Introduction
The overall effect of the global financial crisis was making all financial institutions including the multinational ones experience threats of collapsing. The crisis “played a significant role in the failure of key businesses, declines in consumer wealth estimated in trillions of the US dollars, and a downturn in economic activities leading to the 2008-2012 global recession besides contributing to the European sovereign debt crisis” (Aisenman 2009, p.20). As a result, to shape up the economy suffering from the global financial crisis, nations such as the United States and the UK cautioned their financial institutions to conduct a responsible business. Otherwise, they would be subjected to tougher business regulations. For instance, Master (2009) reckons, “so far, most countries are avoiding a regulatory race to the bottom – if anything, they are going the other way…the UK, for example, is pressing ahead with its own liquidity rules while the Netherlands has pushed through curbs on bankers’ bonuses” (Para. 9). Amid the imposition of tougher regulation on financial institutions, after going through the aftermaths of the global financial crisis many banks are reporting increased financial performances. Indeed, in the light of the changing boundaries of banking in the past 20 years and the recent financial turmoil, there has been a noticeable shift of the banking sector from ‘Balance Sheet Expansion’ to preoccupation with rates of return on capital and risk management. From this position, this paper focuses on the evaluation of the financial performance of HSBC bank and Barclays bank since the start of the global financial crisis. An effort is also made to compare both banks’ capacity to develop risk resilience to avoid circumstances truncating into a crisis similar to the 2007 to 2008 global financial crisis.
Performance of HSBC Bank and Barclays Bank
The global financial crisis immensely threatened the operations of financial institutions. To this end, Brand Directory reckons, “led by the charismatic CEO Bob Diamond, Barclays had to fight hard in 2011 to maintain its profit levels battling the seemingly endless financial disasters, which have ravaged global markets” (Para.2). There have also been heavy criticisms on the bonus culture, which is part of the operation of the many banks including HSBC and Barclays. Other risks that constitute impediments to the realization of high profitability and hence the higher performance of Barclays and HSBC are concerns of corporate greed and allegation of engagement in fraudulent practices (Doward 2012, Para.8). Nevertheless, amid these criticisms, measuring performance from the context of profitability, net returns on investments, and net margins of interests, Barclays has recorded an outstanding performance often making it beat numerous British banks including HSBC. In the UK, the economic environment remained largely unstable throughout 2010 and in the first half of 2011. However, five major banks of the UK including HSBC and Barclays reported combined profits of 7.9 billion Euros before tax (KMPG 2011 p.5). This result was an increase of 1.5 billion Euros in the last half of 2010. While this improvement is an indication of better financial performance of Barclays, HSBC, and the other three banks (RBS, Standards Chartered, and Lloyds ), it is a decrease in pre-tax profits since the same banks had recorded a pre-tax statutory profit of 15.7 billion Euros (KMPG 2011 p.5) in the first half of the year 2010. Arguably, there are numerous explanations for this trend. One of the explanations is that the “less favorable investment banking conditions reduced income while top-line growth in all areas continued to be a challenge” (KMPG 2011, p.5). In the first half of 2012, Barclays reported a net interest income of 6.1 billion Euros. On the other hand, it had reported a net income interest of 6.2 billion Euros in the first half of 2011. This decrement indicates a fall in the financial performance of the bank by 0.1 billion Euros. For the case of HSBC, net income interest stood at 19.4 billion US dollars. However, this was a decline by 4% in the net income interest recorded in the first half of the year 2011 (KMPG 2012, p.6). Therefore, overall, both banks experienced reductions in the net income interest over the first half of 2012. Comparatively, Barclays experienced a decline of 2% in the net income interest while HSBC recorded a 4% decline. Consequently, based on net income interest, Barclays performed better financially over the last two years.
The financial performance of a financial organization can also be measured by the net margin of interest. For a financial institution to have a high performance based on the net margin of interest, the institution should garner higher interests on income as opposed to the interest paid to the lenders, for instance, the direct deposits by customers measured relative to the amount of interest-earning assets (Khrawish 2011, p.151). Therefore, scrutinizing how the margin of interest for both Barclays and HSBC has been varying since the onset of the global financial crisis in 2007 to 2008 through the 2008-2012 recession may help to unveil incredible information on the extent to which the management of both organizations has been handling the tasks of liability and assets management. In fact, for optimal margins of interest for financial institutions to be realized, the institution must earn larger amounts of income on the assets while having low costs on the liabilities. Apparently, in such a situation profits are also high. In the same line of argument, Khrawish (2011) asserts, “how well a bank manages its assets and liabilities is affected by the spread between the interest earned on the bank’s assets and the interest cost on its liabilities” (p.155). The spread referred to here is what banks measure by net margins of interest. Starting from December 2010 to the end of the first half of 2011, both Barclays and HSBC reported a fall in net margins of interest. However, the situation was worse for the case of Barclays which reported the fall in tunes of “11 bps to 197 bps” (KMPG 2011, p. 7). In the first half of 2012, Barclays has encountered a further reduction of net margins of interest from 197 bps to 189 bps. KMPG (2012) attributes this fall to “pressure on customer margins and reduction in benefits from the groups’ structural interest rate hedging activities” (p.7). For the case of HSBC, the bank reported a fall of net interest margins in the tunes of 17 bps to 237 bps in the first half of 2012. This fall is explained by the low returns on excess liquidity coupled with customer lending that was partly offset through a reduction in funds’ cost levied on the accounts of customers. However, as KMPG (2012) informs, “on an underlying basis, after adjusting to foreign currency movements, the sales of the US Credit, and Retail Services portfolio, the net interest income increased by 3 percent” (p.7). From the above statistics, it is arguable that the net margins of interest for both Barclays and HSBC have been falling overall since the onset of the global financial crisis. This means that optimization of the extent to which the banks have been raising funds with liabilities having low-interest costs coupled with the extent to which the banks have been acquiring assets capable of yielding high-interest incomes has been decreasing. About KMPG (2012), “non-interest income comprises net trading revenues, fee income derived from various services including funds management, net insurance revenues, and net income from financial instruments designated at fair value” (p.8). Generally, many banks in the UK encountered mixed results for non-interest incomes over the first half of 2012 especially when the financial markets became volatile in April 2012. This volatility had the impact of dwindling the demand and incomes accruing from trading in financial products. In the case of Barclays Bank, “a strong performance by Barclays’ investment bank was the primary cause of the 6 percent increase in Barclays’ non-interest income (before the impact of gains or losses on own credit) due to improved performances in the interest rate and commodity products” (KMPG 2012, p.8). During the first half of 2012, HSBC encountered decreasing trading and fee income. Net fee income dropped by 8.3 billion dollars, which is approximately 6 percent, in comparison with the first half of 2011. Trading income for the same bank fell by roughly the same percentage to settle at 4.5 billion dollars in the first half of 2012. KMPG (2012) attributes this fall to the “non-favorable fair value movements on economic and non-qualifying (for accounting purposes) hedges in addition to lower average holdings and the associated yields on debt securities held for trading” (p.9). The table below summarises the performance of both HSBC and Barclays bank.
Risk Exposures of Barclays and HSBC Banks
Apart from risks associated with government regulations, for the case of Barclays and HSBC, other risks include credit risks, liquidity risks, technology risks, market risks, sovereign risks, and insolvency risks among others. Every bank is prone to credit risks since virtually all banks must give loans to customers. In the second half of 2011, “Barclays’ loans and advances to customers increased by £14.0 billion (3.3 percent) to £442 billion with growth in both wholesale and retail lending” (KMPG 2011, p. 30). In the same period, wholesale leading also increased to settle at 4 percent due to the increment of settlement balances. Retail lending also increased by 2.7 percent due to the increment of home loans both in the UK and in Italy coupled with the “acquisition of egg consumer card assets which added £2.3 billion of receivables” (KMPG 2011, p.30). On the other hand, HSBC reported, “8.0 percent increase in gross loans and advances to customers to $1,056.6 billion with growth in all regions except North America compared to December 2010” (p.31). Indeed, about a third of the encountered rise was articulated to the weakening of the United States dollar. In HBSC, customers’ loans were most pronounced in the case of commercial and corporate lending due to the increased trade and business activities. Personal lending also grew significantly resulting in higher balances in mortgages in the UK. The above findings are an indication of increasing credit risks since the more consumers hold a financial institution’s money, the more the chances of losing money for the concerned institution.
HSBC bank reported a net credit risk of 734522 Euros as of December 2010. Moreover, the 2011 annual report revealed the sources of credit risks that Barclays bank faces as being “mainly from wholesale and retail loans and advances together with the counterparty credit risk arising from derivative contracts entered into with its clients” (Annual Report 2011, p.29). Addressing liquidity and funding risk by HSBC bank, the annual report of 2011 revealed, “Of total liabilities of £796 billion at 31 December 2011, funding from customers amounted to £346 billion, of which £342 billion was contractually repayable within one year” (p.58). Both banks balance the benefits accruing from availing credit to a customer with the eminent risks posed by availing more credit to consumers in the quest to yield more incomes on interests with the anticipation of increasing the net interest margins.
Compared to 2010, Barclays Bank annual report of 2011 revealed the deteriorating credit status of the bank as affecting its “exposures to retail and wholesale counterparties, including a country’s government or its agencies (via sovereign risk) thus impairing or reducing the value of Barclays credit assets” (Annual Report 2011, p.29). With the evident degenerating credit conditions as witnessed in the UK and the US amongst other countries, there is an anticipated significant impact of the same on insolvency vulnerabilities of retail and wholesale businesses not sparing government agencies. The whole effect will interfere with Barclays bank’s asset status specifically by lowering it. Addressing this issue, the Annual Report (2011) asserts, “The impact of these conditions could adversely affect Barclays and the solvency of its counterparties, custodians, customers and service providers, its credit rating, its share price, the value and liquidity of its assets and liabilities, and the ability of the group to meet its debt obligations more generally” (p.30). Therefore, Barclays has resorted to supervising its sovereign risk vulnerabilities in the Eurozone countries as shown below.
Government regulations like the costs in the financial institutions. For the case of Barclays and HSBC, the development of strategies for compliance with established regulations by the government to help stabilize the performance of the economy to avoid financial crisis poses risk to their financial performance. Following the Eurozone crisis, Barclays reported a market risk because of the witnessed changes “changes in both the level and volatility of prices e.g. interest rates, credit spreads, commodity prices, equity prices, and foreign exchange rates” (Annual Report 2011, p. 30). In the context of this argument, KMPG (2011) asserts, “Banks are spending huge sums on reviewing and re-engineering processes and systems to meet regulations including employing more staff to engage with policymakers and bolstering compliance and risk management departments” (p.20). For this reason, Barclays approximated in 2011 that it would spend 350 to 400 million Euros to execute strategies for compliance with the government regulations. On the other hand, HSBC committed 375 million Euros for the same course. Arguably, the commitment of both HSBC’s and Barclays’ financial resources to cater for costs of complying with government regulations are measured to develop resilience for risks such as operational risks. Both banks encountered market risks that are inherent to their operational activities because, “based on the saving to leading business, bank’s cash flows are sensitive to the uncertainty of interest rates” (Khrawish 2011, p.157). Common to both banks, in 2008 and 2009, the banking crisis resulted in critical securities and derivatives risks that culminated in collapsing of market derivatives. For instance, in the case of Barclays bank, there was “net exposure to asset-backed securities (£42,052 million) was 64.34% of its investment assets” (Master 2009, Para 9) in 2008 to 2009 financial year.
Liquidity risks are also major drawbacks that have been affecting both Barclays and HBSC banks. For this reason, through 2010 and 2011, both banks endeavored to mitigate liquidity risks through efforts to improve “loans to deposit ratios and reducing reliance on wholesale funding” (Ratings Direct, p.34). For instance, in 2010, HBSC put incredible efforts to ensure that loans to deposits ratios were maintained at minimal levels.
When endeavoring to deal proactively with various risks that are encountered by financial institutions, measures are put to reduce risks of increasing sovereign and insolvency risks. This perhaps reveals why both Barclays and HSBC have been focusing on cost reduction strategies over the recession period. The various mechanisms adopted by financial institutions to reduce costs are dedicated to establishing various combinations of trading products so that optimal cost efficiency is reached. To this extent, Hanweck (2005) affirms, “the problems with the cost-efficiency ratios stem from a combination of factors on both sides of the cost to income equation” (p.10). In the first place, to mitigate sovereign risks, Barclays and HSBC focus on increasing their revenues through the expansion of their areas of business. Nevertheless, the interest rates were at their historic lows in 2010 in the UK and other western nations (KMPG 2011, p.16). Indeed, the UK banks including Barclays and HSBC had been facing incredible challenges affiliated to the hiking pressures on the liability of margins coupled with the immense competition for consumer deposits as a means of improvement of funding sources. However, as KMPG (2011) asserts, “the uncertain economic conditions with limited prospects for GDP growth across the European Union and the imposition of more stringent loan criteria by banks mean that personal and business demand for lending also remains subdued thus negatively impacting margins” (p.20). In 2009, both Barclays and HSBC realized hefty returns from their investments in various trading activities. However, the returns decreased tremendously over the first half of 2010 and the first half of 2011.
Apart from the above measures to ensure that reduction in cost associated risks are achieved by both HSBC and Barclays bank, mitigation of various risks that are encountered in the financial sector calls for putting tight control around the banks’ balance sheets. For instance, according to Ratings Direct (2012), “Gross customers’ loan (£452 billion at March 31, 2012), which is still below £468 billion was reported at the end of 2008” (p.10) by Barclays bank. On the other hand, in terms of credit market assets, which entail the asset-backed securities and finances that are legacy leveraged, by June 2012, they were a third of the 2008 figures.
Recommendations
To deal proactively with the challenges facing HSBC and Barclays, both banks must adopt plausible mechanisms of dealing with government regulations so that the costs emanating from the implementation of regulations do not present significant impacts on the performance of the banks. Therefore, it is recommended that both Barclays and HSBC consider optimizing their process of allocation of liquidity and capital in their different areas of business operations in the endeavor to realize higher returns, which are well above the cost of capital-weighted means. Consequently, it is recommended that both banks embark on specialization coupled with reassessing the roles that they play in the increment of value of banking both within the UK and their global banking chains. This means that it is important for both banks to revise their portfolios for returns so that they can pre-occupy themselves in the selling of only non-core assets where it is appropriate, which can earn the highest interest on incomes. However, this recommendation is made in full appreciation of the fact that restructuring business portfolios are a difficult task because minimal banks are essentially acquisitive particularly in the current economic climate. In the continued effort to manage escalating business costs, Barclays and HSBC must adopt cost-effective systems. Therefore, it is recommended that the banks focus on redesigning their information technology architectures through the incorporation of new but simple systems that are cost-effective. This recommendation is based on the realization of the fact that RBS technology has failed. This failure is anticipated to spur investments by making banks in the UK respond to business regulations compelling the banks to hike their endeavors to re-engineer various operational systems. By doing this, it is anticipated that the banks would be able to acquire cost-effective systems. This recommendation is made amid appreciating the fact that “the expense of platform change over the next decade will be considerable” (KMPG 2012, p.17). Additionally, there are incredible risks to be expected in the realization of this recommendation since the upgrading of various legacy systems of banks involves several risks. In particular, about KMPG (2012), “…a failed upgrade triggered the RBS incident” (p1.7). Thus, the success of this recommendation is largely dependent on the capacity of both HSBC and Barclays to mitigate and avoid the mistakes made in the case of RBS. Additionally, in line with the proposition of the recommendation that the banks should focus on mechanisms of reducing costs, it is also vital that they also embark on strategies of overcoming the market conditions, which continue to deteriorate. Therefore, it is recommended that both HSBC and Barclays deserve to reduce costs by adopting various initiatives for cost-cutting such as reducing wage bills, bonuses, and even the headcounts. Other initiatives would include shrinking trading capacity coupled with business activities in areas that demand large amounts of liquidity and capital commitment.
Conclusion
The global financial crisis experienced in 2007 to 2008 has had profound impacts on many financial institutions including HSBC and Barclays. In particular, it has been argued that the crisis threatened many economic institutions with Lahman Brother terminating its operations to be acquired later by Barclays. Even with the enlargement of the Barclays bank following this acquisition, the bank had to deal with the challenge of endeavoring to increase profitability during a period in which the UK’s financial institutions have been experiencing tough unfavorable market conditions. Through comparative analysis of HSBC and Barclays in terms of their financial performance and business operation risks encountered, the paper has revealed that both banks have been experiencing a hard time. Some of the risks analyzed include credit risks, liquidity risks, technology risks, market risks, sovereign risks, and insolvency risks. Specifically, the paper has confirmed the expected effect of the degenerating credit situation as witnessed in the US and the U, which has the overall impact of lowering the asset value of financial institutions like Barclays and HSBC. On this issue, the paper has clarified this impact using Barclays bank as an example since the same situation is true for HSBC. However, from the analysis of the paper, HSBC is more affected by the reduction in the performance of Barclays. Therefore, it has been argued that Barclays has been performing better overall since the onset of the global financial crisis. Many of the challenges affecting the performance of HSBC and Barclays have been argued as being instigated by the increasing cost of business. In this light, the paper has recommended the adoption of various strategies for cutting costs by both organizations in the quest to hike their profitability. It has also emphasized the need of endeavouring to address various risks so that the financial position of the banks can tremendously hike.
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