Archaic bank attitudes to disclosure need rethink

Senior manager, PricewaterhouseCoopers Financial Services Division, on the importance of disclosure for banks.

In a world where innovation and distinctiveness are increasingly being valued and rewarded over and above conformity and customs, disclosure of information should form a key part of a bank’s strategy.

PwC's Peter LiEvery reporting season, bank executives face up to the task of reviewing their performance numbers, and considering how best to report these results to the public. Every year, the Hong Kong Monetary Authority looks at a list of items considered useful for bank assessment purposes and attempts to incorporate them into its ever-growing disclosure requirements.

Throughout all this, a common theme that consistently emerges is banks’ preference to disclose only the bare regulatory minimum. Anything else is regarded as either competitive information or detrimental to their cause. So whilst at a high level disclosure is seen as a way to help differentiate banks, in practice, the prevailing play in the market is to ensure that what they disclose is in line with everyone else.

Why is this important and why should it change?

The fact that information affects value is fairly well understood. In the US, bank executives have to perform the delicate balancing act of disclosing information that helps support the value of their bank and at the same time, making sure they are not giving away the secret to their success. Valuation is important because not only are the shares trading in a bigger market and more widely held but also because the option-based management pay packets depend so much on the value of these shares.

If these shares are undervalued then management is underpaid. Valuation, in the form credit assessments, also determines banks’ ability to obtain cheap funding which has a knock-on effect on profitability and share price performance. Disclosure and valuation are thus very closely related. As a consequence we find that the attitudes to disclosure are generally better developed and more sophisticated.

The situation with local banks in Hong Kong is different. These shares are typically closely held with a number of the small and medium-sized banks still very much controlled within the family network. Managerial performance is not as closely linked to share price movements when compared with their US counterparts and there is generally less of a need to tap the market for capital with relatively cheap funding available through deposits capped at a low interest rate.

For the investment community and others who are interested in distinguishing between these institutions, they would attempt to do so through comparative analysis of the reported figures, leveraging their contacts with management or by following up on snippets of information that they may come across from time to time.

The situation between Hong Kong and the US may appear to be vastly different and lends weight to the argument that disclosure is not as important in the Hong Kong context. The pressure to ensure accurate valuation is simply not as critical. However, all this really means is that in the Hong Kong environment, we are not talking about disclosure purely in the context of valuation. As the banking landscape becomes increasingly competitive and with technology facilitating the speedy dissemination of information, banks will come under greater scrutiny not just from investors and regulators but also their customers and counterparties who in turn are often influenced by investor sentiments.

Disclosure is one tool which can be used to manage this exposure and at the same time bolster a bank’s competitive strategy through enhancing its market profile. To put it more simply, disclosure is very much a strategic matter that helps banks to differentiate themselves. Thus, even though the purposes may be different, a robust disclosure strategy should still be a serious issue in the Hong Kong market.

It is in the banks’ own best interest to critically re-evaluate their current disclosure practices which are derived from the traditional model of providing what is mandated by the regulator. This outdated model does not fit well in today’s dynamic and competitive business environment and banks need to appreciate that, going forward, they simply cannot afford to continue along playing such a passive role.

What needs to be done?

Looking at the current disclosure practices in Hong Kong and benchmarking these against the types of information typically falling within the category of “value reporting”, we find that bank reporting measures well in terms of the traditional categories of financial position, financial performance and to a lesser extent, risk management. This should not be surprising, as they are part of the minimum regulatory requirements. However, there remains significant room for improvement with the non-financial aspects of disclosure that the market considers useful in the assessment of banks (see Table A). These are precisely the areas that banks could focus on should they choose to adopt a more formalized disclosure strategy.

PwC table

Although not all local banks are familiar with disclosure of the non-financial types of information described above, there are signs that this situation is already changing. For example, the push for improved corporate governance and the pressure on the board of directors to discharge its duties effectively will likely result in more being disclosed in this regard as evidence of an effective board function. Some banks (mainly listed ones) are already beginning to disclose this type of information in their annual reports and others are likely to follow once their corporate governance frameworks are better established.

Another piece of evidence is the ubiquitous influence of IT that currently figures prominently in most bank strategies. These days, the issues of product innovation and channel expansion are linked closely to IT. Banks have an incentive to seek an appropriate value to be placed on this investment and disclosure of such information could form part of this strategy. We are already seeing banks making frequent announcements of their online strategies and there is no particular reason why this should not form part of the reporting process.

Nevertheless, there are a number of other areas into which banks should look more closely for the purpose of developing their disclosure strategy. Information on customers and markets are important for not only analysts and investors but also for the bank’s own marketing purposes. Such data are often categorized as competitive information but most banks have done little to determine whether all such data is really that sensitive. The lack of focus on this area could also be one of the reasons why, in many cases, banks do not even have the systems to report this information for their own use, let alone for disclosure purposes.

It is also important to bear in mind that technology can play an important role in the delivery of this information. Overseas regulators are already considering directly accessing banks’ information systems for supervisory purposes. Technically, it would not be difficult for banks to provide some form of online 24/7 reporting to the market in the not too distant future.

The challenge for banks is to begin looking at these other areas and changing their outdated attitudes on disclosure. For sure, there are costs to be recognized, such as creating competitive disadvantages, already onerous reporting requirements and the need to continue reporting once it is instituted. However, these costs must be carefully weighed against the implications of not doing so and whether it is in the bank’s interest to be more proactive in this regard.

The decision of whether to disclose more and better information should be a conscious management choice. The evidence indicates that some bank executives may not fully appreciate the missed opportunities of failing to satisfy the market demand for information. In other cases, it is a matter of having appropriate internal systems to generate reliable information. Regardless of the barriers, the need to communicate effectively to the market is important if bank management wishes to achieve an edge in this increasingly competitive environment. Shown in this light, the issue of disclosure moves away from a regulator-led approach and becomes the strategic issue that each bank would need to decide on to compete effectively in this market.

Peter Li is senior manager, Financial Services Division of PricewaterhouseCoopers.
Email: [email protected]

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