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A sign hangs above a Bank of America branch in the Financial District in Chicago. Should bank boards be more aggressive about questioning their best lines of business, before things go wrong?
Sallie Krawcheck, one of the most successful women to ever work on Wall Street, has a piece upcoming in Harvard Business Review about how institutional banking should be very concerned about returns that aren't sustainable. She points to JPMorgan's recent $2-billion disaster with a trader known as the "London Whale." And then she suggests how such disasters can be averted — by activating the bank's board of directors. Here's a sample, from Krawcheck's preview at HBR Blogs:
Because of the time constraints they face, boards can only focus on a limited number of issues. Corporate governance has to be one of them, and, in banking, regulation falls not far behind. After that, bank boards tend to spend their time on the problem children, the businesses that aren't doing well. These days there's an enormous amount of time being spent on the mortgage businesses, and now at JPMorgan likely countless hours to come to understand what went wrong at the chief investment office.
Yet this focus on problem children ignores that it's the good kids of today who in banking so often turn into the bad kids of tomorrow. The businesses that typically trip up are the ones that appeared to be great businesses, with much better than middle-of-the-road returns. While it's a fight against human nature, bank boards should allocate some of the time they spend on today's problem children to digging in to understand how the businesses with the highest returns on equity are sustaining them in businesses with low barriers to entry.
In these discussions, boards should ask things like, Why are the returns so good? What are we doing that's different? Why are the returns on this better than our competitors'? Why do we think this is sustainable? Spending that time may feel like a luxury given all the have-to-dos that bank boards have. But if you step back in history, it's clear that having done this could have averted any number of debacles.
Bank of America, the country's second-largest bank (or first, depending on if you go by assets rather than market cap), is in a heap of trouble. Its CEO, Brian Moynihan, is presiding over a restructuring that's supposed to refocus the mega-bank on its core consumer business. This means massive layoffs — 30,000, according to various published reports. There's also been speculation that BofA will try to sell Merrill Lynch, the investment back it acquired after the financial crisis. But there's also speculation that Merrill would be absorbed into BofA and become something far less than the top-level i-bank it was back in the day. That's speculation for you! Heads one day, tails the next!
Countrywide is also a major factor. The subprime mortgage lender was picked up by BofA just before the financial crisis and its portfolio of bad loans is often pointed to as the biggest drag on BofA's performance. There's a nightmare scenario in which BofA puts Countrywide into bankruptcy and then witnesses federal regulators take control of the bankruptcy proceeding — and BofA.