CHAPTER 21

An emerging markets bank

IN NOVEMBER 2001 the Goldman Sachs economist Jim O’Neill produced a paper called, intriguingly, ‘Building Better Global Economic BRICs’. The BRICs were Brazil, Russia, India and China and his argument was that these were four major emerging-market economies particularly well placed to maximise the advantages of globalisation: a historic acronym was thus coined, though for the time being it attracted relatively little attention.¹ Of course, HSBC itself had always in a sense been an emerging-markets bank, given its deep roots in Southeast Asia, and during this decade it would have an increasingly intimate and fruitful relationship across much of the world with those growth markets of the new century.

Spreading the footprint in Latin America

In 2001 the most surprising of the BRICs was Brazil, until very recently crisis-ridden but at last seeking to implement a stabilisation plan.² Even so, when Goldman Sachs made an overall assessment of HSBC in August 2002, it was Brazil that was identified as ‘the key operating risk’ – which, in a worst-case scenario involving significant currency, fiscal, government debt and NPL (non-performing loans) pressures, could lead to charge-offs of some $1.4 billion, in turn raising larger concerns about HSBC as a bank ‘with too many moving parts subject to risks’.³ The stakes were therefore high when the left-wing Workers’ Party, headed by Luiz Inácio ‘Lula’ da Silva, took power at the start of 2003. But in practice the new administration turned out to be ‘a model of fiscal austerity’, as The Banker noted gratefully that autumn,⁴ while at the same time the new governor of the central bank, Henrique Meirelles, proved the epitome of steadiness and, as a former commercial banker, was especially welcome to HSBC.⁵ During 2003 the business itself increased its pre-tax profits by over 200 per cent, up to $241 million,⁶ a positive trend complemented in November by the acquisition for $815 million of all Lloyds TSB’s Brazil-related assets, including Losango, its market-leading consumer-finance franchise.⁷ Given that two months earlier Euromoney had speculated, in the context of continuing bank consolidation, that HSBC Bank Brasil looked ‘ripe for the taking’, it was an important acquisition symbolically as well as substantively.⁸ Or, as a post-acquisition internal report succinctly put it: ‘Enhanced credibility and profile for the Group in Brazil – any lingering exit rumours were scotched and we are now viewed as a serious competitor by our peers.’⁹

The other main legacy of the sudden burst into Latin America in 1997 was of course Argentina – the country that in 2001 had its worst economic collapse in more than a century. ‘Unless the situation gets truly dire,’ forecast Goldman Sachs in June 2002, ‘we believe HSBC’s strong preference is to continue operating in Argentina, see the country through in restoring and restructuring its banking sector, and gain new customers and market share in the process.’ The analyst added that though it was tempting to walk away from Argentina, such a move might have ‘massive implications for the bank’s image and reputation across emerging markets’.¹⁰ HSBC Argentina indeed stuck it out, though in December 2002 the Annual Operating Plan for 2003 gloomily anticipated ‘another year of crisis management’, against a background of not only continuing ‘political and economic uncertainty’ and ‘political pressure on financial institutions, particularly foreign-owned’, but also the inevitable fact that ‘social unrest and disorder will continue to be a normal feature of life’.¹¹ The election of Néstor Kirchner as President in April 2003 was a moderately promising sign, but a few weeks later John Bond was at pains to emphasise in person to Alfonso Prat-Gay, president of the Central Bank of Argentina, that ‘the losses taken in respect of Argentina were far and away the largest single losses ever taken by HSBC in its entire history’; and he and Keith Whitson added that ‘we were not quitters – to the contrary, but there had to be a limit somewhere’.¹² Thereafter, things did not get easier overnight – ‘trading conditions remained difficult’, the Group Executive Committee was told in October,¹³ and non-performing loans were running at almost 30 per cent¹⁴ – but by the first half of 2004, partly on the back of record PFS (Personal Financial Services) sales, an operating profit was at last being made.¹⁵

Elsewhere in Latin America, there was by this time a new story for HSBC to tell. ‘Ultimately, an organic strategy in Mexico will be unsatisfying,’ asserted a strategic review in July 2000, two months after HSBC had been outbid by Santander for Banca Serfin. The same review noted that Mexico’s banking landscape was ‘concentrated and increasingly foreign-dominated’,¹⁶ which in practice meant a sense of urgency about achieving a significant acquisition – an urgency heightened when Citibank in 2001 paid over $12 billion to acquire Mexico’s second-largest bank, Banamex.¹⁷ By summer 2002 a serious contender was in the frame: Grupo Financiero Bital, a financial services group centred on Banco Bital and controlled by a family trust. Santander was keen, but the Acquisitions and Disposals Committee of the Holdings board was told in June that owners, management, regulators and government all in principle preferred HSBC. Inevitably the strategic rationale focused on both country and bank: Mexico was a major oil-producing nation, had a 100-million population – largely unbanked − with ‘a strong work ethic’, and had been ‘the first developing country to embark [following its severe mid-1990s crisis] on significant economic reform programmes, through privatisation, trade liberalisation, trade pacts including NAFTA, and development of its domestic capital markets’. Building a presence in Mexico would also hedge against the possibility that China’s competitiveness as a key part of the supply chain to the USA would at some point be eroded because of a narrowing of labour-cost differentials, rising transportation costs or trade disputes. As for Bital itself, it was a full-service bank operating through an extensive branch network, had a customer base of over 5.7 million accounts, produced through non-funds income (e.g. fees on payments and wealth management products) ‘an impressive 48 per cent of total income’ and, amongst top Mexican banks, was ranked third by image and brand awareness.¹⁸ ‘High Noon’ was the name given to the putative acquisition, and the Committee duly gave its go-ahead to a non-binding offer.¹⁹

Bond was determined to land the Mexican fish this time. ‘Our credibility with our board and our international credibility as a winner will be on the line’, he told senior colleagues a few days later, ‘if we are out-bid by Santander in a competitive situation.’²⁰ In mid-July, Sandy Flockhart (head of HSBC’s operations in Mexico from 1999) had an encouraging conversation with Guillermo Ortiz, governor of Mexico’s central bank, who told him, ‘Don’t miss this one for the sake of a few pennies’.²¹ At the same time, due diligence on Bital was reasonably positive (including the assertion that ‘we were quite impressed with the quality of the underlying business’),²² but not positive enough for Whitson. ‘Shortfalls of $700 mln [requiring recapitalisation], poor controls, 5–6 years of economic loss has put a different perspective on the proposal,’ he observed to Bond. ‘If one adds to this the prospect of further Latin American woes and the general world economic climate, I think we could be well advised to stand aside.’²³ The decision, however, was taken to go ahead; and on 21 August, after some to-ing and fro-ing over price, it was announced that a $1.14 billion cash bid had been accepted, working out at less than $1million per branch. The analyst Alastair Ryan of UBS Warburg pointed to the high earnings multiple at twenty-seven times Bital’s 2001 earnings, but overall reckoned that ‘the deal looks like a good fit with HSBC’s other operations in the Americas’.²⁴

HSBC finally took control of Mexico’s fifth-largest retail bank at the end of November 2002, with Flockhart deputed to run the business, having already received his ‘modus operandi’ instructions. Respecting Mexican culture but adhering to HSBC’s world-wide values, establishing good relations with the financial authorities, drawing on the Group’s experience and resources, building a broad team of supportive executives, not rushing rebranding, being as visible as possible – these were among the suggestions made by Bond, who also observed that ‘a few “early-wins” for employees [some 17,000 of them] would be highly desirable to show how life with HSBC will be better’.²⁵ Flockhart spent much of his time in the early months going round the country and doing ‘town halls’ with local staff, discovering in the process that although Bital was indeed a recognised brand name, the strong message coming through was that they wanted to be part of HSBC.²⁶ Accordingly, rebranding had an internal as well as marketing purpose, and as dawn broke over 1,400 branches, 4,500 ATMs and various corporate buildings on 29 January 2004, Bital at a single visible stroke became HSBC Mexico.

Cover story, January 2003.

Prosperous foothills

Emerging markets came of age during the mid-2000s. ‘Dreaming With BRICs: The Path to 2050’ was the title of a high-impact paper in October 2003 by two of Jim O’Neill’s Goldman Sachs colleagues, Dominic Wilson and Roopa Purushothaman, who predicted that by 2025 the four BRIC economies together would account for over half the size of the G6 (whereas currently they were worth less than 15 per cent) and that within forty years they would be larger.²⁷ The emerging markets juggernaut was under way. In 2005, O’Neill and his team then devised the concept, again quickly embraced, of the ‘Next Eleven’, or N-11 (Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey and Vietnam), also with fast-growth potential;²⁸ and in January 2006 The Economist estimated that during 2005 ‘the combined output of emerging (or developing) economies rose above half of the global total’, while over the past three years as a whole the thirty-two emerging economies that it tracked weekly had grown at an average of over 6 per cent, compared with 2.4 per cent in developed countries.²⁹

Was HSBC behind or ahead of the curve? Arguably ahead, given that Bond as early as December 2002 sent Whitson a paper from Goldman Sachs that ‘sets out a similar view to HSBC’s on demographics and the likely strong growth of consumer spending in emerging markets such as China, India and Brazil’. And he added: ‘HSBC probably has the best strategic positioning of any financial services group in the world to meet this scenario and we should weave this into our investor presentations in 2003 and beyond’.³⁰ It was from 2005, though, that the bank really began to bang the drum loudly and consistently. ‘In emerging markets, demand and deregulation will bring new opportunities for growth,’ Bond told the Holdings AGM in May 2005. ‘We are generating sufficient cash from our established businesses to respond to them.’³¹ Soon afterwards, a presentation to HSBC by the analyst Robert Law of Lehmans made the point that these markets within the Group were still ‘relatively small’,³² and that autumn Stephen Green deliberately upped the ante: first by telling senior colleagues at a Chicago offsite meeting that ‘we have a good emerging markets story but it’s only 20 per cent of the total by assets and profits’,³³ and then by explaining to the Wall Street Journal how the bank planned to use its consumer-finance business to gain a competitive edge in these markets.³⁴ ‘Investors perceive that capital deployment will be weighted towards emerging markets,’ noted an investor feedback summary in early 2006,³⁵ while some six months later Mike Geoghegan made the striking assertion, at the unveiling of half-year results that showed a 23 per cent growth in pre-tax profits from emerging markets, that ‘we are at the foothills of what we can do in emerging markets’.³⁶ Perhaps, but even in the foothills the achievement had been considerable, as for three successive years (2004–6) HSBC’s operations within emerging market countries ran at high double-digit growth.³⁷

Growth certainly characterised operations in Latin America, whose contribution to the Group’s pre-tax profits rose to almost 8 per cent by 2006.³⁸ Argentina’s annual profits remained below $250 million, but Brazil by 2006 was up to $526 million,³⁹ helped by increasingly productive involvement in financing and generally facilitating trade between Brazil and the outside world, especially mineral-hungry China.⁴⁰ Even so, there was a problem of scale. HSBC Bank Brasil, reflected Youssef Nasr (in charge of South America as a whole) in October 2004, ‘is larger than the niche banks in Brazil such as Citi but is not as big as the mass market banks’.⁴¹ That was not the problem in Mexico, where pre-tax profits were two to three times bigger than in Brazil and reached over $1 billion in 2006,⁴² making it the fourth-largest contributor to Group earnings. The backdrop was a strongly performing economy, underpinned partly by oil-related revenues and partly by remittances from the USA, where at least 15 million Mexican nationals lived.⁴³ Meanwhile, in HSBC Mexico’s annual operating plan for 2006, cogent reasons had already been put forward for further expansion into Central America. The region was ‘an attractive collection of markets with a decade of stability, favourable demographics, and trade and growth potential’, especially with the ‘imminent implementation’ of the Central America Free Trade Agreement (CAFTA); apart from Mexico, the only significant HSBC operation was in Panama and, accordingly, an acquisition was necessary in order to create ‘a platform, to which we can add scale’.⁴⁴ The target eventually became the Panama-based Grupo Banistmo, which brought to the table Panama’s largest bank (Primer Banco del Istmo) as well as, through other subsidiaries, substantial presences in Costa Rica, El Salvador and Honduras. Although noting that $1.8 billion was a ‘very full’ price, Flint in February 2006 gave a broadly favourable verdict, endorsing Flockhart’s view that ‘this is probably the only sizeable opportunity with a regional presence’. Even so, he did wonder how it was going to be possible to ‘turn what looks like a collection of domestic banks into a regional franchise’.⁴⁵ The acquisition was announced during the summer⁴⁶ – with Green soon afterwards at a press conference in Hong Kong for the Group’s interim results lowering expectations by calling it ‘a reasonable deal’⁴⁷ – and finally completed in November with additional capital of $125 million having immediately to be injected.⁴⁸

The Asian dimension

Complementing Latin America, the other main focus of emerging-market growth was undoubtedly Asia-Pacific, as memories of the financial crisis of the late 1990s and its overhang now faded rapidly. There, under the effective leadership of Mike Smith as CEO for the region, pre-tax profits (excluding Hong Kong) rose from $1.36 billion in 2004 to $2.49 billion by 2006, though some $600 million of that rise was attributable to the BoCom and Ping An stakes in mainland China.⁴⁹ Otherwise the three major contributors were India, Singapore and Malaysia, while, as Smith recalled, praising his country heads around the region, ‘it was just doing more with what we’d got’.⁵⁰ Nevertheless, at a strategy review meeting in early 2006 about personal financial services, Bond ‘noted that Standard Chartered generated greater profits in the rest of Asia [i.e. outside Hong Kong] than we do’ and ‘pointed out that HSBC has been too Hong Kong centric with less focus on the other countries, and that this needed to change’. Yet as he also observed, ‘this does present us with a big catch-up opportunity’;⁵¹ and given that Asia’s GDP growth was now the fastest in the world, with every likelihood of staying so, and given also that Asia’s predominantly youthful population was less averse to borrowing than the older generation and showed a greater preference for foreign banks, this seemed a reasonable proposition.⁵²

Not that, as Bond well knew, it was ever altogether easy or straightforward being a foreign bank in most of these territories. Take India, where in 2003, following apparent relaxation by the financial authorities, the country head Niall Booker was pushing by the autumn to take as large a stake as possible in UTI Bank, the first of the new private banks to have begun operations nine years earlier. Initially planning to take a 20 per cent stake, HSBC frustratingly had to content itself with a 14.62 per cent stake in 2004, which was reduced to a 5 per cent stake two years later. As ever in this type of situation, there was no alternative to realism and the long game. ‘I doubt RBI [Reserve Bank of India] will let foreign banks bid for this asset in their present mood,’ Booker’s successor, Naina Kidwai, told Vincent Cheng in September 2006 with reference to the troubled United Western Bank. ‘This opinion is shared by Chartered and Citi, but we all believe we need to show our interest, as in time they will have to notice and do something about it.’ She added, ‘The mood is not pro foreign banks! However we will do what we can.’⁵³

Kidwai herself was something of a phenomenon. The first Indian woman to graduate from Harvard Business School, she had made her name as an investment banker before coming to HSBC in 2002.⁵⁴ ‘There is no question that Naina is one of, if not the best, network investment or corporate bankers in India,’ noted an admiring John Studzinski after a visit to Mumbai and Delhi two years later. ‘Whether you are at the airport or on the street, she knows everybody and is well liked and respected.’ Studzinski was also impressed more generally by what he saw: Booker ‘representing in my mind the best of the strong international HSBC management structure’; HSBC’s reputation ‘quickly evolving from a mainstream retail bank in India to a broad-based financial services/markets investment bank’; and although India ‘may not have the glamour and the glitz of China’, and its economy was ‘probably 10–12 years behind’, nevertheless ‘on a risk-adjustment basis, given its lack of NPLs and legal structure, this is clearly a market that we cannot ignore and in fact I believe we have perhaps under-invested over the last few years’.⁵⁵ A year later, in March 2005, HSBC announced that it indeed planned to invest $180 million in expanding its operations,⁵⁶ and that summer the decision was taken to move seriously into consumer finance, not least because consumer finance companies could open branches without RBI approval.⁵⁷ ‘This is a bold and challenging strategy which I believe will change the position of HSBC,’ asserted Nick Sibley, PFS head for Asia-Pacific.⁵⁸ Clearly the goalposts were changing since Booker back in 2003 had told The Banker that ‘size in itself is not the issue for us’ and had gone on: ‘It is size within the target customer base that is important. We do not need branches everywhere because a large part of the population is not bankable.’⁵⁹

Naina Kidwai.

Elsewhere in Asia-Pacific, South Korea remained an elusive prize. ‘Korea is an important market for the Group to have a major presence in – given its economic strength, OECD status and long-term growth potential,’ observed strategy’s K. B. Chandrasekar in September 2003 in the course of recommending a bid for Korea First Bank (KFB).⁶⁰ Although that particular bid failed to get off the ground, there would continue to be attempts to find a suitable acquisition. In April 2004 – just before Citibank paid $2.7 billion for KorAm Bank⁶¹ – HSBC’s country head, Rick Pudner, publicly admitted that ‘we have eight branches here and to grow organically would be a challenge’.⁶² With analysts increasingly unanimous that KFB and Korea Exchange Bank were the two remaining prime targets for foreign banks,⁶³ the next denouement arrived in the closing weeks of 2004 with a straight shoot-out between HSBC and Standard Chartered for KFB. ‘I am not convinced that StanChart have got this right,’ reflected Chandra somewhat defiantly on Christmas Eve after that rival had won the day by agreeing to pay a rather hefty $3.3 billion. ‘It is as important to stick to an M&A discipline and walk away from the wrong deal, as it is to do the right deal.’⁶⁴

Radhakrishna Salai branch in Chennai, India.

Which way to go in Korea now? From early 2005 the mantra was organic growth, with local incorporation seen as a key catalyst, especially as a means of removing all restrictions over the permitted number of branches.⁶⁵ Everything depended on whether the application to incorporate would be successful, and Pudner in early April warned Chandra that ‘there is definitely a feeling in government circles that HSBC is not really committed to Korea – we have tried so many times and “walked away” (their view)’.⁶⁶ The application was duly refused, with Pudner explaining that ‘the government case, in a nutshell, centres on concerns about the growing foreign bank influence [currently some 22 per cent] in the domestic market’.⁶⁷ ‘Of course, this is dismaying news,’ conceded Bond on being informed, ‘but we must step back and strengthen our resolve to build our business in Korea’ (of which he was a great admirer); he suggested ‘expanding our business within the existing framework using technology, partnerships with companies that have distribution, telephone sales and the Household model generally’.⁶⁸ Bond himself was in Seoul in early September, when he personally emphasised to the Financial Supervisory Service his bank’s deep commitment⁶⁹ – but to no avail, as that body continued to obstruct branch applications, while at the same time apparently favouring Standard Chartered. ⁷⁰

Meanwhile, there was just one other BRIC in the wall: Russia. In July 2002 a five-year plan for measured medium-term growth was cautiously endorsed. ‘The strategy must be CIBM business-led, not just vanilla lending by a junior RM [relationship manager],’ warned Whitson, with Bond adding that though ‘general approval of this plan was a major sea change from a previously very negative stance,’ nevertheless ‘the Group might not wish to grow as fast as the local team might wish’.⁷¹ By autumn 2003 that local team was pushing hard for a strategic move into retail via a possible acquisition of Russian Standard Bank,⁷² but nothing transpired. Thereafter, during the mid-2000s, as Russia’s oil-rich economy continued to flourish, the noises were positive but the action largely undramatic. ‘As the world’s local bank we cannot ignore Russia,’ insisted Studzinski in May 2004 after a trip to Moscow;⁷³ talking to The Times in October 2005, Bond referred to the recent signing of a project finance agreement with the Vnesheconombank and noted that Russia was ‘constantly on the agenda at HSBC’, though with ‘an organic strategy the more likely’.⁷⁴ Meanwhile, the following February, Green insisted to Geoghegan that ‘we need to get going in Russia in retail’, especially with ‘foreign competitors increasingly active’, before tellingly adding, ‘There are plenty of challenges: the bureaucracy is cumbersome and corrupt and this is not about to become a cuddly democracy. But most of this is a familiar lay from other emerging markets we know.’⁷⁵ Five months later, in July 2006, the Holdings board confirmed that growth would indeed have to be organic, given that Russia was ‘not a place for the Group to make a bold acquisition at present’; as for Eastern Europe more generally, it was noted at the same meeting that ‘countries such as Poland, Hungary and the Czech Republic have great potential for growth, but asset prices have risen to such an extent it is probably already too late to make an acquisition’.⁷⁶ Altogether, historically and culturally, this was not really HSBC’s natural part of the world.

But in Turkey, of course, HSBC had already made its play, acquiring Demirbank in 2001. There, once that year’s financial crisis had been overcome, the economy boomed during the rest of the decade, and the new operation prospered accordingly, with annual profits usually in excess of $250 million.⁷⁷ Customer numbers were boosted by the acquisition in 2002 of the Bencar business (1.3 million store cards) and by an expansion of the branch network.⁷⁸ ‘HSBC Turkey has been by far the fastest-growing bank in Turkey,’ its dynamic CEO, Piraye Antika, told HSBC World in October 2006. ‘We currently enjoy a unique competitive position among other/new foreign banks.’⁷⁹ But neither she nor her colleagues could easily forget the dreadful day of 20 November 2003 when a direct bomb attack on the head office in Istanbul killed three members of staff and injured forty-three, while thirteen other people in the vicinity also died. ‘The support we have received from the Group around the world has been incredible,’ said Antika afterwards, ‘and has sustained us through the difficult moments of the tragedy and helped us on the road to recovery.’⁸⁰

Leading in the Gulf, leading in Islamic finance

In 2006 it was not only Mexico – among emerging markets – that hit the $1 billion profit mark for the first time, but also the Middle East.⁸¹ Climbing oil prices, governments with large amounts to spend on capital projects, high levels of private investment, rising employment, rapid population growth – altogether the mid-2000s, despite the disruptive effect of the Iraq War and its messy aftermath, were (as the Holdings Annual Report for 2006 put it) ‘a strong expansionary phase that HSBC estimates will result in GDP in the Gulf region doubling in the space of just four years’.⁸² Profits further increased in 2007 and 2008, up to $1.75 billion (almost one-fifth of Group profits); but in July 2008 the record oil price peaked, before in 2009 the Middle East was affected much more than other emerging markets by the global recession, as HSBC’s profits there came down with a bump to $455 million.⁸³ Recovery in the region was delayed until the second half of 2010, but was then strong, including a marked improvement in the credit environment, and the Middle East contributed $892 million for the year.⁸⁴

‘The Group has a premier market position,’ asserted a presentation to the Group Management Board (GMB) in May 2005 on the region, pointing out that with 123 branches it was the largest international bank;⁸⁵ while two months later, Euromoney awarded HSBC the accolade of Best Regional Bank, observing that ‘while other international banks have sometimes shown a wavering commitment to the region or managed their operations from their western headquarters, HSBC has been solidly committed to the Middle East’. Expressions of that commitment included ‘a retail presence either directly or as a partner in almost every country’; helping to develop the Arab bond and equity markets; and extending its reach as the region’s best cash management house.⁸⁶ Commercial banking remained a core activity, as did global banking and markets,⁸⁷ while on the PFS front an interesting strategic shift was under way. ‘Investment in the region had initially been in the countries with small populations and high incomes to obtain fast payback,’ commented Youssef Nasr (recently appointed CEO for the region) to the GMB in January 2008. ‘Investment in the countries with the larger populations and lower incomes will be paced with the ability of the bank to service the higher volume of PFS business.’⁸⁸

The biggest profit contributor during much of the 2000s became the United Arab Emirates (UAE), the region’s most liberal economy and a financial services hub: in 2001 they contributed almost one-third of Middle East profits,⁸⁹ rising by 2008, particularly on the back of Dubai’s spectacularly booming economy, to nearly half.⁹⁰ But 2009 was a very different story. ‘The UAE was significantly affected by declines in construction and global trade, losses incurred by regional investors, and tight liquidity and lower real-estate prices, which together resulted in higher loan impairment charges as the crisis affected both personal and corporate customers,’ was how the Holdings Annual Report explained a $3 million loss.⁹¹ It was a situation hardly helped by the dramatic, headline-making troubles late that year of investment company Dubai World, accurately described by one press report as ‘the state-owned builder of many of Dubai’s most extravagant projects’ that was suddenly ‘struggling to repay its debts’.⁹² Stuart Gulliver was able to reassure the Holdings board that ‘the exposure to the government of Dubai has been reduced significantly since 2007’,⁹³ but HSBC was still a member of the creditors’ coordinating committee (comprising five foreign banks) with which Dubai World sought to renegotiate some $25 billion of loans.⁹⁴ HSBC was in effect the lead member, and by spring 2010 a debt-restructuring plan had been agreed, with Gulliver publicly affirming HSBC to be ‘comfortable’ about it.⁹⁵

In addition to UAE, the continuing ‘primary markets’ identified at the 2011 Investor Day were Saudi Arabia, Egypt and Qatar.⁹⁶ The principal HSBC stake in Saudi Arabia (easily the region’s biggest economy) remained through its 40 per cent stake in the Saudi British Bank (SABB), which had over seventy branches and was generally a solid profit earner.⁹⁷ The most interesting development ensued as a result of the capital market law of 2003, in effect opening up the Saudi capital markets⁹⁸ and prompting HSBC to negotiate with SABB an investment banking joint venture. This became HSBC Saudi Arabia (76 per cent owned by HSBC)⁹⁹ and was operational by the end of 2005,¹⁰⁰ soon dominating the Kingdom’s debt market.¹⁰¹ In Egypt, the operations were through HSBC Bank Egypt, as the Hongkong Egyptian Bank was renamed in 2001 at the same time that the Group increased its stake from 40 per cent to 94.5 per cent,¹⁰² a move that presaged some serious growth, especially in global banking and markets,¹⁰³ so that by the end of the decade annual profits were running at well over $200 million.¹⁰⁴ The new kid on the block, so to speak, was Qatar, picked out (along with the UAE) by the Managing for Growth strategy in 2003.¹⁰⁵ Operations there in fact dated back to BBME (British Bank of the Middle East) days of 1954, and HSBC was the largest foreign bank with a handful of branches; but the real step-change – now that the oil-rich city-state had become an increasingly powerful economy – was the many opportunities for project finance.¹⁰⁶ By 2010 Qatar was the Middle East’s fastest-growing economy and HSBC was still the largest foreign bank; but in July that year, responding to a presentation to the GMB on the glittering prospects, Geoghegan took the opportunity to emphasise that ‘the lessons from the previous growth and diversification phase in Dubai must be applied to Qatar’.¹⁰⁷

A branch of the Saudi British Bank, 2006.

Even by the standards of emerging markets, being a foreign banker in the Middle East required an exceptionally sure touch from those on the ground – a touch that two successive CEOs for the region, Andrew Dixon (1998–2003) and David Hodgkinson (2003–6), both from the classic International Officer mould, had done much to foster. Inevitably, there were no-go areas, of which one was Syria, and in July 2003 Hodgkinson sent Bond a briefing note to explain why. ‘The regime still relies heavily on well-developed security services to ensure its grip on power,’ he pointed out, among other reasons, ‘and, whilst the country is making positive steps towards liberalisation, we cannot take for granted that this process will run smoothly.’¹⁰⁸ Yet in one of the most difficult countries, Iraq, a modest but potentially significant step of expansion was taken. This was the purchase in October 2005 of a 70 per cent stake in a privately owned local bank. ‘Details on Dar es Salaam [Investment Bank] are scant,’ reported The Economist rather sniffily, ‘but by international standards it is tiny, with fourteen branches and assets in the tens of millions of dollars.’¹⁰⁹

These were also the years of rapid growth in Islamic finance – growth far from confined to the Middle East, especially given that the vast majority of the world’s Muslims were living in Southeast Asia. Recognition of HSBC’s pioneering role came with the Euromoney awards for 2003, appraising HSBC as Best International Provider of Islamic Financial Services and Best International Sukuk House, two awards that effectively covered all main customer groups and prompted Iqbal Khan, HSBC Amanah’s CEO, to observe that HSBC now had ‘a seat at the top table of the world’s Islamic finance industry’.¹¹⁰ HSBC Amanah was launched as a brand in the Middle East (primarily UAE and Saudi Arabia) in June 2004, providing a full portfolio of services, before being rolled out over the next few months in such markets as Malaysia, the UK, Indonesia and Bangladesh.¹¹¹ ‘HSBC is well positioned to lead the Islamic financial services industry but competition is growing,’ noted the Holdings board the following spring after a presentation by Khan. ‘The Group’s approach will be adjusted to suit each market, but HSBC Amanah will present a unified face to Muslim customers to build brand equity.’¹¹²

In early 2006 Bond acclaimed Amanah as ‘a spectacular success’ for the Group;¹¹³ its profit for that year rose to some $410 million (including a particularly strong PFS performance in Saudi Arabia);¹¹⁴ and in early 2007 Euromoney stated bluntly of HSBC Amanah that in the ‘fast-growing’ industry of Islamic finance ‘no other institution can match its breadth and depth across products and geography’.¹¹⁵ One notable failure, however, was in the generally difficult US Muslim market: back in 2001, HSBC had very publicly launched a Shariah-compliant mortgage, but five years later poor demand led to the product being pulled.¹¹⁶ By the late 2000s, of course, the West’s financial travails were leading to heightened interest in the principles of Islamic finance,¹¹⁷ but HSBC Amanah remained ahead of the game and was still rated by Euromoney as Best International Islamic Bank for 2010. Its competitive advantages included ninety-five Amanah-dedicated branches globally; 90 per cent of the branches of Saudi Arabia converted to Amanah branches; expanding retail product ranges in Bangladesh, Bahrain and Qatar; a 10 per cent global share of Islamic fund management; and in Islamic capital markets, ‘a bigger, broader sukuk business than any other international bank’.¹¹⁸ Malaysia was central to its success, and in April 2011 a paper for HSBC’s executive committee for Asia-Pacific noted the 300,000 PFS customers there since the opening of four Amanah branches, while also identifying Indonesia and Brunei as countries of high potential for Islamic finance. Yet nothing stood still, and the paper added that ‘Standard Chartered Saadiq is emerging as a formidable, fast-moving competitor and HSBC Amanah will need to stay a step ahead to retain market share’.¹¹⁹

Advertisement, 2004.

Regaining the premium

‘Emerging countries are not the havens some people thought,’ ruefully declared The Economist in September 2008 as the failure of Lehman Brothers triggered a huge sell-off.¹²⁰ And by January 2009, ‘Nobody talks about “decoupling” any more. Instead, emerging economies are sinking alongside developed ones.’¹²¹ But during the rest of the year, as the developed world remained seriously poorly, there was an astonishing turn round: far from suffering disproportionately because of their trade and financial links with the West, the emerging markets in 2009 bounced back strongly – so much so that October saw record inflows into emerging-market bond funds. Globally speaking it was a historic moment, with O’Neill’s team at Goldman Sachs calculating that in the last three years of the decade the four biggest emerging markets (the BRICs) had accounted for 45 per cent of global growth, almost double that of 2000–06. Put another way, the emerging markets could now claim to be, in The Economist’s words in January 2010, ‘the real engine for the global economy’, with ‘economic power leaching away from the West’.¹²²

Fortunately for HSBC, it had already in early 2007 significantly strengthened its commitment to emerging markets. The Annual Operating Plan, explained Geoghegan to the Holdings board, envisaged growth being ‘focused towards Asia and Latin America’; while in the ensuing strategy discussion, the emphasis was on the need ‘to respond to the perception that the Group has diluted [i.e. via Household] its emerging markets heritage’, and that accordingly to regain its ‘premium’ in those markets it would be necessary over the next five years to shift the proportion of the Group’s business there from 40 to 50 per cent.¹²³ The strategy’s durability was tested during the severe emerging-markets troubles (especially in Asia) of autumn 2008, but HSBC held firm. ‘We think the Asian economies are much stronger than they were in 1997–8 during the Asian crisis,’ Gulliver insisted to Reuters in November;¹²⁴ two months later the Holdings board reaffirmed its strategic belief in ‘emerging markets growing faster than developed countries’;¹²⁵ October 2009 saw the launch of HSBC’s quarterly Emerging Markets Index;¹²⁶ and by March 2010, Geoghegan was looking to the time in the near future when some 60 per cent of Group profits would be coming from them.¹²⁷ ‘There are still gaps in HSBC’s emerging markets strategy,’ observed Euromoney not long afterwards, pointing to Russia and sub-Saharan Africa, but overall, it correctly insisted, ‘HSBC is one of the few institutions that can call itself a truly global emerging markets bank’.¹²⁸

The magazine might also have pointed to Korea, where again it had been a case of once more with feeling. The latest chapter of the saga began in April 2007 when the GMB was alerted to the potential availability of a substantial stake in Korea Exchange Bank (KEB)¹²⁹ – an attractive prospect, given that regulatory approval for local incorporation had remained unforthcoming and it had thus proved impossible to build up critical mass organically.¹³⁰ The stake in KEB was particularly enticing as it was already in the hands of a foreign owner (funds managed by the US private equity firm Lone Star), making it more likely that its sale to another foreign owner would be passed by the regulators. By September HSBC had agreed to buy a 51 per cent stake for $6.3 billion,¹³¹ and due diligence was completed successfully in October.¹³² No one expected a speedy completion, and by March 2008 six months of sliding markets had strikingly impacted on the real value of the offer price: originally at a 24 per cent premium to the traded price, but now at a 38 per cent premium. Yet as Flockhart (CEO for Asia-Pacific from July 2007) observed to the GMB, ‘any attempt to renegotiate the terms of the transaction will increase the risk of losing exclusivity for the acquisition, which may be the last significant opportunity to enter the Korean market’.¹³³ By late July the premium was still at some 38 per cent, unrealistically high; and although Flockhart reiterated to the GMB that KEB was ‘the only acquisition capable of moving the dial and lessening the Group’s earnings concentration on Hong Kong’,¹³⁴ the decision was eventually taken to try to renegotiate with Lone Star. This was despite Holdings board worries that if this failed, ‘there might be a severe reaction of the Korea government and its regulator if HSBC were the terminating party, with implications for HSBC’s existing and future business in Korea’.¹³⁵ In the event, the renegotiations did fail, and HSBC announced on 18 September that it was letting KEB go.¹³⁶ ‘We are undoubtedly being blamed,’ Flockhart informed Green the next day after a meeting at the Financial Supervisory Commission.¹³⁷ And he sent a separate, metaphor-rich email to Geoghegan: ‘A lot of fences will need to be rebuilt going forward. We should let the dust settle … Sticking to our knitting and business as usual will serve us best.’¹³⁸

Meanwhile, of the two major gaps that Euromoney had identified, there was still no attempt to make a major acquisition in Russia, but a definite stab in sub-Saharan Africa, which in practice was always going to mean South Africa before anywhere else. ‘The country,’ Green told Geoghegan from there in June 2007, ‘has considerable momentum now – growth is higher and business confidence has increased noticeably since I was last here three years ago.’¹³⁹ The main target soon emerged as Nedbank, the country’s fourth-largest bank, and later that year an approach was made that in the event came to nothing;¹⁴⁰ but in 2010 things got much more serious. ‘There is a need to move quickly as it is likely that only one further large South African bank will be permitted to be acquired by a foreign group,’ Flockhart in March after a visit there told the GMB, which then discussed ‘the challenges in a continent where HSBC has limited presence and experience’.¹⁴¹ A month later the GMB agreed in principle to make a non-binding offer for Nedbank,¹⁴² with Geoghegan subsequently observing to the Holdings board that ‘China and India, which are central to HSBC’s emerging markets strategy, are at the forefront of investment in the South African region’.¹⁴³ The offer for the controlling stake, valued at around $4.5 billion, went public in August,¹⁴⁴ prompting a witty headline in The Economist (‘HSBC learns to play the vuvuzela’)¹⁴⁵ and general approbation. ‘HSBC doesn’t have a strong presence in South Africa or the rest of Africa,’ commented Emilio Pera, a partner at Ernst & Young in Johannesburg. ‘Nedbank could be a springboard for expansion.’¹⁴⁶

Due diligence and discussion with the regulators followed. However, on 15 October, HSBC notified Nedbank’s owners, Old Mutual, that after careful consideration and noting regulatory changes which had changed the economics of the deal, it had decided not to proceed. This was not well received by Old Mutual or within South Africa. The decision did not reflect an adverse view of Nedbank itself, but HSBC was not legally permitted to comment publicly on the factors behind its decision. Accordingly, the way ahead would have to be organic growth, though that did not stop Euromoney from expressing regret: ‘The fanfare around the deal showed optimism about Africa’s prospects. HSBC needs Africa – just as much as Africa needs HSBC.’¹⁴⁷

The magazine was more positive about HSBC’s efforts in Latin America, commending the bank in 2008 for having ‘built a competitive franchise in little more than a decade’,¹⁴⁸ while the following January it specifically praised HSBC’s franchise in the region’s debt markets, offering a full range of services and growing new relationships rapidly at a time when ‘other foreign banks are cutting their Latin teams’.¹⁴⁹ Overall, Latin America made a generally solid profits contribution: over $2 billion in both 2007 and 2008, with the lion’s share coming from Brazil and Mexico; in 2009 a dip to $1.1 billion, as the Mexican economy contracted sharply;¹⁵⁰ and in 2010 up to $1.8 billion (or 9.4 per cent share of Group profits), with Brazil for the first time contributing, on the back of an ultra-buoyant economy, over $1 billion.¹⁵¹ Even so, there was relatively little room for complacency. The ‘second-largest footprint in the region, but lagging in efficiency and profitability’, noted Emilson Alonso (CEO for Latin America) in a February 2010 presentation, drawing particular attention to what he called a ‘variety of operations, systems platforms and different work cultures’.¹⁵² Shortly before, moreover, Mexico and Brazil had submitted themselves to individual appraisals by the GMB. ‘HSBC Mexico currently lags competitors in size, cost-income efficiency and credit quality,’ was the verdict on the former; as for Brazil, Geoghegan drew on personal experience when he commented on ‘the major cultural change needed to transform the business’, especially the retail network, ‘and develop leading industry talent’.¹⁵³

There was no collapse either in the contribution from Asia-Pacific (excluding Hong Kong): pre-tax profits of $4.7 billion in both 2007 and 2008, $4.2 billion in 2009, and $5.9 billion in 2010, as Asia put its temporary troubles firmly behind it. Stripping out the financial contribution from the stakes in mainland China, the respective figures for the four years were $2.5 billion, $3.4 billion, $2.7 billion and $3.6 billion, while the two consistent big hitters were Singapore (above $500 million each year) and India (above $500 million for all but one year).¹⁵⁴ ‘Our strategy in Asia is clear,’ Flockhart told The Banker at the end of 2007. ‘We will focus on the region’s emerging mass affluent as well as the booming consumer segments, while exploiting fast-growing trade within Asia’s thriving economies and between Asia and the rest of the world … HSBC Asia Pacific is already the largest international bank in Asia by assets and by profits before tax, but the prospects in Asia remain plentiful.’¹⁵⁵ Soon afterwards, talking to Asia Money, Vincent Cheng added a gloss: ‘We cannot be a universal bank in every market. Basically wealth management and commercial banking, these are the two areas where we hope to get scale. As long as we can produce a decent return on equity for our shareholders, we will invest.’¹⁵⁶ Yet as ever in Asia-Pacific, the ability to expand in certain markets remained constrained: across the region as a whole, the only significant territories without ownership restrictions were (apart from Hong Kong) Japan, Indonesia, Australia and New Zealand.¹⁵⁷ ‘It seems unlikely that organic growth alone will be sufficient, or sufficiently rapid, to meet the demands of the Group’s developing markets strategy,’ reflected the Asia-Pacific Regional Business Review in August 2008. ‘The conundrum is that inorganic growth is not always easy to achieve and financial discipline is required to avoid over-payment.’¹⁵⁸ A conundrum indeed, and in three territories other than Korea – Vietnam, Indonesia and India – it was thrown into particularly sharp, instructive relief.

Few countries grew faster in the mid-2000s than Vietnam, with GDP increasing by more than 8 per cent a year,¹⁵⁹ but for foreign banks like HSBC, which had branches in Ho Chi Minh City (the major commercial centre) and Hanoi (the political capital) as well as in May 2005 establishing a presence in the Mekong Delta city of Can Tho,¹⁶⁰ the playing field with local banks was far from level.¹⁶¹ Inevitably, the inorganic route beckoned: HSBC responded between 2005 and 2009 by taking increasing stakes in Techcombank (Vietnam’s third-largest bank)¹⁶² and Bao Viet Insurance.¹⁶³ Yet through these years it was the organic route that increasingly came to matter. ‘Our strategy to run two horses in the Vietnamese market remains sound,’ observed country head Alain Cany in May 2006 after the central bank’s assurance that in due course foreign banks would be allowed to incorporate locally;¹⁶⁴ while two years later his successor, Tom Tobin, told Flockhart that, ahead of incorporation, ‘we have been quickly catching up with Group core banking capabilities such as the launch of credit cards, internet banking and an ATM network’.¹⁶⁵ Incorporation itself took place at the start of 2009 (HSBC and Standard Chartered the two selected pioneers) and eight new outlets were opened that year. ‘We are not talking about hundreds,’ Tobin, looking ahead, told The Banker in March 2010. ‘The market is not ready for that kind of growth and our competitive advantage is not suited to a huge, mass-market entry.’ Instead, his retail target was Vietnam’s ‘growing affluent middle class’;¹⁶⁶ while more generally, he and his colleagues could take satisfaction in Finance Asia’s recent verdict that, in terms of foreign banks making an impact in Vietnam, HSBC had been ‘the pathmaker’.¹⁶⁷

By contrast, a less organic path was eventually plotted in Indonesia – the resource-rich archipelago in which the authorities during the 2000s were positively keen on the prospect of foreign ownership helping to reform a banking system that had been exposed as rotten by the acute financial and political crisis of the late 1990s.¹⁶⁸ Even so, there was still plenty of activity on the organic side, especially once an ambitious move into consumer finance had been initiated. ‘Indonesia presents a large, growing and highly profitable Consumer Finance opportunity,’ explained Nick Sibley in December 2005, some six months after the similar urgings about India. He added that ‘it is critical to move quickly and establish a comprehensive network given competitor moves and the uncertainty of a future regulatory environment’.¹⁶⁹ Pinjaman HSBC was duly launched in May 2006 to bring Household-style consumer finance to the Indonesian market;¹⁷⁰ a profusion of loan centres were rapidly opened; and by early 2008, HSBC had become the largest foreign bank in Indonesia in terms of footprint.¹⁷¹

But was it enough? The possibility emerged of acquiring Bank Ekonomi, a reputable domestic bank with eighty-three countrywide branches, and in June 2008 a position paper by Stephen Moss of Asia-Pacific Planning explicitly addressed the strategic question of an organic route vis-à-vis an inorganic one. With the former, although there were now seventeen branches and sixty-one consumer finance offices, not only had the central bank recently confirmed that foreign banks would be restricted to opening new branches in eleven designated cities, but there were ‘ongoing difficulties in securing desirable branch locations’ and ‘shortage of suitable skilled staff in the local market’; whereas with the latter, acquiring Ekonomi would instantly confer ‘scale, access to 350k deposit customers and over 5k SME lending customers’.¹⁷² So, inorganic it was, and that October (soon after the decision to walk away from Korea Exchange Bank) it was announced that HSBC would be securing 89 per cent of Bank Ekonomi for $607 million.¹⁷³ The deal was completed in May 2009¹⁷⁴ – shortly after, on the organic side, the decision had been taken to close down the consumer finance business, which in the context of the difficult economic environment of the previous autumn and winter had proved to be of expensively poor quality.¹⁷⁵

Of course, in neither Vietnam nor Indonesia was it an absolute either/or choice between organic and inorganic, and the same applied in India. In September 2007, at a review meeting of the strategic plan for 2008–10, Naina Kidwai set a goal of achieving a pre-tax profit of $1 billion by 2010, so that HSBC ‘remained competitive against its peers’, Standard Chartered (the top foreign bank in India) and Citi; she asserted that ‘the growth story in India was one of organic growth although an acquisition after the expected market liberalisation in 2009 should not be ruled out’; and for that growth she looked particularly to PFS, above all consumer finance and retail broking, as ‘the key areas of expansion’.¹⁷⁶ It was no surprise, accordingly, when HSBC in 2008 took a majority stake in one of India’s leading retail brokerages, IL&FS Investsmart¹⁷⁷ (subsequently renamed HSBC InvestDirect India). As for consumer finance, growing since 2005, it was at the heart of a Mumbai press conference that Flockhart gave in December 2007. ‘Financial inclusion is our credo,’ was his key message for the media. ‘There are many people who still do not have access to the banking sector. Financial inclusion is the need of the hour. RBI [Reserve Bank of India] is urging banks to reach out to this section. HSBC has introduced Pragati Finance, a consumer finance offering.’¹⁷⁸

Yet over the next two or three months the context rapidly changed. Fraud in collections began to surface;¹⁷⁹ the consumer credit market started to turn;¹⁸⁰ and the government shocked lenders by ordering them to cancel $15 billion in loans in order to help farmers weighed down by debt, a move that had huge repercussions as many borrowers – including Pragati Finance borrowers – took this as a welcome precedent and flatly stopped paying. ‘Suddenly it became OK not to repay your loans,’ recollected Kidwai some years later in moderate tranquillity.¹⁸¹ Inevitably, PFS (including consumer finance) suffered badly, racking up losses of $155 million in 2008 and $219 million in 2009,¹⁸² while as early as autumn 2008 a Group Management Office visitor to India was noting that PFS had ‘already changed direction’ from ‘the strategic plan approved earlier this year’ and was ‘not pursuing mass market/consumer finance business’.¹⁸³

The year 2010 saw India back on track with a $679 million profit,¹⁸⁴ and unsurprisingly, when the GMB considered the medium-term outlook in October, the message was that ‘the focus will be on Global Banking and Markets and Commercial Banking, with Personal Financial Services providing a source of customer deposits’.¹⁸⁵ Opportunities for growth, however, remained scarce and in January 2011, two years after the anticipated date for major liberalisation had come and gone, ‘Waiting for the Green Light’ was the expressive headline for a Banker article on the frustration of foreign banks eager to take advantage of India’s galloping economy. Kidwai, however, defended the caution of the regulators. ‘Their fear is valid,’ she told the magazine, ‘that dominance by foreign banks will leave the banking system open to the vagaries of the global environment.’¹⁸⁶ The point was well made, after recent events, and as a seasoned operator she knew the importance of being able to see things from both sides of the table.

A unique spread

‘In a few years’ time who’ll remember the G7?’ asked Mike Geoghegan in a speech in Hong Kong in April 2010. ‘We’ll remember the E (for emerging) 7 – China, India, Brazil, Russia, Mexico, Indonesia and Turkey. These are the ones which will matter.’¹⁸⁷ The rise of the emerging markets had been a thrilling, potentially game-changing aspect to the early years of the twenty-first century, and HSBC had played a sometimes tricky hand pretty well – though perhaps not quite as well in Asia, some commentators thought, as Standard Chartered.¹⁸⁸ Geoghegan offered a measured but essentially positive assessment in his valedictory Euromoney interview, published the same month (January 2011) that his successor Stuart Gulliver told the Holdings board of his expectation that emerging markets would generate 55 per cent of the Group’s ‘banking profit pool growth’ over the next ten years.¹⁸⁹ ‘HSBC’s spread of emerging markets businesses is unique,’ claimed Geoghegan, ‘and I would argue that no other financial institution knows emerging markets as well as we do. Emerging markets go through these huge buzzes. Everybody ploughs in and then they realise actually it is not as easy as they thought it was. Wages then go through the roof. The amount of business is not there to cover the cost base, and then there is “corporate regret.”’ In short, he warned, ‘These markets don’t go up in a smooth, straight line. There are always bumps along the road.’¹⁹⁰