Banks must grasp risk in Asian push

National Australia Bank boss Cameron Clyne has a frank view of how Australian banks' overseas ventures have performed. Mostly, they've tended to "destroy shareholder value", he said at a recent briefing.

Clyne would know. Since he got the top job in 2009, NAB's troubled British business has been an ongoing source of grief and a weight on its share price.

It may seem slightly surprising then that a priority for all our banks - including NAB - is to expand their presence overseas, albeit closer to home, in Asia.

ANZ is leading the charge. Its chief Mike Smith last week stood by its goal of earning at least one-quarter of its profits from Asia by 2017, despite the resignation of the executive spearheading its push in the region, Alex Thursby.

The Commonwealth Bank, Westpac and NAB are less aggressive than ANZ, but all are keen to grab a bigger slice of the market servicing Asia's rising business and consumer classes.

The local industry's exposure to Asia has already increased four-fold since 2009, to $112 billion, Reserve Bank figures show. And it's likely to grow a lot more. So it seems a good time to ask: why do our banks have such a shaky track record overseas? And shouldn't investors be wary about Asian growth strategies being touted by the big four?

Clyne's dim view of the sector's overseas record is well supported by history. NAB's woes in Britain are merely the latest chapter in a series of troubled foreign ventures. NAB also wrote down $3 billion in 2001 after its disastrous foray into the US mortgage market through the purchase of Homeside, a mortgage-origination business.

And others have failed to realise grand plans to take on the world. ANZ bought British bank Grindlays in 1984 as part of an attempt to become a regional power, but it sold out in 2000, (which Smith says was a big mistake).

Outside Australia's industry, international banks that had rapidly expanded overseas were some of the hardest hit by the global financial crisis. So why do overseas forays often go pear-shaped?

Time and time again, managers embark on much-hyped acquisitions that they say will create access to new markets, and will make them more efficient. But research suggests the benefits are all too often overstated.

A 2010 paper from the Bank for International Settlements, for instance, found "scant evidence" that banks become more efficient by expanding into foreign markets.

In theory, banks should gain economies of scale by spreading their hefty investments in technology across a greater volume.

But the BIS economists found this had almost never happened. Indeed, they cited research that the maximum efficient size of a commercial bank was between $US100 million and $US25 billion - significantly smaller than each of the big four.

Instead of being driven by efficiency, expansion of international banking before the global financial crisis was driven by a desire to gain access to new and growing markets, the BIS said. Sounds logical, as developing economies tend to grow fastest.

However, it found the global banks (not the big four) were probably in too much of a hurry. They increased international lending far more rapidly than the world economy was growing, with little regard for risk.

No one is arguing the big four local banks are doing this now. Their international loans and deposits as a share of our economy are much lower than in Britain, Switzerland, or Germany, the Reserve says. NAB and Westpac have particularly conservative Asia strategies built around servicing customers already dealing with Australia.

Nonetheless, the research on international banks' problems contains some useful reminders for the big four.

A critical part of banking is understanding your customers. But when you're new to a country, you will probably know less about the locals than a domestic bank. And you're probably at higher risk of holding the bad assets when conditions turn sour. A case in point is British bank HBOS, which was rapidly expanding here before the financial crisis and lent heavily in commercial property. This just happened to be where many of the bad loans were buried, and the bank had some £3.6 billion in impaired loans in Australia between 2008 and 2011 - 28 per cent of its loan book.

The market is well aware of the risks of overseas expansion, of course. It's no coincidence that shares in the two lenders with the biggest local footprint - CommBank and Westpac - trade at a premium to NAB and ANZ.

None of this means the banks should ignore the potential of Asia, but it suggests a few lessons, such as the value of gradual, rather than rapid, expansion overseas, in areas where Australian banks have genuine expertise. Given the big banks' patchy history in heading offshore, a slow and steady approach in Asia seems to make sense.

Ross Gittins is on leave.