The Path to Value Creation - BCG · PDF fileThe Path to Value Creation GLOBAL CORPORATE...

The Path to Value Creation

GLOBAL CORPORATE BANKING 2003

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BCGREPORT

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The Boston Consulting Group is a general management consulting firmthat is a global leader in business strategy. BCG has helped companiesin every major industry and market achieve a competitive advantage bydeveloping and implementing winning strategies. Founded in 1963, thefirm now operates 58 offices in 36 countries. For further information,please visit our Web site at www.bcg.com.

“Making Payments Pay: Organizing for Success”

Opportunities for Action in Financial Services, September 2003

“Banking’s Changing Dynamics”

Opportunities for Action in Financial Services, August 2003

Winning in a Challenging Market: Global Wealth 2003

A Senior Management Perspective by The Boston Consulting Group,

July 2003

Creating Value in Banking

A report by The Boston Consulting Group, June 2003

“Engaging for Results”

Opportunities for Action in Financial Services, June 2003

Navigating the Maze: Global Asset Management 2003


June 2003

“Banking à la Nike and Dell: Achieving Scale Without Acquisition Premiums”

Opportunities for Action in Financial Services, May 2003

“Making the Most of Mortgage Markets”

Opportunities for Action in Financial Services, April 2003

“Overcoming the Unexpected: A Business Imperative”

Opportunities for Action in Financial Services, March 2003

“Bank Branches: Polishing the Strategic Jewels”

Opportunities for Action in Financial Services, February 2003

The Payments Puzzle: Putting the Pieces Together, Global Payments 2003

A report by The Boston Consulting Group, January 2003

For a complete list of BCG publications and information about how to

obtain copies, please visit our Web site at www.bcg.com.

The Boston Consulting Group publishes other reports and articles that may be of interest to senior financial executives.

Recent examples include:

3265.cvr 11/19/03 12:46 PM



JÜRGEN E. SCHWARZ

LIONEL ARÉ

FRANS BLOM

RANU DAYAL

STEFAN FRANK

NICHOLAS GLENNING

PAUL ORLANDER

ANDREAS REGNELL

N O V E M B E R 2 0 0 3

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3265.text 11/19/03 12:48 PM Page 1

© The Boston Consulting Group, Inc. 2003. All rights reserved.

For information or permission to reprint, please contact BCG at:E-mail: [email protected]: +1 617 973 1339, attention IMC/PermissionsMail: IMC/Permissions

The Boston Consulting Group, Inc.Exchange PlaceBoston, MA 02109USA

2 BCG REPORT

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3The Path to Value Creation

Table of Contents

Note to the Reader 4

Acknowledgments 5

Preface 6

Summary of Key Findings 8

The Corporate-Banking Market 10

Market Overview 10

Regional Overview 11

Product Overview 13

The Challenge of Mastering the Corporate-Banking Business 15

Lever 1: A Focused Business Strategy 17

Develop a Regional Focus 17

Identify Value-Creating Segments 17

Serve Value-Creating Clients 17

Lever 2: A Segment-Specific Business Approach 19

Small-Cap Companies: The Untapped Gold Mine 20

Mid-Cap Companies: The Struggle to Find the Right Balance 21

Large-Cap Companies: The Overrated Segment 22

Lever 3: World-Class Capabilities 24

Establish Comprehensive Credit Management 24

Make the Business Transparent 24

Manage People Effectively 24

Reward Value Creation 25

Practice Management Discipline 25

Methodology 27

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Note to the Reader

4 BCG REPORT

Europe

Frans BlomBCG Amsterdam+31 35 548 [email protected]

Massimo Busetti BCG Milan+39 0 2 65 59 91 [email protected]

Filiep DeforcheBCG Brussels+32 2 289 02 [email protected]

Stephan DertnigBCG Moscow+7 095 258 34 [email protected]

Bruno de Saint-FlorentBCG Paris+33 1 40 17 10 [email protected]

Muzaffer EgeliBCG Istanbul+90 212 310 [email protected]

Rüdiger FilbryBCG Munich+49 89 23 17 [email protected]

Michael FuellemannBCG Zürich+41 1 388 86 [email protected]

Luis GravitoBCG Lisbon+351 21 321 [email protected]

Klaus KeßlerBCG Düsseldorf+49 2 11 30 11 [email protected]

Andrzej KlesykBCG Warsaw+48 22 820 36 [email protected]

Andreas RegnellBCG Copenhagen+45 77 32 34 00 BCG Helsinki+358 9 228 661BCG Oslo+47 23 10 20 00BCG Stockholm+46 8 402 44 [email protected]

Walter SinnBCG Frankfurt+49 69 9 15 02 [email protected]

Carlos TrascasaBCG Madrid +34 91 520 61 [email protected]

Nick Viner BCG London+44 207 753 [email protected]

Nikolas VrettosBCG Athens+30 210 727 [email protected]

Konrad WetzkerBCG Budapest +36 1 235 90 [email protected]

The Americas

Allison BaileyBCG Atlanta+1 404 877 [email protected]

Jorge BecerraBCG Buenos Aires+54 11 4314 2228BCG Miami +1 305 728 6052

BCG Santiago+56 2 338 [email protected]

Rohit BhagatBCG San Francisco+1 415 732 [email protected]

Willie BurnsideBCG Los Angeles+1 213 621 [email protected]

Svilen IvanovBCG New York+1 212 446 [email protected]

Roland LoehnerBCG Monterrey+52 81 8368 [email protected]

Walter Piacsek BCG São Paulo+55 11 3046 [email protected]

Antonio RieraBCG Boston+1 617 973 [email protected]

Carl RutsteinBCG Chicago+1 312 993 [email protected]

Jürgen E. SchwarzBCG Toronto +1 416 955 [email protected]

Asia-Pacific

Tim BennettBCG Kuala Lumpur+60 3 2078 [email protected]

Steven ChaiBCG Seoul+822 399 [email protected]

Julian Durant BCG Bangkok+66 2 667 [email protected]

Nicholas GlenningBCG Melbourne+61 3 9656 [email protected]

Alan Jackson BCG Auckland+64 9 377 [email protected]

Thomas KlotzBCG Beijing+86 10 6567 5755 BCG Hong Kong+852 2506 2111BCG Shanghai+86 21 6375 8618BCG Taipei +886 2 2755 [email protected]

Takashi MitachiBCG Tokyo+81 3 5211 [email protected]

Roman Scott BCG Jakarta +62 21 526 7775BCG Singapore +65 6429 [email protected]

Janmejaya SinhaBCG Mumbai+91 22 2283 [email protected]

If you would like to discuss your corporate-banking business with The Boston Consulting Group, please contactone of the following members of our global Financial Services practice, who specialize in corporate banking:

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5

Acknowledgments

We would like to thank the financial institutions that participated in our benchmarking survey for con-tributing to the insights in this report.

Our special thanks go to Stefan Schlipf—supported by Klaus Moser, Ann-Carolin Samouel, GüntherSchermer, and Frank Schubert—who provided key assistance in the preparation of this report. Our thanksalso go to Tanja Michelberger and Boris Rauls for their valuable research. We would also like to thank ourcolleagues Thomas Gross, Ludger Kübel-Sorger, and Walter Sinn for their contributions.

Several members of The Boston Consulting Group’s Financial Services practice also provided valuable sup-port, including Massimo Armenise, Allison Bailey, Rohit Bhagat, Stefan Brand, Hans-Paul Bürkner, MassimoBusetti, Alberto Camatini, Raffaele Cicala, Stefan Dab, Danny Dale, Filiep Deforche, Stephan Dertnig, Brunode Saint-Florent, Julian Durant, Christophe Duthoit, Andrew Dyer, Eric Ellul, Rüdiger Filbry, ThomasFischer, Michael Fuellemann, John Garabedian, Ralph Heuwing, Matt Holland, Marek Hovorka, ArjanHuisman, Rune Jacobsen, Sunil Kappagoda, Huib Kurstjens, Robert Maciejko, Andy Maguire, Bjørn Matre,Takashi Mitachi, Philippe Morel, Francesco Morra, Martin Naville, Jon Nicholson, Mirko Nikolic, DavidRhodes, Didier Ribadeau Dumas, Ignazio Rocco, Carl Rutstein, Achim Schwetlick, Roman Scott, Bruno vanLierde, Christian Veith, Nick Viner, Jan-Dirk Waiboer, Peter Wetenhall, and Konrad Wetzker.

Finally, we would like to thank Katherine Andrews and Peter Truell for their editorial and marketing support.


Frans BlomVice President and Director

Lionel AréVice President and Director

Jürgen E. SchwarzVice President and Director

Ranu DayalVice President and Director

Nicholas GlenningVice President and Director

Stefan FrankManager

Paul OrlanderVice President and Director

Andreas Regnell Vice President and Director

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Over the past decade, the corporate-banking industry has offered unexciting returns in most regions.Moreover, the industry has failed to create value, because it has not met its cost of capital. Economic growthand the capital markets’ bubble of the late 1990s distracted executives. Few focused on the need to improveprofits significantly. Instead, executives pursued geographic or product expansions that rarely brought suc-cess, and they were unrealistic about the real value of their client portfolios. Such tactics obscured both thefundamental characteristics of the business and the individual weaknesses of many institutions.

The recent economic slowdown in much of the world, greater pressure on credit portfolios, and deteriorat-ing performance in most corporate-banking businesses now challenge many financial institutions. For thebest performers, the question is how to generate growth and create additional value in a slowly growing, frag-mented market. For the rest, the critical question is how to create value at all. We believe that the answers liein understanding the fundamental levers that financial institutions can use to restore or grow their corpo-rate-banking businesses. This is a critical lesson for all competitors. Even the best performers have yet to mas-ter all the levers.

The Boston Consulting Group undertook this research to explore how financial institutions can improve theperformance of their corporate-banking businesses. The term corporate banking—which we use throughoutthis report—covers all client segments, from small businesses to multinational companies. We include theseplayers’ revenues and profits to assess the economics of the corporate-banking industry accurately. Thereport covers all products and services that a corporate client buys from a financial institution: plain vanillalending, value-added financing, transaction services (such as payments and cash management), advisoryservices, investment-banking products, risk management products, deposits, and personal-wealth products.Because of our comprehensive approach, the report’s findings are relevant for all financial institutionsengaged in these businesses—from regional domestic players to global institutions.

This report builds on BCG’s Global Corporate Banking Performance Survey of 65 financial institutions thatuse a variety of business models.1 (See Exhibit 1.) The survey, which we conducted in 2003 by gathering quan-titative data and holding qualitative interviews, allowed us to understand the primary characteristics andmodels needed for success in today’s uncertain economic environment. More than 40 of the world’s top 100banks, measured by tier one capital, participated in the survey, representing more than half of that group’smarket capitalization.

This research has provided us with a wealth of insights into corporate banking. We have presented our majorfindings in this report; those who are interested in obtaining more detailed information about the researchshould contact us directly.

Preface

6 BCG REPORT

1. Our survey does not include standalone investment banks.

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E X H I B I T 1

SIXTY-FIVE BANKS PARTICIPATED IN BCG’S GLOBAL BENCHMARKING SURVEY SURVEY

SOURCES: Thomson Datastream; BCG analysis.

More than 40 of the world’s top 100 banks, measured by tier one capital, participated in the survey, representing more than half of that group’s market capitalization.

Europe

40 participantsNorth America

15 participants

Asia-Pacific

10 participants

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Summary of Key Findings

8 BCG REPORT

The corporate-banking industry destroyed almost€50 billion of value in 2002.

• Our macroeconomic research showed that theindustry yielded an average pretax return onequity (ROE) of 5.3 percent for 2002, based on an estimated allocation of capital to corporate-banking businesses of approximately €460 bil-lion.2 Even in 2000, ROE amounted to only 8.6 percent.

• This performance compared with an average costof capital for the corporate-banking industry of20 percent before taxes and 12 percent aftertaxes. The cost of capital, therefore, after ac-counting for a capital benefit of about 4 percent,totaled €74 billion. This cost far exceeded anaggregate net operating profit of €24 billion forthe industry in 2002. Consequently, the industrydestroyed almost €50 billion of value.

Only 25 percent of the banks we surveyed gener-ated value in their corporate-banking businesses.Loan losses contributed significantly to the destruc-tion of value in the other 75 percent of participat-ing institutions.

• Fourth-quartile performers will have to bridge asignificant gap if they are ever to cover their costof capital.

• We found top performers among both large andsmall banks. High-performing small banksshowed that size by itself does not exclude excel-lent results.

Global market revenues will improve, along withgross domestic product, as the economic recoverypicks up.

• We estimate that global corporate-banking rev-enues totaled €272 billion in 2002, comparedwith €312 billion in 2000. At the same time, cor-

porate banks’ net operating profits decreasedfrom €44 billion in 2000 to €24 billion in 2002, asloan losses soared and investment-banking busi-nesses suffered.

• We predict that revenues will grow approximately4 percent per year until 2007 and that net operat-ing profits will recover at an annual rate of about12 percent.

• Despite this improving outlook, financial institu-tions cannot expect to outgrow their problems.Creating value will continue to be challenging incorporate banking.

BCG has identified three critical levers for improv-ing profitability and growth in corporate banking.The industry’s top performers skillfully use theselevers, which combine measures for producing ashort-term impact on the bottom line with long-term, fundamental business changes.

• Lever 1: A Focused Business Strategy. The first leverrequires disciplined concentration on value cre-ation within regions and for specific clients andsegments. It generates superior performance forleading players. Banks have to examine theircommitments to regions, client segments (espe-cially large companies), and, most important,individual clients.

• Lever 2: A Segment-Specific Business Approach. Thekey to excellence and superior performance is anapproach that customizes a business model forspecific client segments. Competitors should tai-lor sales and distribution, production and serviceplatforms, and sales management processes to thevalue creation potential of a particular client seg-ment. Managing to the average leads to subparperformance and destroys value.

• Lever 3: World-Class Capabilities. Strategic invest-ments in building critical business capabilities pay

2. Throughout this report, we use a 1:1 conversion rate for the euro and the U.S. dollar. We have converted all other currencies to euros. See theMethodology section on page 27 for details.

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off. Leading institutions are far ahead of the fieldin such areas as credit management, businesstransparency, people management, and employeeincentive schemes.

Incremental improvements are insufficient formost players.

• We believe that too many players have relied onincremental “wait-and-see” strategies that havenot addressed their main problems.

• In particular, financial institutions need to im-prove their credit management, ensure trans-parency in their activities, and make tough deci-

sions about their businesses if they are to gener-ate value and improve profitability.

Top players generate sustainable value; but eventhey can improve their performance considerably.

• None of the best-practice players we examinedexcelled in all the major client segments or madefull use of all the critical levers.

• Leaders that mastered the key value levers, how-ever, have maintained their position despite theeconomic downturn. They achieve returns onequity that are four to five times higher thanthose of many of their peers.

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Financial institutions have long prided themselveson the services they provide to their corporateclients. Indeed, corporate banking is among themost essential of a financial institution’s core busi-nesses. Furthermore, corporate bankers fund andadvise the enterprises that fuel the economy.However, the corporate-banking industry is far fromhealthy. It’s time to review its performance andunderstand how it can—and should—be signifi-cantly improved.

Market Overview

Overall, the corporate-banking industry destroyedsignificant value in recent years. In fact, the indus-try’s annual revenues and profits declined by 7 per-cent and 26 percent, respectively, from 2000 to theend of 2002. (See Exhibit 2.) Our research showedthat the industry destroyed almost €50 billion in2002. This figure assumes estimated allocated capi-tal of about €460 billion and a capital charge of

The Corporate-Banking Market

10 BCG REPORT

E X H I B I T 2

GLOBAL CORPORATE-BANKING REVENUES AND PROFITS DECLINED SIGNIFICANTLY MARKET

SOURCE: BCG global corporate-banking market-research database.

1Approximately half of this decline resulted from the yen’s decline against the euro.

2000 2001 2002 2000 2001 2002 2000 2001 2002 2000 2001 2002

2000 2001 2002 2000 2001 2002

2000 2001 2002 2000 2001 2002

7 2444

284 272312

World

€billions

Revenues Net operating profits




CAGR (compound annual growth rate), 2000–2002

–26%

–9%

–3%

–32%

–9%1

0%

–20%

–7%

North America

€billions

Europe

€billions

Asia-Pacific

€billions

14 1117

76 6983

16 1226

117 121129

–23

11

9110082

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€74 billion. We expect revenues and profits torecover in the next several years as economic activ-ity picks up and loan losses decline. (See Exhibit 3.)

Despite the downturn in critical areas of the corpo-rate-banking market, our survey participants main-tained stable revenues and operating expenses dur-ing the past three years. (See Exhibit 4, page 12.) Inaddition, they delivered an average ROE of 12 per-cent—a figure more than double the overall corpo-rate-banking market’s ROE of 5.3 percent. Partic-ipants in our survey had relatively high ROE for theindustry because the survey included top players inmost regional markets. In addition, because we didnot include standalone investment banks in our sur-vey, the volatility of earnings was reduced.

Regional Overview

Loan losses drove major differences in perfor-mance across regions. (See Exhibit 5, page 12.) Oursurvey showed that, in Europe, they dragged ROEdown from 13 percent in 2000 to 10 percent in2002. In North America, particularly among largecompanies, ROE fell sharply from 26 percent in

2000 to 12 percent in 2002. Australia and NewZealand fared better: ROE rose from 22 percent to27 percent over the same period.

Cost-to-income ratios improved in Europe but re-mained static in North America, Australia, and NewZealand between 2000 and the end of 2002. How-ever, the dramatic increases in loan losses—and theattendant fall in ROE—in Europe and NorthAmerica highlight how important outstandingcredit and capital management are to profitability incorporate banking.

Europe. Revenues dropped from €129 billion in2000 to €121 billion in 2002, representing an an-nual decline of about 3 percent.3 (Refer to Exhibit2.) A drop in investment-banking business drovethis downturn. Net operating profits fell from €26 billion in 2000 to €12 billion in 2002—owingprimarily to an increase in write-offs. Improvedlending margins caused a slight revenue increase in

E X H I B I T 3

WE EXPECT REVENUES AND PROFITS TO RECOVER MARKET


1Transaction banking includes the deposits business.

121

140

8295

12 16

3%

5% 55%

3%

69

1117

9%

North AmericaEurope Asia-Pacific

916%

2442

272

4%

12%

World

€billions €billions€billions €billions

326

2002 2007 2002 20072002 2007 2002 20072002 2007 2002 20072002 2007 2002 2007

19

Asset management Corporate risk management Investment banking FinancingTransaction banking1

CAGR, 2002–2007

Revenues Net operating profits Revenues Net operating profits Revenues Net operating profits Revenues Net operating profits

3. We derived our European figures from a detailed analysis of core mar-kets (Austria, Belgium, France, Germany, Italy, the Netherlands, Spain,Switzerland, and the United Kingdom), extrapolated for the entireEuropean market.

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12 BCG REPORT

E X H I B I T 5

LOAN LOSSES DROVE DIFFERENCES IN PERFORMANCE ACROSS REGIONS SURVEY

SOURCE: BCG global corporate-banking benchmarking database.

1Index (100)=Europe 2000 value.

2Largely Australia and New Zealand.

2000 2001 2002 2000 2001 2002 2000 2001 2002

Loan losses (index1)

Cost-to-income ratio (index1)

Pretax return on equity (%) 13 11 10

100 102 96

100 121169

2619

12

102 103 102

128231

365

2226 27

75 72 75

59 49 49

Europe North America Asia-Pacific2

Pretax cost of capital= 20%

E X H I B I T 4

CAPITAL MANAGEMENT PARTIALLY OFFSET PROFIT DECLINES FROM LOAN LOSSES SURVEY


1Index (100)=corporate-banking revenue 2000 value.

2Capital index (100)=corporate-banking capital 2000 value.

2000 2001 2002

2000 2001 2002

2000 2001 2002

2000 2001 2002

2000 2001 2002

2000 2001 2002

Revenues

Loan losses

Capital

Index1

0%

Index1–1%

Index1 32%

Index1–19%

Index2

–3%

–13%

Return on equity

Net operating profits

Operating costs

100 101 101

52 54 51

16 21 28

32 26 21

100 101 95

16 13 12

CAGR, 2000–2002

Percentage

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2002. We estimate that corporate-banking revenuesin the region will grow at about 3 percent per yearuntil 2007. (Refer to Exhibit 3, page 11.) Revenuesfrom financing products will increase at the samerate as the European economy as a whole, butinvestment-banking and risk-management productsshould display faster growth. Net operating profitswill also rise—at about 5 percent annually—becauseof an expected decline in loan losses.

North America. Revenues dropped sharply from€83 billion in 2000 to €69 billion in 2002. Half ofthis decline resulted from a drop in investment-banking business. North America’s net-operating-profit pool also fell significantly—from €17 billionin 2000 to €11 billion in 2002—largely because ofthe decrease in investment-banking revenues andthe increase in loan losses. Over the next few years,however, North American revenues should rise byabout 6 percent per year, reaching €91 billion by2007. Growing demand for structured-financeproducts and gains in leasing and transaction busi-nesses should drive this increase. Meanwhile, weexpect net operating profits to grow at about 9 per-cent annually, to €17 billion by 2007.

Asia-Pacific. Corporate-banking revenues droppedfrom €100 billion in 2000 to €82 billion in 2002—a9 percent annual decrease.4 The decline of financ-ing in Japan dominated revenue losses there, asbanks reduced lending because of the economicdownturn. In addition, profits tumbled in 2001 be-cause of soaring loan losses, especially in Japan. Weexpect revenues to increase by 3 percent per yearuntil 2007. We predict that net operating profits willrise significantly during this period, to €9 billion.As in North America and Europe, a decline in loanlosses in Asia-Pacific is expected to lead to improv-ing profits.

The corporate-banking market remained depressedglobally in 2002. The recovery in many economies,however, should fuel an improvement.

Product Overview

Plain vanilla lending remains the most importantcorporate-banking product. (See Exhibit 6.)


4. We derived our Asia-Pacific data from a detailed analysis of six coun-tries: Japan, Singapore, South Korea, Taiwan, Australia, and NewZealand.

E X H I B I T 6

THERE ARE WIDESPREAD DIFFERENCES IN PRODUCTS ’ REVENUE GROWTH AND PROFIT POTENTIAL MARKET


1Net operating margin for financing products does not include capital costs.

2Risk management includes flow and structured products.

Leasing/factoring1

Risk management2

M&AFixed-

income trading

Deposits businessTransaction banking

Asset management

Structured finance1

Plain vanilla financing1

Equity capital markets

Positive

Negative

High

Zero

Zero Low

Revenues (approximately €10 billion) Investment-banking products

Estimated revenue growth, 2002–2007

Net operating margin after loan losses, 2002

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Globally, it accounts for about 40 percent of rev-enues. We expect the business to become moreprofitable once the Basle II regulations take effectand risk-based pricing is consistently used by themajority of players. Nevertheless, the business willremain relatively unrewarding. And many competi-tors will need to enhance their credit-managementcapabilities to ensure profitability. Most partici-pants in our survey expected a continuing shift tomore sophisticated products, such as structuredfinance and leasing, which we estimate will showsteady revenue growth of 5 to 7 percent per year.Europe’s financing structures, for example, willcontinue to follow U.S. practices and shift moretoward sophisticated products and off-balance-sheet lending.

Investment-banking offerings—such as merger-and-acquisition advice, equity-capital-markets products,and fixed-income products—and risk-managementofferings will also grow at rates of between 5 and

10 percent per year and will not reach the levels ofthe late 1990s for some time. In any case, the mar-kets for these offerings will remain relatively smallcompared with those for established corporate-banking products, such as plain vanilla financing,transaction banking, and the deposits business. Riskmanagement products will become more promi-nent, seeing particularly strong growth in Europeand Asia-Pacific. Asset management revenuesshould recover and achieve growth rates above thelevel of price inflation. We expect to see revenuesfrom some transaction businesses decline in Europebecause of the mandatory equalization of domesticand inter-European transfer fees and further pricepressures. In North America, revenues from trans-action businesses should grow, albeit slowly.

The challenge for competitors is to develop effec-tive product-management and sales-and-distribu-tion strategies. To date, few competitors have man-aged to meet this challenge.

14 BCG REPORT

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The Challenge of Mastering the Corporate-Banking Business


Three-quarters of the participants in our surveydestroyed value in their corporate-banking busi-nesses, but we did find that the top quartile gener-ated substantial value with an average ROE of 28 percent—well above the cost of capital.5 (SeeExhibit 7.) Overall, first-quartile competitorsachieved returns on equity that were approximately75 percent higher than those of players in the sec-ond quartile and four times higher than those ofthird-quartile competitors. Players in the bottomquartile underperformed significantly and will haveto ask themselves whether they will ever be able togenerate the necessary target returns.

Loan losses, which increased at a 32 percent com-pound annual growth rate for the financial institu-tions in our survey, contributed significantly to thedecline in profits for all quartiles. (Refer to Exhibit4, page 12.) Many underperformers will need toconsider more radical approaches, such as narrow-ing their focus by serving only selected client seg-ments, partnering with competitors, or exiting thebusiness. Such banks should see their currentunderperformance as an opportunity to make

bold—and most likely unpopular—decisions. Manyof today’s best players did just that to get to wherethey are now.

We found examples of performers—and underper-formers—that focused on each of three client segments, which we define as follows: small-cap companies are those with revenues of less than€25 million; mid-cap companies are those with rev-enues of €25 million to €250 million; and large-capcompanies are those with revenues of more than€250 million. (See Exhibit 8, page 16.)

The large-cap segment showed the lowest prof-itability, with an average ROE of 7 percent; and itcomprised substantial value creators as well as mas-sive value destroyers. Obviously, few players mas-tered the segment. Most overestimated their abilityto generate cross-selling fees with this clientele. Inaddition, too many players consistently underesti-

5. ROE figures throughout this section are unadjusted and thus reflectan investor’s point of view. They are not normalized to account forprice-level differences among countries or for loan-loss variations overseveral years.

E X H I B I T 7

ONLY FIRST-QUARTILE PLAYERS COVERED THE COST OF CAPITAL IN 2002 SURVEY


1ROE figures are unadjusted and thus reflect an investor’s point of view. They are not normalized to account for price-level differences among countries or for loan-loss

variations over several years.

28

16

7

–8

FirstQuartile Second Third Fourth

Average pretax return on equity, 20021 (%)

Pretax cost of capital = 20%

3265.text 11/19/03 12:48 PM Page 15

mated the hazards of lending to large companiesand took too many risks with respect to their port-folios’ size and structure. This led to underpricedloans and a reluctance to shed clients that repeat-edly destroyed value. Mid-cap clients are generallymore attractive. On average, banks in our surveythat served this segment had an average ROE of 15percent and therefore destroyed value. In the small-cap segment, our participants generated value,averaging a 21 percent ROE. We found that the toptier generated an ROE of 42 percent.

All too often, financial institutions pursue large-capcompany clients and, in the process, ignore the

potential benefits of mid-cap and small-cap-com-pany clients.

Furthermore, there is a myth that scale matters incorporate banking. In fact, our study revealed thatthere is basically no correlation between size andprofitability. Small and large banks alike can makeoutstanding or dismal profits in corporate banking.

But what really matters is three common levers usedby best-practice players: a focused business strategy,a segment-specific business approach, and world-class capabilities. We found striking differences inhow the players in our survey used those levers.

16 BCG REPORT

E X H I B I T 8

TOP PERFORMERS CAN BE FOUND IN EACH MAJOR CLIENT SEGMENT SURVEY


1ROE figures are unadjusted and thus reflect an investor’s point of view. They are not normalized to account for price-level differences among countries or for loan-loss

variations over several years.

Average return on equity1 (%)

Pretax return on equity, 20021 (%)

Large-cap segment Mid-cap segment

7 15

Institutions

Pretax cost of capital = 20%

Small-cap segment

21 42 40 38

14 10

5

42 38

35

5 4

38 35 34

–23

–33 –36

–3

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Lever 1: A Focused Business Strategy


A key maxim for competing in corporate banking is“Don’t get distracted.” The first lever, a focusedbusiness strategy, consists of disciplined concen-tration on value creation within regions, withinclient segments, and with individual clients. Such astrategy has two aspects: first, a commitment toareas of the business where a competitor has aproven track record or at least a high probability of creating value; and second, a quick and disci-plined exit from underperforming businesses.Overambitious expansions into new locations ornew client and product segments (such as invest-ment banking) have failed for many institutions.Every institution we interviewed claimed to have afocused business strategy, but many had not fol-lowed through on it.

Top performers rely on sound and transparentportfolio assessments and employ clear risk-returnpolicies and mechanisms that prevent them fromcommitting resources to unprofitable regions, seg-ments, and individual clients.

Develop a Regional Focus

Regional focus is the first issue to address in design-ing a successful business model. Most players thathave tried to build broad international franchisesorganically have had little success. Banks oftenunderestimate the competition, barriers to entry,and the degree of differentiation required to attractlocal clients. Several large corporate banks havestruggled in vain to become pan-European players.Meanwhile, many North American players haveexpanded across the United States and intoEurope, Latin America, and other overseas loca-tions—and have met with little success. In somecases, attempts to expand geographically have evencaused severe loan losses and write-offs that haveendangered the banks’ home businesses. There-fore, players have to seriously consider withdrawingfrom unprofitable areas.

We believe that there are only two principal ways forcorporate banks to increase their geographic cover-age successfully. First, they can expand throughlarge acquisitions, which usually include both retail-and corporate-banking assets. To establish competi-

tive advantage, they need to apply superior capabil-ities developed in their home markets to their newacquisitions. Second, some players are successfullybroadening their geographic scope through selec-tive product-driven expansion. They focus on a par-ticular area in which they have product capabilitiesthat are superior to those of local competitors—forexample, international cash management. Thanksto their presence and expertise, they can differenti-ate themselves and provide value to local clients.

Identify Value-Creating Segments

Most players cover all three segments—small-cap,mid-cap, and large-cap—in their respective homemarkets. Our research showed that it is difficult forany single player—even for the top players in oursurvey—to create value in all three. Again, focus iskey. Banks should review their coverage of clientsegments—especially the commitment to large andmultinational companies, where most playersdestroy value. For many second- and third-tier insti-tutions, this may mean shrinking the balance sheetto increase profitability. Such a review requires asound and unbiased analysis of all the products thatclients use. It also might require taking a closerlook at production and distribution costs.

Serve Value-Creating Clients

Banks often make large and poorly priced loans to corporate borrowers. In some cases, they fail toleverage their balance sheets properly to ensurethat their lending is strategic and that it helps tomake the overall client relationship profitable.

The distribution of clients by value follows a typi-cal pattern at most institutions—irrespective of thesegment. As Exhibit 9 on page 18 shows, valuedestroyers waste time and resources for all players.For banks, it is better to tightly control any capitalcommitment to such clients and let the productspecialists seek out profitable individual transac-tions. In fact, less than 10 percent of our survey par-ticipants used value assessments, such as thosebased on economic value added (EVA), to measurethe performance of all clients across all segments.

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18 BCG REPORT

E X H I B I T 9

THE DISTRIBUTION OF CLIENTS BY VALUE FOLLOWS A TYPICAL PATTERN SURVEY

SOURCE: BCG global corporate-banking project database.

Value destroyers

15–25 40–60 100

Number of clients (%)

0

Return on equity (%)

Cost of capital

Potential value creators

Value creators

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Lever 2: A Segment-Specific Business Approach


Competitors have to improve their corporate-banking profitability segment by segment, reflect-ing each segment’s specific business character-istics. Segments differ according to the revenuepotential of their clients and those clients’ productand service needs. In addition, each segment has its own distinct drivers of costs and risks per client.Only those banks that reflect these differences intheir segment definitions and approaches will tap the full value of their client base. A segment-specific approach comprises four elements: devel-oping sophisticated client segmentation, establish-ing a dedicated sales organization, tailoringproduction and service platforms, and managingthe sales process by segment.

Develop sophisticated client segmentation. Morethan half of the participants in our survey reworkedtheir client segmentation during the last two yearsin an effort to better respond to their clients’needs. We observed a wide range of approaches tosegmentation—from basic segmentation based onrevenue boundaries to detailed client-selectionalgorithms based on value-oriented share-of-walletanalyses. Most players lack key tools and processesor fail to employ them fully. Several players, forexample, even lacked essential data—such as profit-and-loss (P&L) statements and detailed client num-bers—for major client segments.

We are convinced that a segmentation based onactual value generated over two to three years and arealistic assessment of prospective client needs arethe preferred approach to segmentation. Then,with the right segmentation in place, the businessmodel needs to be tailored to segment-specificrequirements. Any attempt to deploy a uniformmodel across several segments can only end in thesales force setting arbitrary priorities. Players thatmix segments together dilute their economics. Wedid not find any players in the first quartile, forinstance, that used an integrated approach acrossseveral segments.

Corporate bankers often believe that simple solu-tions, such as adjusting coverage ratios to bench-

mark levels, are the key to the economics of thebusiness. In fact, there is much more to it than that.

Establish a dedicated sales organization. It is essen-tial to design a segment-specific coverage modelthat reflects realistic goals, with guidelines for therelevant coverage ratios, the deployment of productspecialists, the use of direct channels, and the chan-nel mix.

Tailor production and service platforms. The rele-vant cost and value drivers differ significantlyamong client segments. (See Exhibit 10.) In thesmall-cap segment, direct and indirect operation-al costs accounted for more than 50 percent ofcosts. Tight cost controls and efficient front- andback-office processes are therefore critical to supe-rior performance. In the large-cap segment, costsassociated with risk and capital charges dominated

0

25

50

75

100

Small-cap segment

Mid-cap segment

Large-cap segment

Cost structure within client segments,2002 average (%)

Direct and indirect costs

Actual loan losses (average)

Cost of capital1

3238 43

14

20

5442

34

23

E X H I B I T 1 0

SEGMENT-SPECIFIC COST STRUCTURES OFFER OPPORTUNITIES FOR IMPROVEMENT SURVEY


1There was a 20 percent pretax cost of capital.

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20 BCG REPORT

by far. Therefore, the careful management of riskand capital is the main driver of value generation inlarge-cap corporate banking.

Manage the sales process by segment. Tailoring thesales management process to the requirements ofsegmentation is essential. Setting and monitoringtargets in the sales force—for specific clients andproducts—are key to achieving optimal bottom-lineresults. In all segments, we often found a lack ofsales force coordination—or even a traditionalhands-off approach to sales force management.Relying on the sales force’s ability to manage itselfand prioritize time and capital allocation—oftenlabeled the entrepreneurial approach—will deliveronly limited value.

Banks must develop a deep understanding of thecharacteristics of the major segments. Now we willdescribe the main features of the three segmentsthat should be the focus of their attention.6

Small-Cap Companies: The Untapped Gold Mine

Many believe that small-cap companies constitutethe least attractive business in corporate banking.When it comes to creating value, however, theyoffer the greatest opportunities for most players.Admittedly, small-cap companies have basic needs(such as financing, investments, payments, and lim-ited risk management) that offer relatively low rev-enue potential per client. Nevertheless, the com-mon myth that this segment necessarily deliverspoor—or at best average—profits is wrong.

Our survey showed that top small-cap performers achieved an average 37 percent ROE. (See Exhib-it 11.) That figure was far more than double the

6. ROE figures throughout the following three sections have been ad-justed for price-level differences among countries and for loan-loss varia-tions. In adjusting for loan-loss variations, we took an average of each ofour survey banks’ actual loan losses for the years 2000, 2001, and 2002in each segment. By doing so, we were able to better understand thetrue drivers of value creation in each segment.

E X H I B I T 1 1

SUCCESSFUL SMALL-CAP PLAYERS HAVE LOW COST-TO-INCOME RATIOS AND LOAN LOSSES SURVEY


1ROE figures have been adjusted for price-level differences among countries and for loan-loss variations. In adjusting for loan-loss variations, we took an average of each of

our survey banks’ actual loan losses for the years 2000, 2001, and 2002 in this segment.

2Total operational costs to total income.

Capital per risk-weighted assets

Cost-to-income ratio2

600 600

37

15

Top players

Index

Index

Index

Index

Peer group average (excluding top players)

Adjusted pretax return on equity1 (%)

Net operating profits per risk-weighted assets

Basis points

Total income per risk-weighted assets

Average loan losses of last three years per risk-weighted assets

(f)

3265.text 11/19/03 12:48 PM Page 20


average ROE of 15 percent for the small-cap groupas a whole. They also had higher income per risk-weighted assets and significantly lower cost-to-income ratios than most of their peers be-cause their costs to serve were lower and their salesforces more effective. Top performers also dis-played better control of portfolio risks than theircompetitors did. They more strictly applied risk-adjusted pricing, used private assets to secure lend-ing, and relied on automated credit-scoring andproduction-and-servicing processes.

The sales forces of successful corporate banksserving small-cap companies adopted retail ap-proaches as much as possible. They managed front-office costs intelligently, ensuring that they focusedtheir coverage on their value creators and potentialvalue creators through their relationship managers.The financial institutions sought to eliminate theirvalue destroyers by moving them online with coverageratios of greater than 1,000, by offering a servicepackage at substantially higher prices, or by weed-ing them out. Furthermore, they deployed productspecialists very selectively.

To manage such high coverage ratios, financialinstitutions need to invest heavily in service plat-forms, actively migrate clients to these channels,and reduce relationship managers’ administrativetasks. The leading small-cap coverage modelsdeliver services through direct channels and assignrelationship managers to less than half of thebank’s clients.

Competitors will achieve solid profitability growthin the small-cap segment not only by managing risksand costs but also by tapping all available revenuepools. This means serving the needs of the com-pany and of its individual managers. The personal-banking needs of executives at small-cap companiesoften present one of the best opportunities forbankers. If financial institutions are to take fulladvantage of this opportunity, they must integratetheir retail and corporate-banking efforts in target-ing small-cap businesses. We have yet to see aneffective working model for referral systemsbetween corporate-banking and retail divisions. Animportant first step toward establishing best prac-tice may be to manage the whole segment throughthe retail division—ideally through a separatesmall-cap organization.

Mid-Cap Companies: The Struggle to Find the Right Balance

The mid-cap-company segment is probably the mostdifficult to manage, and players are struggling withtheir business models. The gap between best-prac-tice players, which achieved an average 40 percentROE, and the average player in the mid-cap group,which reached only a 12 percent ROE, revealed thatmost competitors still have tremendous room forimprovement. (See Exhibit 12, page 22.)

In the middle market, clients’ demands for rela-tionship managers’ and product specialists’ time faroutweigh their willingness and ability to pay forthose services. Most players overserve this seg-ment—and suffer on the bottom line. Instead, theyneed to resegment their clients to ensure that theyset their priorities correctly, directing full servicesto high-value clients. Leading institutions apply abalanced approach to operating costs and capitalallocation as they work to maximize their share oftheir clients’ revenue potential. Because mid-capcompanies do not attract much interest from ratingagencies, there are often weaknesses in lendinginformation, which in turn increase portfolio risks.World-class credit management is critical in the seg-ment, with a clear separation of credit functionsamong sales, production, and portfolio manage-ment. Best-practice players confront the weaknesshead-on with clear risk-return policies, and theyreport less than half the loan losses that their peersdo, thanks to superior credit management.

Leading players tackle the challenges of the mid-cap segment in similar ways. They adapt productcapabilities that the industry has developed forlarge-cap clients to the needs of their mid-capclients—and then combine that with a finely tunedapproach to distribution. They also use client-tar-geting techniques—such as centralized segmenta-tion for product campaigns—from the small-capsegment. To deliver such services successfullyrequires excellent sales-management capabilitiesand a focus on value. In determining the organiza-tion of their sales force, they apply a rigorous cost-to-serve coverage approach. Coverage models basedon regional resource allocation often do not focuson client value and encourage banks to devote auniform amount of attention to all clients.

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22 BCG REPORT

In sum, serving mid-cap clients requires capabilitiesused in both the large- and the small-cap segments,and very disciplined, value-oriented implemen-tation.

Large-Cap Companies: The Overrated Segment

Corporate bankers like large and multinationalcompanies and the prestige they bring, but suchclients often destroy value for them. Many playersare lured into the segment because they underesti-mate its operating costs and credit-default risks.They also frequently overestimate their achievableshare of wallet in fee businesses. Indeed, their inter-nal accounting too often neglects the cost of han-dling all of a multinational company’s subsidiariesand the true costs of product platforms (particu-larly in investment banking).

Best-practice players achieved an average ROE of 34percent compared with a 9 percent average for the

large-cap group as a whole, but performance in thissegment varied widely. (See Exhibit 13.) The topperformers were especially good at generating suf-ficient fee income to justify their capital commit-ments. These fee income masters achieved a ratio ofnoninterest income to total income of more than50 percent across their large-cap-client portfolios.

Leading players achieve superior performance inseveral ways. They use clear value-oriented risk-return policies—a practice that many competitorshave yet to adopt. Successful players adopt a value-based sales approach, relying on individual accountplanning to ensure that the bank has either a prof-itable relationship or plans that reflect a realisticshare of wallet for every single client. Large-capclients can be profitable—provided that playerscarefully identify their value-creating relationships,focus their efforts mainly on them, and weed outclients that consume a lot of capital but bring insuf-ficient income.

E X H I B I T 1 2

TOP MID-CAP PLAYERS PURSUE A RIGOROUS COST-DRIVEN APPROACH TO INCOME GENERATION SURVEY







600 600

40

12

Top players

Index

Index

Index

Index




Basis points



(f)

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E X H I B I T 1 3

THE BEST LARGE-CAP PLAYERS GENERATE SUBSTANTIALLY MORE INCOME THAN AVERAGE PLAYERS SURVEY







600 600

34

9

Top players

Index

Index

Index

Index




Basis points



(f)

3265.text 11/19/03 12:48 PM Page 23

Lever 3: World-Class Capabilities

24 BCG REPORT

Focusing your business strategy and constructing asegment-specific approach require world-class capa-bilities in credit management, business transpar-ency, people management, performance measure-ment and incentives, and management discipline.Leading banks are at least three to four years aheadof most players in these areas. For many competi-tors, building these capabilities will require signifi-cant investments in infrastructure and management.

Establish Comprehensive Credit Management

Outstanding credit management is one of the mostimportant capabilities for banks. Best practice incredit management deconstructs the credit-busi-ness value chain into three major components: salesand origination, credit servicing, and portfoliomanagement.

Sales and Origination. Some players have alreadyestablished a disciplined sales culture in their dis-tribution force. The sales force no longer just pro-duces and sells credit but instead regards credit asone of several products. Another functional unitindependent of the sales organization provides andprices credit based on the bank’s target credit-port-folio structure. If a relationship manager decides tounderprice for client relationship reasons, his orher P&L suffers the loss. This transparency in creditpricing allows management to impose ceilings onthe amount of credit subsidy. Contractual agree-ments with clients adjust credit pricing for any dete-rioration in credit ratings, especially a drop belowinvestment grade.

Credit Servicing. Most players can improve theirstandardization and centralization of processingand administering credit. Best-practice players dis-play a high degree of standardization in creditprocesses. They invest substantially in upgradingtheir infrastructure, including establishing inte-grated data warehouses and central archiving. Inmost cases, they cut back to one or two productionsites. They also work on improving the standardiza-tion and transparency of their credit-approval andautomated-scoring processes.

Portfolio Management. Actively managing the loanportfolio is key to mitigating risks. Some survey par-ticipants had an advanced approach to portfoliomanagement, but it often had a limited impact oncredit origination. At leading players, portfoliomanagement, run as a profit center, actively man-ages the bank’s loan book to minimize risk andimprove returns. Portfolio management sets priceson the basis of value at risk and guarantees the li-quidity of the portfolio through credit trading andhedging.

Make the Business Transparent

It is essential for businesses to be clear about wherethey create and destroy value. Many of our surveyparticipants rated their business transparency as“sufficient”; but from our findings, we would rateonly about 10 percent of participants as having hadthe transparency necessary to manage all businesssegments well.

To ensure sufficient clarity, banks’ reporting shouldreflect changes in EVA across segments, clients, andproducts, as well as across relationship managersand product units.

Most leading players relied on risk-adjusted andvalue-based measures, such as risk-adjusted returnon capital and EVA. Management should use thosemeasures to segment clients, devise coveragemodels, and prioritize sales efforts. Several playershave shown that by achieving excellence in creditmanagement and performance transparency, they were able to achieve returns on equity farabove the cost of capital—and thus generate sub-stantial value.

Manage People Effectively

People, not capital, are the scarcest resource in cor-porate banking. More than 90 percent of the par-ticipants in our survey mentioned people as themost important factor differentiating them fromtheir competitors. One would assume, therefore,that participants would have ensured that they had

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recruited and retained the best people for theirsales forces. In reality, however, most institutionslacked a systematic recruiting and hiring process,and relied on formal qualifications and a looselymanaged, decentralized recruiting process.

When it comes to developing people and meetingclient demands, one rule is key: the most capablesalespeople should serve the most valuable clientsfor as long as they can. Continuity is critical in managing corporate-banking relationships. Toooften, however, institutions hire overambitious fast trackers, give them a couple of years in thefield, and then promote them to management positions in which they have much less contact withclients.

Best-practice players strictly manage both promo-tion and attrition within the sales force. They tiepromotion to sustained performance in sales;tenure is of no importance to them. Successful sales staff receive compensation that is comparableto that of management; and for top performers,compensation exceeds management levels. Leadinginstitutions also set explicit attrition targets, regu-larly “managing out” their worst performers.

Reward Value Creation

Many institutions recognize that rewarding valuecreation is critical to success in corporate banking,but few actually practice what they preach. In arecent study of 20 European banks, for example,most people interviewed acknowledged that value-oriented compensation was key to increasing theirbusiness. However, almost half of these competitorsconfessed that they hardly ever linked their com-pensation schemes to the value created by individu-als or business units.

Banks do face some significant barriers to imple-menting value-oriented compensation—such asunreliable or insufficient data that reinforce areliance on discretionary bonuses, a compensationculture that regards bonuses as part of guaranteedincome, and difficulties in implementing more vari-able compensation across the bank. Furthermore,at institutions that had adopted more value-oriented approaches, differences in the salaries of

top and bottom performers were small—usuallybetween three and four months of salary.

By comparison, leading institutions have three dis-tinguishing factors when it comes to managingcompensation:

Key performance indicators reflect individual valuecreation. Banks have a long tradition of managingto the average and have therefore missed significantopportunities in the sales organization. Best-prac-tice players reward value creation on the basis ofmeaningful and accepted standards. They use awell-balanced mix of lagging (retrospective) andleading (prospective) indicators that are bothfinancial and nonfinancial—instead of relying tooheavily on retrospective financial indicators. Theyalso employ regular client surveys and comprehen-sive performance reviews that track the perfor-mance of individual relationship managers.

The compensation scheme rewards top performers.Leading institutions match compensation with per-formance. They use highly variable compensation toreward top performers, with about 30 to 50 percentof an individual’s compensation tied to his or hervalue creation. Instead of allowing the performanceof the division or the bank as a whole to determinethe bulk of a bonus, financial institutions need tounderscore the importance of individual perfor-mance—and tie it inextricably to compensation.

Management is willing to use its control systems.Best-practice players live by their principles andregularly cut underperformers. They introduceforced rankings—for example, by distributingbonuses to only the top 50 percent of their salesforce. They also limit the use of discretionarybonuses. Too often, executives disregard such bestpractices in order to avoid conflicts in the salesforce. However, identifying and rewarding top per-formers are critical to developing a superior salesculture and ensuring high performance.

Practice Management Discipline

Management discipline is the final capability that iscritical for success in corporate banking. Best-prac-tice players have a tremendous ability to implementtheir insights and deliver on their promises. Bold

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moves, such as withdrawing from regional marketsor client segments, require discipline and strictimplementation.

By practicing rigorous management discipline,financial institutions will achieve the significantimprovements in profitability that they need. Toensure success, however, they must use all three

levers to the fullest effect: focusing their businessstrategies, pursuing segment-specific approacheswith their corporate clients, and honing world-classcapabilities. The key to success is to avoid managingto the average and to keep the focus on the mostvaluable clients. Staying on the path to value cre-ation is difficult, but it will ensure a healthy androbust future.

26 BCG REPORT

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Methodology


BCG’s Global Corporate Banking PerformanceSurvey covered 65 financial institutions, manyactive in all client segments. The questionnaire,which we used to gather quantitative data, con-tained separate sections for each segment. We alsoconducted interviews to gather qualitative data.

The market sizing encompassed a broad definitionof the corporate-banking market. It included allproducts and services that a corporate clientsources from a bank: plain vanilla lending, value-added financing, transaction services, advisory ser-vices, debt and equity underwriting and trading,derivatives, and investments, including deposits andpersonal-wealth products. It also covered all clientsegments from small companies to multinationalcorporations. The findings therefore apply to allinstitutions engaged in corporate banking. Keysources of the market sizing included statistics fromnational governments, central banks, and special-ized research firms. We adjusted financing volumesand operating costs for inflation; and we calculatedthe conversion rate between the euro and the U.S.dollar using the interbank exchange rate based onThomson Datastream at the time participant dataand the market assessment were compiled. Werounded off the 184-day average of 1.00823 dollarsto the euro to a 1:1 conversion rate.

To assess banks’ relative performance, we havemade several adjustments and assumptions:

Comparability of Competitors. We selected peergroups for the respective segment comparisons onthe basis of a comprehensive assessment of eachplayer’s segment boundaries, client mix within thesegment, and such quantitative indicators as rev-enue per client, allocated capital per client, andnumber of clients.

Cost and Income Figures. We have included the rev-enues of all corporate-banking products (includinginvestment-banking revenues), as well as adjacentrevenues from asset-management and personal-wealth products. We reviewed all profit-sharingagreements and shadow accounts with other prod-uct units or backed them up with correspondingcost allocations. We calculated the return for the

allocated equity on the basis of the ten-year govern-ment-bond rate.

We defined net operating profit as revenue minusoperating expenses (direct and allocated costs) andactual loan losses. To normalize for annual varia-tions in loan losses, we calculated the average of theyears 2000 through 2002 based on data provided byindividual participants. In the sections of the reportwhere we directly compare participants’ perfor-mance, we adjusted all income figures (interest andnoninterest) for differences in domestic-marketprice levels. We used statistical analyses of the datasets provided by our participants and additionalresearch data to determine differences in achiev-able gross margins resulting from regional marketconditions. These adjustments eliminated marketdifferences that prevent a clear understanding ofthe levers that drive value in corporate banking.

We assumed allocated regulatory capital accordingto the risk-weighted assets of an institution’s corpo-rate-banking division. We uniformly priced thatcapital at 6 percent for all players in order to ensurea comparable capital basis. We also indexed all keyperformance indicators to risk-weighted assets inorder to make the performance indicators compa-rable. Unless stated otherwise, client numbers referto business groups, not individual legal entities.

The cost of capital for corporate banking equals thecost of equity allocated to the corporate-bankingdivision. For the overall assessment of the industry’sperformance, we calculated cost of equity using thecapital asset pricing model. We approximated risk-free rates by taking the returns of ten-year govern-ment benchmark bonds provided by ThomsonDatastream. For 2003, we used country-specificmarket-risk premiums provided by Bloomberg. Formarket sensitivity, we used the value provided byThomson Datastream on the basis of two-yearweekly return data. The after-tax cost of capital hov-ered between 11 and 13 percent for most partici-pants; we therefore assumed an average of 12 per-cent. Furthermore, we assumed a tax rate of 40 percent, reflecting the weighted average tax ratein participants’ home countries. This calculationyields a pretax cost of capital of 20 percent.

3265.text 11/19/03 12:48 PM Page 27

The Boston Consulting Group is a general management consulting firmthat is a global leader in business strategy. BCG has helped companiesin every major industry and market achieve a competitive advantage bydeveloping and implementing winning strategies. Founded in 1963, thefirm now operates 58 offices in 36 countries. For further information,please visit our Web site at www.bcg.com.

“Making Payments Pay: Organizing for Success”

Opportunities for Action in Financial Services, September 2003

“Banking’s Changing Dynamics”

Opportunities for Action in Financial Services, August 2003

Winning in a Challenging Market: Global Wealth 2003


July 2003

Creating Value in Banking

A report by The Boston Consulting Group, June 2003

“Engaging for Results”

Opportunities for Action in Financial Services, June 2003

Navigating the Maze: Global Asset Management 2003


June 2003

“Banking à la Nike and Dell: Achieving Scale Without Acquisition Premiums”

Opportunities for Action in Financial Services, May 2003

“Making the Most of Mortgage Markets”

Opportunities for Action in Financial Services, April 2003

“Overcoming the Unexpected: A Business Imperative”

Opportunities for Action in Financial Services, March 2003

“Bank Branches: Polishing the Strategic Jewels”

Opportunities for Action in Financial Services, February 2003

The Payments Puzzle: Putting the Pieces Together, Global Payments 2003

A report by The Boston Consulting Group, January 2003

For a complete list of BCG publications and information about how to

obtain copies, please visit our Web site at www.bcg.com.

The Boston Consulting Group publishes other reports and articles that may be of interest to senior financial executives.

Recent examples include:

3265.cvr 11/19/03 12:46 PM Page 2



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BCGREPORT

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