates (Ecomomist.com, 2008) to cover abnormal returns (Yoroulmazer, 2008) in post bailout activity. This move reflects the actual market and not the forced Central Banks’ frequent reduction of inter-banking interest rates, created for liquidity and lending boosting. One can notice that, all recently bailout banks in U.K. utilize higher loan interest rates compared to non-bailout banks. At the same time once a bailout is announced, the other banks in the respective market follow a certain degree of abnormal returns in their share price, but also modifications of their balance sheet structure, that can direct them to undertake more speculative actions for their rehabilitation. Such events though may disturb the equilibrium of those healthy banks. In time, such confidence erosion may bring further problems to the already bailout banks. The higher the propagation effect to the banking sector, the more severe the healthy banks get affected, should the bailout banks be largely linked through wholesale funding to other local financial institutions (Bank of England, 2007). Another cause for high new interest rates charging customers, despite their temporary character is due to market forces remedy and is correlated to the fact that bailouts are also costly in the model. This is so since the regulators suffer an opportunity cost of capital from not receiving any earnings from bank sales or liquidations. (Acharya and Yoroulamzer, 2007).


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10th Lesson (Bailout recuperation time-and investors’ money-loop) Soft budget constraint (SBC) is actually a commitment issue in an economic system. Modern studies focus on the transitional economies, “lack of financial disciplines in the state sector” (Kornai, 1980, 1992). The unenforceable bankruptcy threats, as well as various subsidies, credits, and price-supports, etc., cause this lack of discipline, recognized by Kornai (1980). There are some other explanations of the soft budget constraint (Shleifer and Vishny, 1994) which are related to the politics: the reason that a government bails out a firm or a bank comes from the fact that the political price of permitting bankruptcy is too high. Government ownership in a bank at this point seems to be a disadvantage when attracting and retaining good customers and employees. But, in a banking system, the central bank will not just let the local banks go to bankruptcy and then she has to deal with systematical financial crisis. In any case, the central bank would like to rescue those local banks which are suffering from a huge amount of bad loans, when there is also a prospect that the bank will repay sooner the financial support. This are the cases of USB in Switzerland (Simmons J., Logutenkova E. (2009), RBS and LLoyds in U.K (Mail Online, 2009). and other 10 banks in the U.S. The US Treasury announced that 10 banks had been cleared to repay Government aid because they had raised sufficient capital (Hudson and Judge, 2009). Yet, thinking of the 5th lesson, a responsible or sustainable way in bailout repayment means that the bank can repay mandatory convertible bonds or buy-back shares when it’s stable enough to fulfill capital requirements. In this respect it is noticeable to see how the bank that repays the state is viewed by investors as a sign of strength, no matter the depth of the financial aid allocated per GDP. And, indeed, just let’s have a look at the total costs these bailouts weigh in the various economies over the years:

I. Latin America 1980s: Argentina 13% Chile 20% II. Mexico 1994-5: 15-20% III. East Asia 1997-98: Thailand 42% Indonesia 36% Korea 20% Malaysia 21% III. The US banking crisis: 2007-2010*

USA: 60%- no .1 GDP provider in the world

(2009/2010)

UK:46% - top 6 GDP provider in the world

Table 2. Banking Sector Bailout Cost/GDP (Sources: Ricardo Hausmann and Liliana Rojas-Suarez, eds., Banking Crises in Latin America, 1996;Deutsche Bank Research, Global Emerging Markets, December 1998, and author


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anaysis and estimates 2007-2010.) *But, Western Economies (U.S. Canada and Europe) fell off in World’s GDP from 52% to 49.5% during 2008-2009.

Fig. 1. UK bailout costs in total GDP year 2009. Sources: Ricardo Hausmann and Liliana Rojas-Suarez, eds., Banking Crises in Latin America, 1996;Deutsche Bank Research, Global Emerging Markets, December 1998.

Then, once emerging economies bounce back more rapidly than mature economies, we can foresee a shorter timeframe for this financial crisis, despite is stretching and depth. RECOMMENDATIONS TO INCREASE SHAREHOLDERS’ VALUE Each single lesson presented tries to raise a signal on why to keep, when to sell, where to buy shares in the banking industry and which aspects of this industry were most dynamic during the financial crisis. Along with the possible outcomes of bailouts, there is a chance to be able to identify good bailout deals that can eventually be a sound source of profit for investors. Thereby, a banking institution bailout it does not mean it overlaps with a negative connotation for investors or existing shareholders. Should it turns out that the bank is a new potential target for cash holders and opportunistic investors, the issue is then to protect eventually these organisations from predatory takeovers. In the anticipation of such actions it is not totally mistaken treating bailouts as takeovers which miss the pre-merger or pre-acquisition phase, let alone the integration phase.


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Specifically, each potential or existing bank shareholder that is aware of these bailout lessons could take advantage in trying to identify her/his target and compare other options in the market. In order to optimise their portfolio profitability and safety, investors should act on certain moves at each stage of the bailout as it follows: 1.

bailout environment (legislation background, socio-economic connotations to the public, fraud related perceptions and management abuse systems, at the base of building trust and rapport with locals);

2.

bailout announcement (lack of pre-bailout information could harm the transaction afterwards), it has to be in line with a clear vision of the future bank strategy and focused on an appropriate time horizon with resilience on short term pressures;

3.

bailout procedure understanding (cash vs. bond issuance or guarantee provision);

4.

bailout financial commitment (both the government and the banks’ commitment in redressing the financial institution, i.e maintaining the private decentralised decision making through professional teams expertise of the both parties involved);

5.

bailout managerial board nomination (in case of board change or dismissals) and keep directors independence;

6.

identification of the new bailout bank customer base (clientele refocus);

7.

bailout strategy rethink (should be analysed and disclosed in a transparent way for feedback purposes as well, also leave room for innovation capabilities to develop that are investment cycle dependent and improve lending practices standards) ;

8.

new bank share price recalculation and company revaluation (market flotation and control of rumor selling), analyse short term trading, but pay attention on long term position taking.


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Possible Scenarios The Bank has authorization from its investors to increase its share capital by as much as “x” percent, which wouldn’t allow The Bank to repay the state in full at the current price. Under other scenarios, the government could convert the bonds into shares and sell them on the market, or find investors to buy the mandatory convertible notes. “It would certainly be right for the state to get out from this investment,” “In global business, we still see a lot of insecurity among employees at The Bank as long as the state is involved.” The Bank’s Tier 1 capital ratio, a gauge of the bank’s ability to absorb losses, stood at 10.5 percent at the end of the first quarter, compared with 14.1 percent its competitor, which declined government assistance. By converting bonds while The Bank trades at or below the minimum conversion price of 18.21, the government would get the highest amount of shares. The government would have to sell shares at a minimum of about 12.5 to recoup its investment, taking into account interest payments on the bond, according to calculations based on terms of the deal. The state is entitled to receive interest payments of about 750 million per year until the notes mature in June 2011, regardless of the timing of the conversion. Source: Simmons and Logutenkova (2009)

1.

Nevertheless, investors could keep track of the market moves and rumors under Efficient Market Hypothesis (Fama and French, 1970). They may also foresee the share prices Random Walk (Burton, 1973), despite the close probability of Irrational Exuberance (Burton, 2000) in pricing.

2.

Yet, some studies have attributed this forecastability to the tendency of stock market prices to “overreact.” DeBondt and Thaler (1985), for example, argue that investors are subject to waves of optimism and pessimism that cause prices to deviate systematically from their fundamental values and later to exhibit mean reversion. They suggest that such overreaction to past events is consistent with the behavioral decision theory of Kahneman and Tversky (1979), where investors are systematically overcontent in their ability to forecast either future stock prices or future corporate earnings.

3.

These findings give some support to investment techniques that rest on a “contrarian” strategy, which is, buying the stocks/groups of stocks, that have been out of favour for long periods of time and eluding those stocks that have had large run-ups in the past.

4.

When the bailout banks come back in the market, due to governmental economic support and bailout massive schemes, investors tend to trust the bailout firm based on its behaviour prior to the financial crisis rather then the capital input. Thus, shareholders could experience sudden share price augmentation just before the payback of the bailout and other opportunistic investors could enter the equation, so beware of the bad wolf.


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5.

For example, what it is noticeable two and a half years after the beginning of the financial crisis is that a few countries from the Arab Golf (Qatar, UAE, Saudi Arabia), most of them US “partners” support through either government or private equity firms cash injections in the U.S as well as in other E.U. feasible target financial institutions (Reuters, 2009).

6.

Higher global credit crisis was exacerbated by excessive complexity of structural credit products (which will resume their demand sooner or later, as complex solutions to investors and risk management problems are always in need, no matter the effort and skills required to analyse and resolve them. Just like junk bonds came back from the crisis of the ‘80s, we will have the same effect on securitization. New bills will be issued even it will have to be under a simpler securitization form or a more complex one later on. Eventually, a long term solution related to the banking systems is improving risk management techniques through tighter regulation and supervision of risk control mechanisms, providing structured products transparency, while foreseeing the next move in these banks' financial strategy (Mihai Yiannaki, 2008). Innovation and creativity remains a key ingredient as long as it is explained and understood by everyone.

7.

However, such regulations should not discriminate between banks, hedge funds and other alternative investment market players in the financial sector. Such a flaw could ruin the other financial intermediaries’ competitive power, while redistributing it to banks.

CONCLUSIONS Why do governments bail out banking systems in distress? There is possible for the central banks to supply liquidity by issuing government securities backed by tax revenue and at the same time to pay attention to the follow up of the situation as well as the redress of the main cause of the bailout (i.e. the financial crisis). As for the regulators and governments, there is no bigger mistake than to bail out a ‘too big to fail bank’ neglecting all combined efforts from the industry to help the public cope with social costs or overlooking the social corporate responsibility. There is not much banks can do to stay away from bailouts in financial crisis anyway, just to stay focused on their environment rebuilding while participating to it, focusing on retail banking, with limited investment banking operations, and lean on a long-buoyant domestic market. At the same time a large alternative and hedge funds market will replace the trust given to banks, but in a less regulated environment as well. Most likely, due to still fierce competition, such funds will be further regulated in their detriment (as they are not a bailout target), but for customer/investor’s benefit. However, bailed institutions, healthy banks and other financial institutions together with the government should carefully resume the monitoring and the reestablishing of the bank supervision at least as per already existing international standards and agreements such as Basel II Accord or the Credit Directives in the E.U. Specifically, the element of control becomes the


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wheel when navigating in murky waters while re-analysing all costs incurred, not just book losses, and it should advance the solution to a positive upturn. Eventually, it is the customer who is affected and has to pay much more not only in terms of tax, but also for obtaining loans from bailout institutions at higher costs, apart from often having restricted access to such products. Not only the customer is a key element in re-establishing share prices through indirect payments, but also by restoring her/his confidence and trust in the banking organization, if not in the whole banking system. Hence, the investor or even any common customer would be now the most interested in not having bank bailouts in the economy at a first glance, but in time, it proves that bailouts are not that bad if one can provide a sound economic education to the two categories. Eventually, bailout banks can yield investors acceptable returns as soon as, or if the bailout mechanism pays back. It is important to clearly mention that it would be useful in near future to apply this paper’s framework to more aspects in banking, to a larger panel of banks across the Globe as well as on a longer period. In terms of bank performance, the author continues her research by preparing another paper on bank efficiency after the recent credit crunch. In the next study, there are other financial aspects considered in a comparative relation between healthy banks and bailed out banks whose shares were/are listed. This new paper aims at identifying through financial data analysis first the reasons behind the financial crisis, secondly the bailout need and last but not least the main triggers that made some banks more bailout dependent then others. Such a study will close the loop in the lessons learnt from recent bailouts and it is related to bailouts’ ultimate effects related to banks’ financial standing. REFERENCES: Acharya, V. and Yorulmazer, T. (2007),”Too Many to Fail - An Analysis of Time-Inconsistency in Bank Closure Policies”. Bank of England Working Paper No. 319; London Business School IFA Working Paper, available at: http://ssrn.com/abstract=626242 or DOI: 10.2139/ssrn.626242 (accessed 11 November 2008) Bank of England. (2007), Financial Stability Report. October, 22, 5-15. Bebchuk, L. A. (2008), “A Plan for Addressing the Financial Crisis”, Harvard Law and Economics Discussion Paper No. 620. available at: http://ssrn.com/abstract=127324 (accessed 11 October 2008) Burton, M (1973), A Random Walk Down Wall Street,W. W. Norton & Co., New York. Burton G. Malkiel, (2000). “Review of Robert J. Shiller’s Irrational Exuberance.” Wall Street Journal. April 4. Congleton, R. D. (2008), “Notes on the Financial Crisis and Bailout of 2008”, available at: http://ssrn.com/abstract=1288586 (accessed 30 November 2008) Cordella, T. and Levy-Yeyati, E. (2004), “Bank Bailouts: Moral Hazard vs. Value Effect”. Journal of Financial Intermediation, Vol. 12, pp. 300-330, 2003, available at: http://ssrn.com/abstract=539542 (accessed 4 October 2008) Daily Mail Reporter (2009), “Lloyds Banking Group gives £2.6billion back to the taxpayer”, Mail Online, available at: http://www.dailymail.co.uk/money/article-1191561/Lloyds-Banking-Group-gives-26billion-taxpayer.html (accessed 14 June 2009) DeBondt, Werner F. M. and Richard Thaler. 1985. “Does the Stock Market Overreact?” Journal of Finance. July, 40, pp. 793– 805. Managerial and Entrepreneurial Developments in the Mediterranean Area

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