The world is growing aware that some banks have simply become too complex to manage.

Many are now forcefully advancing this idea, including experts testifying before the British Parliament, the president of the Kansas City Federal Reserve Bank, Federal Deposit Insurance Corp. Chairwoman Sheila Bair at a Senate Banking Committee, and Bank of England Governor, Mervyn King, testifying before the House of Lords Economic Affairs Committee.

The problem is not so much size, as it is complexity. Citibank could be reduced to 10% of its current size and it still would be too complex to manage. See the essay, Uncontrollable Risk.

The secret of good banking is a four letter word

Sound banking requires strict adherence to the KISS principal.

That’s right, KISS stands for: “Keep It Simple Stupid!“.

Banking is a business in which you borrow money that you have to repay today (but hope you won’t have to) and lend it to someone who is supposed to repay you tomorrow (but may fail to do so). And your margin of error for this amazing feat of daring is paper thin, because you’re leveraged from seven to twenty times your capital.

Success depends upon every bank manager’s ability to know:

• The character, capacity, and collateral of every borrowing client;
• The operational and legal ramifications of every type of banking operation;
• The character and credit and operational skills of every bank officer that is in the chain of command from the CEO to the banker that deals with the borrower.

Specialization, where only a few managers are privy to certain essential knowledge, is the formula for bank failure, and the problem becomes exponentially worse as the number of products increases and fewer and fewer bank officials, at any level, can grasp, in detail, the range of activities carried out by their organization.

Sound banking practices are gone at big banks

Sound banking practices have been forgotten in today’s big international banks.

The senior management of Citicorp have no way of comprehending the hundreds (or perhaps thousands) of banking products that are dealt in daily.

They have never met 999 out of every thousand clients.

Worst yet, they don’t even know (or have even met) 99 out of every one hundred bank officers on which the success of their bank depends.

Their “control” of the bank depends entirely upon financial reports, statistics, and mathematical formula — all based on mysterious premises, dubious accounting rules, and shaky, incomplete internal audits.

Their matrix organization charts already defy comprehension, even before being overlaid by conflicting legal jurisdictions and the complexities of affiliate relationships, partial ownership side agreements, and the cultural and political nuances of over 100 countries.

When Citibankers were bankers

Once upon a time, Citibank had the admiration of the world.

Citibank wasn’t always run the way it is today.

In 1956, when Citibank was arguably one of the world’s most respected banking institutions, it followed the KISS principal rigorously. The bank knew, at the highest level, its clients, its operations, and its officers — in detail.

The Citibank advertisement in that year, shown below, reads, “How bankers ‘on the scene’ make the difference overseas”.

But what I would like to draw your attention to is the insert at the bottom of the ad that shows the international banking platform on the 7th floor of 55 Wall Street.

This ‘platform’ was the key to Citibank success, and the bank knew it.

If you could travel back to 1956 and walk around the 7th floor of 55 Wall Street, and talk to the fifty or so senior officers whose desks are arranged without walls or doors, and observe how they worked and what they knew about Citibank operations, it would be immediately clear what the problem is with Citibank today and why this once great bank has fallen so far.

The 7th floor at 55 Wall Street

Let me take you back to the 7th floor at 55 Wall Street as it was in 1956.

Here you would find the fifty or so officers of the First National City Bank of New York whose job it was to oversee (not manage) a worldwide network of commercial lending operations.

None of these officers had private offices, and very few had private secretaries.

The highest officials had the doors removed from their offices. Transparency and openness was the basic policy.

None had stock options. All were modestly paid by today’s standards. None were working for the bank in order to get rich.

The hidden wonders

But what would be startling today and could not be seen by just looking at these officers or the physical layout of the 7th floor, is what was in their heads and the overwhelming simplicity of the bank organization chart.

The organization chart ran from the bank president, to the senior vice president in charge of a geographical area, to the branch manager overseas, to the credit officers responsible for approving loans and the “accountant” who was responsible for running the branch back office.

There were no “product managers” and the staff functions were atrophied, succinct, and essential.

Most importantly, all of the people that held key positions had spent their entire working lives with Citibank and many, especially at the large branch manager level and above, knew each other.

What also would be surprising today is that the most prized positions weren’t the desks on the 7th floor at 55 Wall Street. In fact, a manager of a large branch bank overseas that might be “promoted” to a desk on the 7th floor, was often reluctant to go home to the “head office”. All the action was abroad. No one was working for a big year-end bonus (there weren’t any). The prize was to run a big branch and to have the respect of the brethren.

There was very little boot-licking or back-stabbing, because most decisions were made by consensus. A report of the international audit team could have a greater impact on your career than the opinion of your titular boss.

A band of brothers

What you might not notice at first about the bankers on the 7th floor was that they acted together as a cadre — a band of brothers, so to speak. Their role was to oversee, guide, and observe the operations of the rest of their brethren, the bank managers and accountants stationed far away in a wide network of foreign branches.

In 1956, most communication was by mail. There was no e-mail; international phone calls were expensive; and telegrams were used mainly to order the transfer of money. Power was vested mainly with the foreign branch managers, who were watched very intently, from afar.

Almost all of officials on the international banking platform had served fifteen to twenty years as branch managers overseas.

They all had come through the same inhouse management training program.

Many, at some point in their careers, had worked with the international auditors, inspecting overseas branches in detail. These auditors were extremely good, taking two or three weeks to go through each branch, at least once a year.

Officials on the 7th floor all understood and fully supported the hallowed principles of internal control. Lapses in control that brought down Barings Bank a generation later, could not have happened in Citibank in 1956.

It would be extremely rare for someone to occupy a desk on 7th floor of 55 Wall without having devoting a lifetime of faithful, proven service to Citibank. They saw themselves as guardians, custodians, fiduciaries of the institution, responsible first to their depositors, and secondarily to bank shareholders.

A simple product line and focused knowledge

Citibank in 1956 had an extremely simple and short product line.

Officials on the 7th floor understood each of these products thoroughly.

There were short-term commercial loans with various forms of collateral, demand deposits, time deposits, collections, money transfer, commercial letters of credit, travelers checks, and foreign exchange. That was about it. Nothing fancy. Nothing hard to understand.

The peculiarities of each product to each particular market were thoroughly understood by the men on the platform, because they had dealt with local conditions themselves at first hand over many years.

All loans over $25,000 anywhere in the world were reported to officers on the 7th floor overseeing that particular country. This reporting was accompanied by a financial statement, recast into the Citibank format, with comments of the three credit officials that were needed to approve each loan. There would also be memoranda describing visits to a client’s factory, results of credit checking with other banks, and details of the terms and conditions each type of credit that had been extended.

Furthermore, because the official on the 7th floor had himself worked so many years in the country or countries that he was overseeing, he often knew the borrowers from personal experience, and, if not, certainly knew the Citibank officials that had signed off on the loan, having followed their careers since they were first hired as management trainees.

Reform will not be easy

It seems to me that the attention given today to “bad assets” on big bank balance sheets is missing the point.

The “bad assets” are the symptom, not the cause of the problem.

To put it bluntly, the problem really seems to be “bad bankers”, not “bad assets”.

The world can’t go back to the grand simplicity of banking in the 1950s, mainly because big bankers today are motivated by year-end bonuses and the perks of their executive power.

How can we expect bankers to willingly don what would seem to them as the “hair shirts” that Citibankers wore in the 1950s? One wouldn’t expect Las Vegas gamblers suddenly to give up their calling to assume the role of parish prients.

Besides, financial markets have made a fetish of complexity. KISS is not the motto of today’s bankers.

The 7th floor at 55 Wall no longer houses bankers. It now houses the Ciprioni Club Residences, whose symbol seems to be a bartender shaking up a martini.

Wall Street itself now refers to a concept, rather than to a physical location.

However, the vestiges of old time banking can still be seen in small community banks. Once the big complex banks are nationalized and tougher bank regulations are put in place, perhaps these community banks will be transformed into Citibanks of the future.

Like the little mammals waiting in the underbrush, as the dinosaurs move on to extinction.

This entry was posted on Sunday, April 5th, 2009 at 12:54 pm and is filed under Bankers, Brokers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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