Creating shared value - community banking in the 21st century
As central bankers rake over the coals of the world's biggest financial crisis in 80 years, Bendigo and Adelaide Bank Managing Director Mike Hirst discusses lessons to be learned about how banks interact with their communities. An edited version of this article appeared in the Fairfax press on Saturday 9 July 2011.
Google "GFC explained" and you will quickly see why global markets remain in disarray almost four years after the onset of the biggest worldwide slump since the Great Depression - Loss of confidence in the financial paradigm that created the disaster.
One cartoon version of the story winds up with a trustee of a Norweigan pension fund roundly abusing and being abused in turn by a New York banker whose triple-A rated mortgage bonds turned out to be the worthless paper that torched his members' life savings. It gets blue, so make sure the kids have gone to bed, but it reveals the root cause of our woes - a total disconnect between investors and borrowers. Norweigan krone paying top US dollar for non-recourse mortgages sold to people who had no hope of paying them once the cheap money hurdy gurdy stopped.
Banking was not meant to be like this.
And it actually hasn't been for long.
'Sub-prime mortgages', 'Collateralised debt obligations' (CDOs) and 'credit default swaps' (CDSs) are all new. The first CDO was issued in 1987, just ahead of the first CDS. Sub-prime loans - the literal definition being a loan to someone who might have trouble meeting payments - didn't gain traction until the mid-1990s. The very thought of lending to a bad credit risk is anathema to what every banker is taught, yet it was a vast sea of US sub-prime debt and all the financial instruments hitched to its wagon that landed us in this mess.
So what to do about it?
The response that must be avoided is to simply recapitalise the banking system, bolster reserves a bit just in case, wait for confidence to reassert itself and then carry on with our CDOs and CDSs - and presumably new Norweigan trustees - as though nothing happened.
To this end, there is much diligent and thoughtful work from central bankers worldwide to reconstruct a global banking system that can again provide strong capital flows at reasonable risk premiums. But the point worth making is that this reconstruction work is seemingly starting from the premise that the global markets are and will remain both ubiquitous and omniscient. That there is now no other way possible.
To quote an old cliche: Those who fail to learn from history are doomed to repeat it. Yet while we certainly don't want to repeat the GFC, there is one aspect of financial history that might well be worth repeating. It was the genesis of banking itself: the notion that everyone should benefit from a financial transaction - the investor who provides the funds, the borrower, the bank's shareholders who bear the risk of the borrower not paying, and society itself.
It used to be thus. Banks were formed to feed into prosperity this way - to accept cash from people who had excess to lend to people who lacked cash but could add value to it once obtained. The bank charged the borrower a bit more than it paid the investor and returned the risk margin to its shareholders in the form of dividends. Win, win, win. And add to that a fourth win, because the value added along the way was invariably beneficial to society – people gained employment, houses were built, businesses started and public infrastructure funded.
This worked particularly well in early banking for one other reason - banks were formed in villages where investors, borrowers and bank shareholders lived cheek-by-jowl and therefore shared a common interest in seeing their community prosper. Over time, banking has become more technical - some might say impenetrably so - and global-linking technology enables financial transactions to be remote from and unsupervised by both investor and borrower. Overlay on that the centralisation and growth of government, and people have never been more detached from and powerless to influence the financial forces that dictate their lives.
But from the ashes of the GFC is stirring a phoenix of recognition that there are alternatives to a resumption of big government and global market domination. No lesser authorities than Harvard economic luminaries Michael E. Porter and Mark R. Kramer envisage a new business world order they have dubbed 'shared value'. It "involves creating economic value in a way that also creates value for society by addressing its needs and challenges". Capitalism, they argue, is under siege, with companies widely perceived to be prospering at the expense of the broader community". Short-term profit objectives blind firms to the need to nurture the long-term health of the markets from which they draw their revenues. The authors conclude: "Businesses must reconnect company success with social progress. Shared value is not social responsibility, philanthropy, or even sustainability, but a new way to achieve economic success. It is not on the margin of what companies do but at the centre. We believe that it can give rise to the next major transformation of business thinking."
Meanwhile, in the UK, David Cameron's government is pursuing his 'big society' in which – hooray! - some power is devolved to local communities to determine their own future. Germaine to this article is Cameron's idea for a Big Society Bank funded by government and, one suspects grudgingly, banks that is charged with providing funds for local social enterprise projects. Although this week saw the announced delay of this new bank - ironically because of delays caused by European regulators - Cameron seems determined to push on with his agenda for less government, more community and more community determination over the expenditure of funds sourced from banking.
If shared value and banking for and by community sound familiar, it's because the bank I head started just such a venture 13 years ago. It's called Community Bank and it was founded on the belief that successful customers and successful communities create a successful bank - in that order. That last phrase is the key, because it returns us to the philosophy on which banking itself was founded - that the bank feeds into prosperity, not off it. Simply put, you can't run a successful company in a poor community, so it makes sense to invest in helping to create a wealthier, more cohesive and inclusive community.
Community Bank works as a shared value model precisely in the way in which Messrs Porter and Kramer envisage: it creates economic value at the same time it helps communities address their needs and challenges.
In a nutshell, it enables local people to become shareholders in a community company formed to run a Bendigo Bank branch. The community aggregates the banking business of its members; pays the costs of running its branch and receives half the income that business generates (from inception this amounts to over $764m); Bendigo collects the other half for providing banking support and infrastructure. Local profits are split, with shareholders entitled to no more than 20 per cent and the rest being ploughed into community development.
Today there are 275 of these Community Bank branches operating across Australia. In 13 short years, they have returned $56 million in community grants and paid $18 million in shareholder dividends. They have created 1400 jobs and each year now spend around $40 million in wages and services locally, which has a significant positive impact on these micro economies when you consider the multiplier effect of local spend. Their profits have been responsible for building community centres and health services; they have bought fire trucks and community buses; funded nursing and student scholarships. Hundreds of sporting teams wear guernseys and uniforms bearing the name of the Community Bank that purchased them. And increasingly governments are lining up to co-fund projects with Community Banks because they know they'll get a bigger bang for their buck because of that sense of community ownership. (David Cameron's critics take note.)
The return on equity of the leading Community Bank companies stand out in any Australian company cohort (including my bank) - 41 per cent, and without any of the consumer backlash that would normally entail. Those community companies are opening new branches, servicing new communities, creating jobs, paying great dividends and funding an ever-expanding portfolio of local projects. Viewed through that prism, Community Banking looks rosy. It looks easy although I can assure you it is not.
But as English novelist Arnold Bennett observed, change is always accompanied by drawbacks and discomforts, and Community Bank is no different.
Turn the spotlight on to under-performing companies (many of which are in their formative years) and a different picture emerges - in debt, little or no dividends, relatively modest community funding and seemingly little prospect of immediate improvement in their circumstances (although the experience of early underperforming sites suggests they will turn around given perseverance). In some cases, shareholders wanting to sell their shares are finding it difficult so Bendigo is working to improve liquidity for them.
Critics of our model have invariably focused on those struggling companies while ignoring the successful ones. The truth, of course, is that both comparisons are distortions. Community Bank is not a wonder, nor a blunder. It is for the most part a successful new shared-value business model providing solid returns for all parties plus the bonus of great social outcomes.
From Bendigo and Adelaide Bank's viewpoint, it has enabled an expansion of our branch network on a reverse inquiry basis ensuring that there is a base of business demand that might otherwise have taken longer to emerge. That in itself has enabled us to become a meaningful alternative to the big four banks. Community Bank has enabled us to expand into all States and Territories. It has differentiated our retail bank from any other, enabling us to grow an identity without the crushing advertising costs that generally preclude small players from competing effectively with the oligopoly. And Community Banking is now starting to deliver Bendigo some reasonable returns, although it has been a long haul to get to that point.
So how might communities evaluate Community Banking 13 years on? I am always happier to let our partners speak for themselves, but some of their observations might be:
- In 90 cases, it is the only bank they have. Say no more.
- Two-thirds of companies are making sustainable profits and communities therefore have an income source they never had.
- Approximately three quarters are either in profit or close to it whilst the majority of the remaining sites are in the capital drawdown period that characterises a start up business. (A complete financial analysis of Community Bank performance is available on the ASX website under BEN company announcements).
- Their communities have new skills; their leaders can now run public companies and are adept at tapping into local resources.
- With those new competencies has come new collaboration; mostly these communities are more united and there are alliances being formed between community groups, not-for-profits and local government that are beginning to create some stunning social outcomes. See some of them at www.bendigobank.com.au/stories
- Communities have renewed confidence and a new sense of purpose.
- Momentum is building as older sites mature. In 2009, for instance, communities were able to invest $9.4 million into local projects; last year that grew to $16 million and this year will comfortably exceed that again. And this, don't forget, during a global economic meltdown compounding the effects of Australia's worst drought - and almost-worst floods!
The final observation I should add is to reiterate that government now looks very favourably on communities that have shown the drive and wherewithal to take on Community Banking. We have only just started to see how communities can leverage their newfound cashflows to greater effect. Henty in southern NSW, for example, turned $150,000 into a $1.5 million community centre through a judicious combination of capital, debt and matched government funding. In the not-too-distant future, PPP (public private partnership) might well be rivalled by a new acronym - PCP (public community partnership) - as governments and communities increasingly combine their resources to fund local infrastructure.
No one is suggesting Community Bank is a panacea or the new way of doing business. But as business leaders the world over contemplate the latest tablet to come down from Harvard, and David Cameron embarks on his bold new venture, it is perhaps worthwhile them having a peek into a corner of Australia where an army of willing and capable community volunteers and one small bank are together creating new value from old values.