Tuesday 26 April 2016 4:15 am  |  Updated:  Monday 02 August 2021 5:49 pm

Quantifying bank quality: Why four star TSB beats one star Barclays at delivering shareholder value

By: Morning Wire Contributor

Imagine you are on the short-list to become the chief executive of a bank. The interview is going well. It looks like you are their man. But then the conversation turns to rewards. The headhunter explains that you will be rewarded for increasing the bank’s price/book value. They give you a blank sheet of paper and ask you to write down how you would do this. What would you focus on?

Return on equity (RoE)? If you said RoE, you’ve failed the job interview. RoE as a measure has completely lost credibility, given that some very high RoE banks failed during the banking crisis. In fact, there is an inverse correlation between historic RoE and bank failure. Many of the lower RoE banks came through the banking crisis better. They had more conservative equity/total asset funding, while higher RoE banks did not reward shareholders because their business models were too risky.

RoE does not equal shareholder value. But what does then? The Bank of England and the Max Planck Institute of Berlin have done a detailed study on this, entitled “Taking uncertainty seriously”, which looks at the simple rules of thumb that helped predict which banks came through the crisis and which didn’t.

Inspired by this, we decided to look at successful banks across the world, to see what they are doing right. We then formalised this into a kind of Piotroski score for banks that we have just launched called Lafferty Bank Quality Ratings (LBQR).

The 15 criteria used to determine a bank’s quality rating are both quantitative and qualitative and were arrived at after extensive interviews with senior bankers, regulators and investors around the world. These include return on assets, equity capital and deposit funding, as well as strategy, culture, customer satisfaction and management experience. The resulting score is then translated into star-ratings – ranging from five for the best banks to one for those at the other end of the scale.

The results of our first 100 ratings of the largest banks by stock market capitalisation across the globe are fascinating and include:

• The best banks are focused on retail or corporate banking or a combination of both;
• There are many different successful banking models – but unfocused universal banking is not one of them;
• Most of the best banks come from emerging markets like South Africa, Singapore/Malaysia, and India – and many are relatively young;
• High-rating European and US banks are few but include Handelsbanken and Swedbank from Sweden, TSB from the UK, and Discover from the US.

The LBQR bank quality rating scores banks for their ability to deliver sustainable returns. It does not rate debt instruments like the credit ratings of the likes of Moody’s, Standard and Poor’s and Fitch. It rates the quality of the bank. It is an ideal tool for boards of directors, regulators and others with exposure to banks.

For further information, visit bankqualityratings.lafferty.com