Global Players See Great Opportunity for Retail Banking in Emerging EconomiesPublished: September 22, 2004 in Knowledge@Wharton
These firms, watching the erosion of U.S. and European banking profit margins, are increasingly willing to face the risks of setting up retail operations, such as offering checking and savings accounts and credit cards, in new markets. These initiatives, if successful, can provide a foot in the door for future growth, according to Wharton professors and banking executives.
GE's acquisition last month of DeltaBank of Russia - along with other holdings in the Czech Republic and Hungary - illustrates the company's new retail-banking strategy, which builds on GE's consumer finance business. "When developing countries get to a certain level of wealth, which is not always well-defined, the population can support a new array of more sophisticated financial services," says Carol Leisenring, co-director of the Wharton Financial Institutions Center. "Typically it starts with basics such as checking accounts and savings accounts, and then it gradually evolves to something that looks more like what we have with mutual funds, credit cards and lending services."
Yet opportunities in emerging markets also come with risk, Leisenring notes. Foreign bankers doing business in emerging economies face regulatory systems that often favor local companies. Emerging economies also do not have the kind of credit rating systems that help banks assess risk, nor do they have advanced bankruptcy codes to protect lenders in case of default. "The attraction is that it's a vast new market. But you have to manage the risk appropriately, and there will be a big learning scale for people to do that."
Some Sour Experiences
According to Mauro Guillen, Wharton professor of international management, banking profits in the United States and other developed countries are growing thin as a result of increased competition and low interest rates. The interest rate spread, or the difference between what banks pay to borrow and lend, can now be less than one percentage point, says Guillen, adding that in emerging markets the spread can range from four to ten percentage points. "It's a massive difference, but again it's risky."
Bankers treading into emerging markets also face the risk of political or economic instability. Skyrocketing inflation, which can quickly erode lenders' positions, is common in developing economies where "every five to ten years there's a major financial crisis," Guillen says. "Whenever that happens it's not clear who is going to win, borrowers or lenders. Certainly lenders have had some very sour experiences."
Robert Rendine, vice president for global communications in GE's consumer finance division, which has $106 billion in assets in 39 countries, says the company has years of experience writing consumer and business loans overseas. "Moving into retail banking is a new strategic dimension, but working in emerging markets is not new." GE is selective in where it chooses to do business, he adds, and structures its operations in each country to take advantage of local conditions and to build on the knowledge of markets it has gained in other businesses. "We're not doing this with a cookie cutter."
Wharton finance professor Richard Herring, co-director of the Wharton Financial Institutions Center, says GE has been able to snap up some promising financial acquisitions in Asia and Eastern Europe. "They have a pretty good sense of when to enter the market. They have gotten some wonderful deals."
GE, Herring adds, has been "opportunistic" in taking on non-performing loan problems around the world. "That often takes them into the business of resolving troubled debt, which gives them a good understanding of a portfolio of consumer retail credit. It also seems to be true that there are lessons one learns in dealing with those situations in emerging markets that are transferable from one country to another."
Meanwhile, Citigroup is also beefing up consumer operations abroad. Deryck Maughan, chairman and chief executive of Citigroup International, told analysts this summer that his company, which has been active in global banking for more than a century, is expecting to make new investments in banking operations in emerging and growth-oriented economies. He singled out China, India, Russia and Turkey as attractive emerging markets. Brazil, India, Korea, Mexico and Poland were identified as prime growth economies.
Maughan pointed out that the United States now makes up 62% of Citigroup's total business, but he expects that percentage to drop to 50% in the next few years, displaced by growing international business. "Nowhere is the opportunity more compelling than in consumer financial services."
The number of "bankable" households with disposable income of more than $10,000 per year is expected to grow from 112 million to 122 million in the United States by 2008, Maughan said. Internationally, the number of bankable households is expected to grow from 349 million to 415 million in the same period. "You get a chance like this once in a generation," he told analysts.
According to Herring, Citigroup's long experience abroad leaves it well positioned for expansion in the current window of global financial liberalization that began in the late 1980s. "Citigroup's franchise was built in the early 20th century at a time when countries were more open than they became from the 1930s through the 1970s. Citigroup had both the courage to buy in and the real ability to stay with it through thick and thin."
Herring points out that that the arrival of efficient retail bankers, offering new credit and other financial services, can grease an evolving economy, thereby allowing the market to grow even faster.
Weak Domestic Competition
In addition to Citigroup and GE, HSBC Group and other European banks are pushing emerging market strategies, says Adrian Tschoegl, adjunct professor of management at Wharton. Banks from developed countries, he notes, have little domestic competition in emerging markets and have learned how to operate efficiently in their own highly-competitive home markets. Banks operating in different countries are also able to take ideas that work in one country and put them to work in another developing market.
"You can succeed simply by being the one to introduce some clever new contract term or way of doing things," he says. "You have played in the big leagues, so in terms of your processes you are probably pretty good." Furthermore, domestic competitors in Asia and Latin America remain weak after years of government protection. "The market hasn't pushed them to be as competitive." Eastern Europe, Tschoegl suggests, is particularly attractive to bankers from the United States and Europe because the local competition is sparse after generations of communism.
China, says Leisenring, is also attractive. "A lot of financial institutions salivate when they look at the size of the market in China." India is another target market, Leisenring adds, noting that its historic ties to Britain may make the legal system easier to navigate for foreign bankers. "In some Asian countries and China is among them the legal structure can be very different or non-existent."
Retail banking is a way for financial firms to gather additional market share in countries where they could also sell mutual funds or other services. "These countries are growing rapidly and presumably will follow the same general pattern that we have, of banking services being demanded at a higher and higher level," says Leisenring, adding, however, that emerging markets may bypass some steps of the financial evolution experienced in the United States. "For example, they might skip over the whole process of having checking accounts that require physical checks to be written out and cleared, and just jump right into doing it electronically."
Over time, Tschoegl predicts, global banks will eventually lose their edge in the emerging economies they now seek to conquer. Local competition, he says, will spring up, most likely in the form of local employees hired by Citigroup, GE or other international banks. "They will say, 'I have been working for GE for 10 years. I know the business. Let's start something.' And pretty soon there will be local competitors who can offer the same product and operate a little more cost-effectively and not have to report to a faraway headquarters."
The arrival of international bankers actually helps locals grow stronger in the long run, says Tschoegl. Global players make the environment for banking better for lenders in emerging markets by establishing new structures, such as credit bureaus, stricter bankruptcy procedures or new ways to register collateral. "This makes it easier for local firms to get started and to grow."
In the past, Tschoegl says, international financial firms have sold off operations to employees in developing countries because they were no longer making the profits they once did. Also, he says, problems at home can cause international bankers to give up operations in far-flung countries and leave them in the hands of locals. "What we are looking at is a window of opportunity of five to ten years."