Banking : Emergence of a new post financial crisis model

Sanjay UppalGroup Chief Financial OfficerEmirates NBD

23 November 2009Dubai

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It is possible that this presentation could or may contain forward-looking statements that are based on current expectations or beliefs, as well as assumptions about future events. These forward-looking statements can be identified by the fact that they do not relate only to historical or current facts. Forward-looking statements often use words such as anticipate, target, expect, estimate, intend, plan, goal, believe, will, may, should, would, could or other words of similar meaning. Undue reliance should not be placed on any such statements because, by their very nature, they are subject to known and unknown risks and uncertainties and can be affected by other factors that could cause actual results, to differ materially from those expressed or implied in the forward-looking statements.

There are several factors which could cause actual results to differ materially from those expressed or implied in forward looking statements. Among the factors that could cause actual results to differ materially from those described in the forward-looking statements are changes in the global, political, economic, business, competitive, market and regulatory forces, future exchange and interest rates, changes in tax rates and future business combinations or dispositions.

We undertakes no obligation to revise or update any forward looking statement contained within this presentation, regardless of whether those statements are affected as a result of new information, future events or otherwise. Further, we do not guarantee the information’s accuracy or completeness and accept no liability for any direct or consequential losses arising from its use. Any views expressed in this presentation are those of the individual presenter and do not necessarily reflect the views of Emirates NBD PJSC or any other related subsidiaries, entities or persons.

Forward Looking Statements

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“Those who ignore history

are

condemned to repeat it”

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The business of Banking :A historical perspective

Banking : Its humble origins ……

Banks have been around ever since the concept of money came into existence

Temples

Wealthy Merchants

Institutions

Landed noblemen were untouchable through most of history, passing debts off to descendants until either the creditor's or debtor's lineage died out.

Evolution of ‘bankers’

Ref. : The Evolution Of Banking by Andrew Beattie 4

A monumental shift of power in the relationship of creditor & debtor

Julius Caesar (100BC – 44 BC)

In one of the edicts changing Roman law after his takeover, gives the first example of allowing bankers to confiscate land in lieu of loan payments.

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Banking : The Middle Ages

Monarchs that reigned over Europe noted the strengths of banking institutions

Banks existed by the grace, explicit charters or contracts of the ruling sovereign

Royal powers began to take loans to make up for hard times at the royal treasury –often on the king's terms.

Easy finance led kings into unnecessary extravagances, costly wars and an arms racewith neighboring kingdoms that lead to crushing debt.

1557 : Phillip II of Spain managed to burden his kingdom with so much debt as the result of several pointless wars that he caused the world's first national bankruptcy - as well as the 2nd, 3rd & 4th, in rapid succession. The reason – 40% of the country's GNP went toward servicing the debt.

The trend of turning a blind eye to the creditworthiness of big customers continues to haunt banks up into this day and age

Ref. : The Evolution Of Banking by Andrew Beattie 6

US Banking : 1776-1900

Banking was well established in the British Empire when Adam Smith came to US in 1776 with his "invisible hand" theory

Empowered by his views of a self-regulated economy, moneylenders and bankers managed to limit the state's involvement in the banking sector & the economy

This free market capitalism & competitive banking found fertile ground in the US as it was getting ready to emerge

In the beginning, Smith's ideas did not benefit the American banking industry. The average life for an American bank was five years.

This saw the formation of National banks in the US

Damage had been done already - average Americans had already grown to distrust banks and bankers in general

This led the state of Texas to actually outlaw bankers – a law that stood until 1904

Ref. : The Evolution Of Banking by Andrew Beattie

Subsequent banking crises have witnessed a re-enactment of this era of banking

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Emergence of Merchant Banks : The early 1900s (US)

Until 1920s, merchant banks parlayed their international connections into both political & financial power

Emergence of Corporate Finance, bond market, IPOs

Bank's reputation and history mattered more than anything.Upstart banks came and went but the family-held merchant banks had long histories of successful transactions

Banks were under no obligation to disclose capital reserve

Public in the U.S. & foreign investors in Europe knew very little about investing (disclosure was not legally enforced) – public's perception of the underwriting banks mattered most

Consequently, successful offerings increased a bank's reputation

1913 : Federal Reserve Bank (FED) instituted to allow governmentto wrest financial power from the banks

8Ref. : The Evolution Of Banking by Andrew Beattie

Glass-Steagall Acts : 1932 & 1933

The lessons from the crash of 1929 saw emergence of new policy framework by 2 Democrat Senators

Clear line drawn between being a bank & being an investor. Banks no longer allowed to speculate with deposits.

The 2nd Act established the Federal Deposit Insurance Corporation in the US to convince public it was safe to come back to banks

The Act included banking reforms, some of which were designed to control speculation

Unfortunately, the public was not convinced & the depression continued

World War II saved the day as economy rebounded by the industriousness it generated –lifting the American and world economy back out of the downward spiral.

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“I believe that banking institutions are more dangerous to

our liberties than standing armies.

If the American people ever allow private banks to control

the issue of their currency, first by inflation, then by

deflation, the banks and corporations that will grow up

around the banks will deprive the people of all property until

their children wake-up homeless on the continent their

fathers conquered.”

A quote from history…….

Thomas Jefferson 1802

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The 1980s & 90s :The new economic (r)evolution

A new world order was emerging . . . . .

Economic liberalization

Changing balance between Developed & Developing markets

Emergence of multi-national corporations as global model

Outsourcing & new (economical) manufacturing locations

Debt crises

9/11 & Technology-Media-Telecom (TMT) crisis

Stronger linkage of banks and the economy

Banking – Increased complexity, innovation, competition, regulation,…….

The question emerged – is the over-regulation constraining banking innovation, competitiveness and global economic growth ?

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…so did the debate on increased regulation vs. deregulation

Battle-lines were drawn : Glass Steagall Act – Supporters vs. The Opposition

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1987 : Arguments AGAINST Glass Steagall Act

Banks will now operate in “deregulated” financial markets where distinctions between loans, securities, & deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.

Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending & credit functions through forming distinctly separate subsidiaries of financial firms.

The securities activities that banks are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.

In much of the rest of the world, banks operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure & regulation.

Compelling arguments that perhaps found their basis in Adam Smith’s theories dating back over 200 years

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1987 : Arguments FOR Glass Steagall Act

Conflicts of interest characterize the granting of credit & use of credit (investing) by the same entity, which led to abuses that originally produced the Act.

Banks possess enormous financial power by virtue of their control of other people’s money; its extent must be limited to ensure soundness & competition in the market for funds, whether loans or investments.

Securities activities can be risky & possibly lead to enormous losses that could threaten the integrity of deposits. In turn, Government insures deposits and could be required to pay large sums if banks were to collapse as the result of securities losses.

Banks are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

As evident, the above concerns were ignored.These comments surfaced in form of multiple headlines 20 years later.

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Glass Steagall Act – Repealed : 1999

After 25 years and 12 attempts, Congress finally approved the Gramm–Leach–Bliley Act that saw the demise of the Glass-Steagall Act in 1999

The bills were passed by a Republican majority, basically following party lines by a 54–44 vote in the Senate and by a bi-partisan 343–86 vote in the House of Representatives

The legislation was signed into law by President Bill Clinton on 12 Nov. 1999

Grounds were laid for the commencement of a new era in banking.The modern-day Adam Smiths had prevailed

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Global Financial Markets : Stormy times

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The current downturn could be the most severe of the modern era

* Extracted from aggregated income statement, selected balance sheet, and employment data on the U.S. domestic broker-dealer operations of all NASD and NYSE member firms doing a public business derived from their Financial and Operational Combined Uniform Single (FOCUS) Report filings

Source: SIFMA; McKinsey

Securities firms revenueAbsolute revenues below corresponding quarter in previous year

U.S. securities industry financial results* 1980 value indexed to 100 (quarterly figures)

Q1 1980 2000 2001 2002 2003 2004 2005 20061982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 19991981 2009E

Q1 2001 - Q2 2005"9/11 and TMT collapse"

Duration of decline – 9 quarters% max. fall – 43.0%Time to recovery – 19 quarters

2008

?

2007

?

Q1 1994 - Q4 1994"U.S. interest rate hike"

Duration of decline – 2 quarters% max. fall – 15.8%Time to recovery – 4 quarters

Q2 1987 - Q1 1989"Black Monday"

Duration of decline – 3 quarters% max. fall – 33.5%Time to recovery – 8 quarters

Q3 1998 - Q3 1999"Emerging markets crisis"

Duration of decline – 1 quarter% max. fall– 15.2%Time to recovery – 5 quarters

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

2,800

Post Glass-Steagall Era : The effect

The repeal enabled commercial lenders to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles that bought those securities.

Experts say that the repeal of this act contributed to the current Global financial crisis.

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US Dollar, Oil & Gold price movements in this decade

Oil

Gold

$ : Euro

Note 1: Chart indexed to 1 Jan 2000 : $1 = Euro 0.95, Oil Price = $30 & Gold = $ 300 per ounce

Is Gold the new safe haven ?

Oil prices dropped to pre-boom levels & recovered quickly

Future of the Dollar : Ayes vs. Nays – Opinions divided

2000-2009 price movements

37 37

42

49

5657

79

87

68

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

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Global banking assets bubble

Note: Banking Assets data includes United States, Latin America, Western Europe, China, India & Japan

Lower Fed rate has not resulted in lower costs of borrowing

Customer credit (ex-China) has been stagnant in 2009

Unwinding of some of the excesses of 2005-2007 remains

US Fed Funds rate

Low cost of funds

Effect

+ W

eak

Gover

nanc

e &

Regu

latio

n

Banking Assets (US $ trillion)

The challenges are systemic – pursuit of individual victories will by myopic

Contraction deterred by various stimulus . . .

. . For now ?

Glass-Steagall Act

repealed

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Looking ahead : Emergence of a new Banking model…….

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Forces shaping the New Banking Model : The stakeholders

Economy

This crisis has once again highlighted the interdependence of the banking sector & broader economy

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We are in a new era with transforming. . . .

Global Economic Dynamics

Countries – inwards looking, protectionist

Country & individual wealth : Winners & Losers

Business models – across sectors

Market participants

Regulations – rapid reforms & increased scrutiny

Customer behavior

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Every Crisis has resulted in changes in regulatory regime….

Crisis New Regulation

1929-30 : Financial Crisis of Glass-Steagall Act

2001-02 : Enron, WorldCom Sarbanes Oxley

1973-74 : Oil Price Crisis Basel Committee on Banking Supervision

1982 : Latin America’s Debt Crisis Basel 1

1994-95 : Mexican Crisis1997-98 : Asian Crisis

Basel 2

2007-?? : Global Financial Crisis ???

Solution – More regulations and improved enforcement ?

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Regulators

Domestic

More intrusive, qualitative & real time

Macro Prudential regulation

Dynamic Provisioning

Asset scrutiny & liquidity management

Too-Big-to-fail ?

Foreign

Banks in multinational jurisdictions to face additional regulatory scrutiny

New proposals for improvements in governance of risk management

G20 agreements

Important to ensure regulations & regulators keep pace with innovation

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Shareholders & Investors

Shareholders becoming more sensitive to sound governance

Disclosures & transparency

Board & Management credibility

Averse to over leveraging

Ring fenced balance sheets to minimize impact of failure on any one nation

Risk Management & disclosures

Forms of Capital being reassessed[Is Tier 2 relevant ?]

Investors will exercise enhanced influence on corporate behavior

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Customers

Demanding more transparency and security of their funds

Funded deposit protection / insurance schemes

Credit generation to support the economy

Mis-selling & Client suitability : Increased responsibility on the banks

Rebuilding trust

Enhanced governance frameworks & investments to strengthen systems will increase complexities & costs for the customer

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Measurement & Reporting - IAS / Basel II

Upgraded Basel II & global implementation

Increase in regulatory capital requirements

More Tier 1 Capital & increased contingent Capital

More high-quality liquid assets

New requirements to mitigate procyclicality

Proposed amendments to IAS 39 & IFRS 7

Upgraded Risk management functions

New Liquidity standards

‘Ratings’ under transformation

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Boards & Staff

Upgrade Risk Management Function

Focus on Capital & Liquidity Management

Changes in remuneration structures

Increased Government / Regulatory oversight on Supervisory Boards

Significant increase in management time devoted to stakeholder relationships

Improved alliance between banks, regulators, accountants & policy makers

Focus on sound governance, not just compliance

Need to rebuild credibility & focus on core stakeholders

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In conclusion

The theory that moral responsibility and self-interested competition in the free market would alone tend to benefit society has failed the world again

A new balance between free markets & regulation –however, compliance with regulation is itself not enough

Start of an era of “Responsible Banking”

Adapt quickly : late can be too late

Regulatory & Policy frameworks requires strengthening – both inside the banks and outside

Focus on core stakeholders – Rebuild trust

The crisis is not over yet….neither are the lessons