ANZ learns the hard way

By Richard Braddell

Twice bitten, thrice shy was the message ANZ's chief executive officer John McFarlane brought to the business leaders at Apec.

After being stung less than a decade ago from ill-judged lending to lesser developed countries, ANZ was again caught out by the Asian financial crisis which by the end of this year will have cost the bank $A300 million in write-offs.

Furthermore, a London business specialising in trading Latin American and East European bonds cost another $A200 million.

No more, said Mr McFarlane, a former executive director of Standard Chartered Bank who was appointed as head of ANZ two years ago.

ANZ has moved decisively to trim its Asian exposure to less than half the $A13 billion it was before the crisis and has closed all proprietary trading within the group.

"It is very clear to us now that the majority of our Asian exposures were in non-core activities, as was the London bond trading activity," Mr McFarlane said.

In recognition that 80 percent of the bank's risk profile was determined by two factors: the businesses it was in and the extent of exposure it should take, ANZ made dramatic reversal in business focus to two-thirds consumer, one-third business.

But ANZ learned another important strategic lesson: Where a material domestic position was held in a country, for instance Bangladesh, and there was a balance between consumer and corporate business, the bank was generally successful, but in places such as Thailand and Hong Kong where there were material exposures but unbalanced positions, it usually failed.

"This has led us to target deeper positions in core markets where we can be in the top two foreign or top five domestic banks; such as the Pacific, India and the Middle East, in addition to Australia and New Zealand," Mr McFarlane said.

But how does a bank get into a position where it is so heavily exposed to a downturn? Mr McFarlane's explanation: "Having watched banking crises over the last 25 years, I am in no doubt that bankers are not as balanced as we think but are fundamentally optimists.

"Have you ever seen a set of cash flows that fail to repay a loan? I have never. And yet, how many bad loans have we seen?"

In addition to tackling problem exposures and changing its business mix, ANZ also changed its risk management processes.

"Why were we in this position in the first place, given that we had been in a similar position at least once previously? The truth is that we hadn't learned from our previous experiences," Mr McFarlane said.

"This is not restricted to ANZ but appears to be a recurrent anomaly in banking. Immediately following a crisis, banks shut down all major risk activity.

"Conversely, after a period of stability, they relax once again and become over-exposed."

A more sensible approach, he suggested, would be to take advantage of the very high lending margins after a crisis and gradually reduce exposure towards the end of the cycle in preparation for the next downward economic movement.

Another factor generating a false sense of confidence is that after a crisis, the surviving banks generally bounce back strongly on the back of lower debt provisions and the lower cost of carrying non-performing loans.

In the end, ANZ has moved away from an intuitive approach to managing risk to a more systematic model which actively "stress tests" exposure to various economic scenarios.

Mr McFarlane said: "In fact, the systems we had were capable of sending the right signals. It is just that we didn't ask the right questions, nor did we believe material losses were likely."