Description
Pursuing Best Practice In Bank Turnarounds
An in-depth look at the challenges facing senior managers Published by The McKinsey Quarterly June 2004
McKinsey on Banking
Article at a glance: Financial crises are inevitable, but bank closures are not. When a crisis strikes,
careful attention to the liquidity of a bank—and, if necessary, the assistance of a central bank—can prevent
it from failing. Whether the crisis was the result of poor management or of macroeconomic conditions,
a successful turnaround depends on using well-known but frequently ignored management skills to restore
confdence as conditions improve.
The take-away: The formula for a successful turnaround is straightforward and similar around the world:
monitor liquidity, rein in bad lending practices, and fnd creative ways to add fresh capital.
Pursuing best practice
in bank turnarounds
Failing banks must overhaul their management and focus on the bottom line
if they hope to get back on track.
L
l
o
y
d
M
i
l
l
e
r
1
Pursuing best practice in bank turnarounds
Dominic Barton,
Roberto Newell, and
Gregory Wilson
Economic recovery is under way at last in some
emerging markets, but distressed banks are still all too
common in Asia, Eastern Europe, and Latin America.
During this turbulent time, however, some bankers and
governments in these regions have accumulated valuable
experience about managing the short- and long-term
restructuring of financial institutions. Best practices
for successful turnarounds have emerged and hold
important lessons not only for bankers in other markets
but also for governments, which too often play a
stewardship role for which they are unprepared.
Successful turnarounds involve neither exotic formulas
nor financial magic. Instead, management must
undertake actions that appear to be obvious but are
frequently ignored or resisted. Such a program usually
requires banks to bring in a new management team, for
example, but incumbent executives in many emerging
markets are often socially or politically well connected
and can thus retain their positions. A successful
turnaround includes both operating improvements
and a focus on the bottom line. We have worked in
some markets where executives and the government
thought that simply hanging on was good enough—an
attitude that can prolong the agony of a troubled bank
without resolving the underlying problems. During a
multiyear change program, a management team might
confront hundreds of options. Yet in our work with ailing
banks, we found three broad areas that are critical to
their survival after a financial crisis: managing liquidity,
reducing the number of high-risk loans, and adding
fresh capital.
Manage the bank’s liquidity
Maintaining liquidity during a crisis gives a bank time
to concentrate on its next steps without worrying
about a government takeover—but that’s easier said
than done. During the first days of a banking crisis,
domestic depositors line up to get their money back.
Meanwhile, volatile foreign-exchange and interest-
rate markets, which frequently accompany banking
crises, vastly complicate liquidity management. Wrong
guesses are costly and often fatal because many banks
in emerging markets lack a fundamental understanding
of the necessity of liquidity.
1
A deep knowledge of what
funds are leaving the bank (and what funds, if any, are
coming in) and of the mismatches between interest and
exchange rates is critical to sustaining liquidity during and
immediately following a crisis.
During the crisis
When liquidity drains from an institution during a crisis,
there’s only one place to go for relief: the country’s
central bank. For this reason, close collaboration
between the central bank and illiquid but solvent banks
is vital. When cooperation between the banks and
the government breaks down, as it did in Argentina in
2001, banks have to face the disintegrating situation
alone. After the Argentine government made a series of
decisions that all but destroyed public confidence—
a currency devaluation, a freeze on consumer deposits,
and a series of bank holidays—the entire banking
system nearly collapsed. Conversely, a solid relationship
between the public and private sectors during the
financial crises in Malaysia and South Korea helped keep
banks afloat and allowed them to emerge in relatively
good shape. Depositors had enough confidence to leave
their money in financial institutions, which were able
to operate throughout the crisis. During the economic
recovery, bank executives and regulators communicated
constantly, and all parties understood that working
together was best for the system and their shared
interests.
In recovering or unstable financial markets, banks
and governments can cause full-blown crises by
working at cross-purposes. We observed one Latin
American country where both a large institution and the
government, which plays a pivotal role in any country’s
money and currency markets, tried to raise money
without coordination. Interest rates spiked and
investors panicked, leading to rapid cash withdrawals
and a renewed run against the local currency. In effect,
the bank and the government were crowding each
other out of the markets—a state of affairs that can
1
Brazil and Venezuela are exceptions. When crises are fresh in the bankers’ memories, the importance of liquidity is generally understood.
2
Pursuing best practice in bank turnarounds
confuse investors and depositors alike and make a
deteriorating situation worse. Following this incident, the
government agreed to cooperate more closely with
the banking industry.
And afterward
Once the crisis passes, CFOs and treasurers of banks
should focus on three steps.
Restoring access to liquidity. In a banking crisis,
sources of cash dry up; the central bank provides
funds temporarily or not at all. With a return to relative
normality, bankers must restore credit lines with
domestic and foreign correspondent banks. Given the
damage to both the country’s and the bank’s image,
this effort can take a long time.
Managing ongoing liquidity conditions. CFOs should also
hold more frequent asset and liability reviews as part
of this new approach. These meetings help a bank to
anticipate its liquidity requirements, to ensure that assets
match liabilities, and to verify that the line officers—
whose responsibilities include investing in government
bonds and making new loans—recognize the bank’s
needs and the potential impact of large withdrawals.
Maximizing available cash. Such measures as repricing
products, resetting interest rates, and renegotiating
reserve positions with the central bank can generate
more cash to bolster a bank’s liquidity. A bank must
carefully monitor its discretionary spending and cash
disbursements to ensure that it meets its liquidity
requirements. Bankers can, for example, delay spending
on projects with long-term returns and on IT systems,
advertising, and other discretionary items. But we have
yet to see a turnaround that didn’t require big personnel
cuts, a reduction in cash disbursements (including
salaries and bonuses), and a significantly smaller scope
of operation to stabilize the bank and position it for new
growth.
In 1998, the year following South Korea’s economic
crisis, more than 30 percent of the country’s banking
employees lost their jobs. Similarly, the new CEO and
chairman of Kookmin Bank
2
was forced to lay off 30 percent
of the workforce in the first three months of his tenure—
a previously unheard-of course of action in South Korea.
3
Stop making risky new loans
Officers who booked their institution’s bad loans shouldn’t
make decisions on new ones without a wholesale
revamping of its credit- and risk-management processes.
This overhaul usually means canceling all unused credit
lines, examining every loan on the books and determining
its relative value against the current market, centralizing
credit decisions, and suspending loan rollovers until it is
possible to conduct a rigorous review, including scenario
planning. Ultimately, a whole new credit- and risk-
management system must be imposed.
We have seen firsthand the damage poorly supervised
loan officers can cause. Workers Bank of Jamaica, for
instance, continued to make unprofitable loans even after
it was taken over by the government. So did a large Latin
American bank, which offered new loans to relatives
and favored customers before analyzing the risk-reward
trade-offs and pricing loans accordingly. In 1999 this
bank failed—not surprising given the oversight by the
government’s new, untested, and understaffed deposit-
guarantee agency. After injecting roughly $800 million in
government bonds, it installed new management but
did little else to oversee the bank’s rehabilitation.
From the time the new management arrived until the
bank’s failure, no attempt was made to manage and collect
nonperforming loans, sell bad assets, improve lending skills,
or impose new risk-reward processes and metrics. Since
there was no investment contract between the bank and
the agency, no management incentives were in place to
support a successful turnaround effort. The bank continued
to make loans to unreliable borrowers in the same way
that had contributed to its initial downfall. It even took the
agency’s bonds, sold them on the secondary market, and
used the proceeds to go on lending as it had before its
takeover.
Analyzing the lending practices of a failing bank may bring
some unpleasant surprises to the surface. We advised a
2
Formerly Housing & Commercial Bank of Korea.
3
Dominic Barton and Jaehong Park, “Asia’s banking maverick,” The McKinsey Quarterly, 2003 Number 1, pp. 108–19
(www.mckinseyquarterly.com/links/12899).
3
Pursuing best practice in bank turnarounds
Mexican bank, for example, to cancel its credit lines and
call in its short-term loans. In this way, the bank could
gauge the health of its evergreen portfolio (its long-term,
low-risk assets and liabilities) and track profits from
some parts of its short-term portfolio. The study revealed
that a significant proportion of the loan portfolio’s value
was impaired and would never be recovered fully. In
addition, the bank’s short-term loan operations were in
part actually funding fixed assets and other nonliquid
investments.
Although many of the bank’s loans had to be
restructured, it finally learned the actual extent of the
problems. Determining the true value of the loan portfolio
forced the bank to create reserves and to reprice many
of its lending products. Management focused on the
right credit issues and kicked off a loan-recovery process
that might have taken longer to start if these measures
had not been implemented. Drastic action made the
bank the very first in the country both to recognize
its problems and to clean up its nonperforming loans.
By moving fast, it improved the conditions of its loan
portfolio and minimized write-offs.
Unfortunately, many countries lack not only adequate
bankruptcy laws but also proper courts and procedures
to adjudicate defaults. The absence of a channel to
resolve delinquent accounts actually prevents rapid loan
workouts and thus the return of productive assets to the
economy. In countries where legal systems can’t cope
with the complexities of a financial crisis, it is possible
to avoid lengthy delays and any resulting effect on the
economy by undertaking loan and asset workouts—
settlements between creditors and debtors that are
negotiated outside a problematic legal framework. Even
in developed markets, legal systems often hinder banks
in the midst of a restructuring from fully recovering their
bad loans.
4
In almost every bank turnaround, recovering
debt from the nonperforming-loan portfolio has proved
to be the most important way to improve profits.
5
If
reserves have already been taken on these loans, the
assets recovered drop straight to the profits column,
thereby shoring up the capital base of the bank and
restoring its ability to book fresh loans. Even when this
isn’t the case, bank managers should act as if all loans
were impaired, if only to reflect the fact that in turbulent
times the value of collateral may fall.
For this reason, banks should immediately review their
customers’ payment status and consider action—such as
renegotiating conditions or payment terms and agreeing
on mutually beneficial workout plans—to prevent loans
from going bad. These measures will not only protect
the loan portfolio but also, perhaps, increase the bank’s
value relative to that of its competitors. Although banks
in crisis may not return to lending for some time, they
need to reevaluate their strategies and redesign their
loan-approval processes to prepare for the day when
they do. Institutions also need to ensure that appropriate
rating systems and review processes are in place, since
a marked improvement in credit skills should be a top
priority before new lending can begin.
Add new capital
Banks can begin raising fresh capital as soon as they
can tell a credible turnaround story to regain the trust
of investors and the government. Combined with new
credit skills, an influx of capital is critical to restart lending
and earnings growth.
Kookmin Bank, for instance, became South Korea’s
leading retail institution just five years after the start
of that country’s banking crisis, in part by making
the infusion of private capital an important part of its
strategy. The new leadership of the bank differentiated
it from most other domestic competitors by improving
its risk-management skills and pursuing corporate-
governance reforms, among other initiatives. As a
result, the former Housing & Commercial Bank (H&CB)
attracted new capital from foreign banks. (One of them,
the Dutch bank ING, purchased roughly 9 percent of
H&CB, got a board seat in exchange, and helped the
bank develop new credit- and risk-management skills,
which gave it a competitive advantage over its slower-
4
During the banking crisis of the late 1980s in Texas, for example, many large banking organizations, such as North Carolina National Bank,
set up separate subsidiaries to manage loan workouts and bad-asset sales as an alternative to watching the value of their assets diminish while
they waited for a court decision.
5
For more on managing nonperforming loans, see Laurence W. Berger, George R. Nast, and Christian Raubach, “Fixing Asia’s bad-debt mess,”
The McKinsey Quarterly, 2002 Number 4, pp. 138–49 (www.mckinseyquarterly.com/links/12901).
4
Pursuing best practice in bank turnarounds
moving competition.) Despite recent problems with
its credit card portfolio, Kookmin remains one of the
most successful examples of a bank turnaround and
transformation.
Systematic problems (such as cronyism in the loan-
approval process and poor monitoring of cash positions)
that go unchecked for years make it difficult for banks in
some countries to attract new capital, thereby forcing
them to rely on public funds for survival. Recently,
China had to inject massive amounts of capital from
both its central-bank reserves and its tax revenues to
stabilize important banks systemically until fresh private
capital could be obtained. Although a publicly funded
asset-management company stepped in to save one
large bank that was critical to the nation’s struggling
financial system, action of this type is only part of the
solution. Chinese asset-management companies typically
purchased bad assets from a failing bank, which received
much-needed cash. But since the asset-management
company, not the bank, collected these bad loans,
Chinese banks weren’t necessarily acquiring new and
better risk-management skills.
Creating a “bad bank” can be an excellent way to
sweep such assets from the books of restructuring
banks and, at the same time, to generate capital (see
sidebar, “’Bad banks’ are good”). A bad bank is often
staffed with employees from the parent company who
likely would lose their jobs if nonperforming loans were
sold to an asset-management company. Retaining
experienced people for these positions keeps valuable
knowledge about loan workouts in the bank, thereby
providing continuity to the endeavor. Ultimately, banks
must also acquire new workout and resolution skills. The
bad-bank strategy requires the same level of leadership
and commitment regardless of the setting—private or
state-run banks, in developed or developing nations. By
selling bad loans quickly in one lump sum, banks can raise
fresh capital and return to profitability while management
focuses on the core business strategy.
In analyzing our experiences with bank turnarounds,
we have arrived at two major conclusions. First, the
architecture of successful turnarounds throughout
the world is very similar. The details may vary, but the
fundamentals that drive these programs are surprisingly
alike. Thus the lessons learned are generally applicable
throughout the world. Second, the requirements for
success are relatively straightforward; execution is the
determining factor. Investors and management teams that
recognize and embrace these lessons sooner rather than
later are sure to see faster results and better returns for
their customers and employees.
Dominic Barton is a director in McKinsey’s Shanghai office;
Roberto Newell, a former director in the Miami office, is now
the director general of the Mexican Institute for Competitiveness
(Instituto Mexicano para la Competitividad); Greg Wilson is a
principal in McKinsey’s Washington, DC, office. Copyright © 2004
McKinsey & Company. All rights reserved. This article can be
found at www.mckinseyquarterly.com.
’Bad banks’ are good
Although Mellon Bank is a large institution in a developed
market, many struggling banks in emerging markets
can apply its turnaround model: isolate bad loans and
maximize their recovery value over time, either before or
after government intervention.
Mellon uncovered problems in its loan portfolio in 1987,
two years before the US banking crisis began. For the
new executive team at Mellon, finding cost savings and
resetting the bank’s strategy weren’t sufficient. It was
necessary to raise about $500 million in fresh equity
capital—and fast.
Working with E. M. Warburg Pincus, a New York–based
venture capital group, the team decided to tap into the
junk bond market and to finance the creation of Grant
Street National Bank (GSNB), known as a bad bank.
The plan was to transfer roughly $1 billion—in book
value only, for the market value was half that figure—of
Mellon’s nonperforming assets to this new subsidiary,
using the proceeds of two common-stock offerings. The
sale of stock netted $525 million, which offset the losses
from the loans and other bad assets and injected new
capital into Mellon.
5
Pursuing best practice in bank turnarounds
This new entity was spun off to Mellon’s existing
shareholders, and a new class of stock was provided
as incentive compensation for its directors. GSNB also
entered into a management contract with another Mellon
Bank subsidiary, Collection Services, to work out the bad
loans on the basis of costs plus 3 percent of collections.
This unit worked under the close direction of GSNB’s
management and had a staff of more than 50 people
with strong workout skills.
A host of investment bankers, lawyers, and accountants
worked for the venture, and by all accounts GSNB was a
success. The well-structured subsidiary offered
appropriate incentives to an experienced workout team,
which went back to Mellon after its mission was
complete. GSNB even returned its charter to the banking
authorities ahead of schedule, retired its debt early,
repaid the preferred stock held by Mellon, and gave
essentially all of the common equity back to GSNB’s
shareholders. As an added benefit, the subsidiary
provided Mellon’s employees with a psychological lift:
once the bulk of the problems had been separated
from the remaining bank, a light suddenly appeared at
the end of the long tunnel.
doc_295221438.pdf
Pursuing Best Practice In Bank Turnarounds
An in-depth look at the challenges facing senior managers Published by The McKinsey Quarterly June 2004
McKinsey on Banking
Article at a glance: Financial crises are inevitable, but bank closures are not. When a crisis strikes,
careful attention to the liquidity of a bank—and, if necessary, the assistance of a central bank—can prevent
it from failing. Whether the crisis was the result of poor management or of macroeconomic conditions,
a successful turnaround depends on using well-known but frequently ignored management skills to restore
confdence as conditions improve.
The take-away: The formula for a successful turnaround is straightforward and similar around the world:
monitor liquidity, rein in bad lending practices, and fnd creative ways to add fresh capital.
Pursuing best practice
in bank turnarounds
Failing banks must overhaul their management and focus on the bottom line
if they hope to get back on track.
L
l
o
y
d
M
i
l
l
e
r
1
Pursuing best practice in bank turnarounds
Dominic Barton,
Roberto Newell, and
Gregory Wilson
Economic recovery is under way at last in some
emerging markets, but distressed banks are still all too
common in Asia, Eastern Europe, and Latin America.
During this turbulent time, however, some bankers and
governments in these regions have accumulated valuable
experience about managing the short- and long-term
restructuring of financial institutions. Best practices
for successful turnarounds have emerged and hold
important lessons not only for bankers in other markets
but also for governments, which too often play a
stewardship role for which they are unprepared.
Successful turnarounds involve neither exotic formulas
nor financial magic. Instead, management must
undertake actions that appear to be obvious but are
frequently ignored or resisted. Such a program usually
requires banks to bring in a new management team, for
example, but incumbent executives in many emerging
markets are often socially or politically well connected
and can thus retain their positions. A successful
turnaround includes both operating improvements
and a focus on the bottom line. We have worked in
some markets where executives and the government
thought that simply hanging on was good enough—an
attitude that can prolong the agony of a troubled bank
without resolving the underlying problems. During a
multiyear change program, a management team might
confront hundreds of options. Yet in our work with ailing
banks, we found three broad areas that are critical to
their survival after a financial crisis: managing liquidity,
reducing the number of high-risk loans, and adding
fresh capital.
Manage the bank’s liquidity
Maintaining liquidity during a crisis gives a bank time
to concentrate on its next steps without worrying
about a government takeover—but that’s easier said
than done. During the first days of a banking crisis,
domestic depositors line up to get their money back.
Meanwhile, volatile foreign-exchange and interest-
rate markets, which frequently accompany banking
crises, vastly complicate liquidity management. Wrong
guesses are costly and often fatal because many banks
in emerging markets lack a fundamental understanding
of the necessity of liquidity.
1
A deep knowledge of what
funds are leaving the bank (and what funds, if any, are
coming in) and of the mismatches between interest and
exchange rates is critical to sustaining liquidity during and
immediately following a crisis.
During the crisis
When liquidity drains from an institution during a crisis,
there’s only one place to go for relief: the country’s
central bank. For this reason, close collaboration
between the central bank and illiquid but solvent banks
is vital. When cooperation between the banks and
the government breaks down, as it did in Argentina in
2001, banks have to face the disintegrating situation
alone. After the Argentine government made a series of
decisions that all but destroyed public confidence—
a currency devaluation, a freeze on consumer deposits,
and a series of bank holidays—the entire banking
system nearly collapsed. Conversely, a solid relationship
between the public and private sectors during the
financial crises in Malaysia and South Korea helped keep
banks afloat and allowed them to emerge in relatively
good shape. Depositors had enough confidence to leave
their money in financial institutions, which were able
to operate throughout the crisis. During the economic
recovery, bank executives and regulators communicated
constantly, and all parties understood that working
together was best for the system and their shared
interests.
In recovering or unstable financial markets, banks
and governments can cause full-blown crises by
working at cross-purposes. We observed one Latin
American country where both a large institution and the
government, which plays a pivotal role in any country’s
money and currency markets, tried to raise money
without coordination. Interest rates spiked and
investors panicked, leading to rapid cash withdrawals
and a renewed run against the local currency. In effect,
the bank and the government were crowding each
other out of the markets—a state of affairs that can
1
Brazil and Venezuela are exceptions. When crises are fresh in the bankers’ memories, the importance of liquidity is generally understood.
2
Pursuing best practice in bank turnarounds
confuse investors and depositors alike and make a
deteriorating situation worse. Following this incident, the
government agreed to cooperate more closely with
the banking industry.
And afterward
Once the crisis passes, CFOs and treasurers of banks
should focus on three steps.
Restoring access to liquidity. In a banking crisis,
sources of cash dry up; the central bank provides
funds temporarily or not at all. With a return to relative
normality, bankers must restore credit lines with
domestic and foreign correspondent banks. Given the
damage to both the country’s and the bank’s image,
this effort can take a long time.
Managing ongoing liquidity conditions. CFOs should also
hold more frequent asset and liability reviews as part
of this new approach. These meetings help a bank to
anticipate its liquidity requirements, to ensure that assets
match liabilities, and to verify that the line officers—
whose responsibilities include investing in government
bonds and making new loans—recognize the bank’s
needs and the potential impact of large withdrawals.
Maximizing available cash. Such measures as repricing
products, resetting interest rates, and renegotiating
reserve positions with the central bank can generate
more cash to bolster a bank’s liquidity. A bank must
carefully monitor its discretionary spending and cash
disbursements to ensure that it meets its liquidity
requirements. Bankers can, for example, delay spending
on projects with long-term returns and on IT systems,
advertising, and other discretionary items. But we have
yet to see a turnaround that didn’t require big personnel
cuts, a reduction in cash disbursements (including
salaries and bonuses), and a significantly smaller scope
of operation to stabilize the bank and position it for new
growth.
In 1998, the year following South Korea’s economic
crisis, more than 30 percent of the country’s banking
employees lost their jobs. Similarly, the new CEO and
chairman of Kookmin Bank
2
was forced to lay off 30 percent
of the workforce in the first three months of his tenure—
a previously unheard-of course of action in South Korea.
3
Stop making risky new loans
Officers who booked their institution’s bad loans shouldn’t
make decisions on new ones without a wholesale
revamping of its credit- and risk-management processes.
This overhaul usually means canceling all unused credit
lines, examining every loan on the books and determining
its relative value against the current market, centralizing
credit decisions, and suspending loan rollovers until it is
possible to conduct a rigorous review, including scenario
planning. Ultimately, a whole new credit- and risk-
management system must be imposed.
We have seen firsthand the damage poorly supervised
loan officers can cause. Workers Bank of Jamaica, for
instance, continued to make unprofitable loans even after
it was taken over by the government. So did a large Latin
American bank, which offered new loans to relatives
and favored customers before analyzing the risk-reward
trade-offs and pricing loans accordingly. In 1999 this
bank failed—not surprising given the oversight by the
government’s new, untested, and understaffed deposit-
guarantee agency. After injecting roughly $800 million in
government bonds, it installed new management but
did little else to oversee the bank’s rehabilitation.
From the time the new management arrived until the
bank’s failure, no attempt was made to manage and collect
nonperforming loans, sell bad assets, improve lending skills,
or impose new risk-reward processes and metrics. Since
there was no investment contract between the bank and
the agency, no management incentives were in place to
support a successful turnaround effort. The bank continued
to make loans to unreliable borrowers in the same way
that had contributed to its initial downfall. It even took the
agency’s bonds, sold them on the secondary market, and
used the proceeds to go on lending as it had before its
takeover.
Analyzing the lending practices of a failing bank may bring
some unpleasant surprises to the surface. We advised a
2
Formerly Housing & Commercial Bank of Korea.
3
Dominic Barton and Jaehong Park, “Asia’s banking maverick,” The McKinsey Quarterly, 2003 Number 1, pp. 108–19
(www.mckinseyquarterly.com/links/12899).
3
Pursuing best practice in bank turnarounds
Mexican bank, for example, to cancel its credit lines and
call in its short-term loans. In this way, the bank could
gauge the health of its evergreen portfolio (its long-term,
low-risk assets and liabilities) and track profits from
some parts of its short-term portfolio. The study revealed
that a significant proportion of the loan portfolio’s value
was impaired and would never be recovered fully. In
addition, the bank’s short-term loan operations were in
part actually funding fixed assets and other nonliquid
investments.
Although many of the bank’s loans had to be
restructured, it finally learned the actual extent of the
problems. Determining the true value of the loan portfolio
forced the bank to create reserves and to reprice many
of its lending products. Management focused on the
right credit issues and kicked off a loan-recovery process
that might have taken longer to start if these measures
had not been implemented. Drastic action made the
bank the very first in the country both to recognize
its problems and to clean up its nonperforming loans.
By moving fast, it improved the conditions of its loan
portfolio and minimized write-offs.
Unfortunately, many countries lack not only adequate
bankruptcy laws but also proper courts and procedures
to adjudicate defaults. The absence of a channel to
resolve delinquent accounts actually prevents rapid loan
workouts and thus the return of productive assets to the
economy. In countries where legal systems can’t cope
with the complexities of a financial crisis, it is possible
to avoid lengthy delays and any resulting effect on the
economy by undertaking loan and asset workouts—
settlements between creditors and debtors that are
negotiated outside a problematic legal framework. Even
in developed markets, legal systems often hinder banks
in the midst of a restructuring from fully recovering their
bad loans.
4
In almost every bank turnaround, recovering
debt from the nonperforming-loan portfolio has proved
to be the most important way to improve profits.
5
If
reserves have already been taken on these loans, the
assets recovered drop straight to the profits column,
thereby shoring up the capital base of the bank and
restoring its ability to book fresh loans. Even when this
isn’t the case, bank managers should act as if all loans
were impaired, if only to reflect the fact that in turbulent
times the value of collateral may fall.
For this reason, banks should immediately review their
customers’ payment status and consider action—such as
renegotiating conditions or payment terms and agreeing
on mutually beneficial workout plans—to prevent loans
from going bad. These measures will not only protect
the loan portfolio but also, perhaps, increase the bank’s
value relative to that of its competitors. Although banks
in crisis may not return to lending for some time, they
need to reevaluate their strategies and redesign their
loan-approval processes to prepare for the day when
they do. Institutions also need to ensure that appropriate
rating systems and review processes are in place, since
a marked improvement in credit skills should be a top
priority before new lending can begin.
Add new capital
Banks can begin raising fresh capital as soon as they
can tell a credible turnaround story to regain the trust
of investors and the government. Combined with new
credit skills, an influx of capital is critical to restart lending
and earnings growth.
Kookmin Bank, for instance, became South Korea’s
leading retail institution just five years after the start
of that country’s banking crisis, in part by making
the infusion of private capital an important part of its
strategy. The new leadership of the bank differentiated
it from most other domestic competitors by improving
its risk-management skills and pursuing corporate-
governance reforms, among other initiatives. As a
result, the former Housing & Commercial Bank (H&CB)
attracted new capital from foreign banks. (One of them,
the Dutch bank ING, purchased roughly 9 percent of
H&CB, got a board seat in exchange, and helped the
bank develop new credit- and risk-management skills,
which gave it a competitive advantage over its slower-
4
During the banking crisis of the late 1980s in Texas, for example, many large banking organizations, such as North Carolina National Bank,
set up separate subsidiaries to manage loan workouts and bad-asset sales as an alternative to watching the value of their assets diminish while
they waited for a court decision.
5
For more on managing nonperforming loans, see Laurence W. Berger, George R. Nast, and Christian Raubach, “Fixing Asia’s bad-debt mess,”
The McKinsey Quarterly, 2002 Number 4, pp. 138–49 (www.mckinseyquarterly.com/links/12901).
4
Pursuing best practice in bank turnarounds
moving competition.) Despite recent problems with
its credit card portfolio, Kookmin remains one of the
most successful examples of a bank turnaround and
transformation.
Systematic problems (such as cronyism in the loan-
approval process and poor monitoring of cash positions)
that go unchecked for years make it difficult for banks in
some countries to attract new capital, thereby forcing
them to rely on public funds for survival. Recently,
China had to inject massive amounts of capital from
both its central-bank reserves and its tax revenues to
stabilize important banks systemically until fresh private
capital could be obtained. Although a publicly funded
asset-management company stepped in to save one
large bank that was critical to the nation’s struggling
financial system, action of this type is only part of the
solution. Chinese asset-management companies typically
purchased bad assets from a failing bank, which received
much-needed cash. But since the asset-management
company, not the bank, collected these bad loans,
Chinese banks weren’t necessarily acquiring new and
better risk-management skills.
Creating a “bad bank” can be an excellent way to
sweep such assets from the books of restructuring
banks and, at the same time, to generate capital (see
sidebar, “’Bad banks’ are good”). A bad bank is often
staffed with employees from the parent company who
likely would lose their jobs if nonperforming loans were
sold to an asset-management company. Retaining
experienced people for these positions keeps valuable
knowledge about loan workouts in the bank, thereby
providing continuity to the endeavor. Ultimately, banks
must also acquire new workout and resolution skills. The
bad-bank strategy requires the same level of leadership
and commitment regardless of the setting—private or
state-run banks, in developed or developing nations. By
selling bad loans quickly in one lump sum, banks can raise
fresh capital and return to profitability while management
focuses on the core business strategy.
In analyzing our experiences with bank turnarounds,
we have arrived at two major conclusions. First, the
architecture of successful turnarounds throughout
the world is very similar. The details may vary, but the
fundamentals that drive these programs are surprisingly
alike. Thus the lessons learned are generally applicable
throughout the world. Second, the requirements for
success are relatively straightforward; execution is the
determining factor. Investors and management teams that
recognize and embrace these lessons sooner rather than
later are sure to see faster results and better returns for
their customers and employees.
Dominic Barton is a director in McKinsey’s Shanghai office;
Roberto Newell, a former director in the Miami office, is now
the director general of the Mexican Institute for Competitiveness
(Instituto Mexicano para la Competitividad); Greg Wilson is a
principal in McKinsey’s Washington, DC, office. Copyright © 2004
McKinsey & Company. All rights reserved. This article can be
found at www.mckinseyquarterly.com.
’Bad banks’ are good
Although Mellon Bank is a large institution in a developed
market, many struggling banks in emerging markets
can apply its turnaround model: isolate bad loans and
maximize their recovery value over time, either before or
after government intervention.
Mellon uncovered problems in its loan portfolio in 1987,
two years before the US banking crisis began. For the
new executive team at Mellon, finding cost savings and
resetting the bank’s strategy weren’t sufficient. It was
necessary to raise about $500 million in fresh equity
capital—and fast.
Working with E. M. Warburg Pincus, a New York–based
venture capital group, the team decided to tap into the
junk bond market and to finance the creation of Grant
Street National Bank (GSNB), known as a bad bank.
The plan was to transfer roughly $1 billion—in book
value only, for the market value was half that figure—of
Mellon’s nonperforming assets to this new subsidiary,
using the proceeds of two common-stock offerings. The
sale of stock netted $525 million, which offset the losses
from the loans and other bad assets and injected new
capital into Mellon.
5
Pursuing best practice in bank turnarounds
This new entity was spun off to Mellon’s existing
shareholders, and a new class of stock was provided
as incentive compensation for its directors. GSNB also
entered into a management contract with another Mellon
Bank subsidiary, Collection Services, to work out the bad
loans on the basis of costs plus 3 percent of collections.
This unit worked under the close direction of GSNB’s
management and had a staff of more than 50 people
with strong workout skills.
A host of investment bankers, lawyers, and accountants
worked for the venture, and by all accounts GSNB was a
success. The well-structured subsidiary offered
appropriate incentives to an experienced workout team,
which went back to Mellon after its mission was
complete. GSNB even returned its charter to the banking
authorities ahead of schedule, retired its debt early,
repaid the preferred stock held by Mellon, and gave
essentially all of the common equity back to GSNB’s
shareholders. As an added benefit, the subsidiary
provided Mellon’s employees with a psychological lift:
once the bulk of the problems had been separated
from the remaining bank, a light suddenly appeared at
the end of the long tunnel.
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