global capital, global markets, and creating value

A partner at Palamon Capital talks about the inevitability of global financial regulation (to an extent we have this with Basel III). 

One interesting consequence of a more uniform global financial regulatory structure is a destruction of value through the creation of efficiency. Right now, the very differences between markets (capital markets, commodity markets, media markets) create wealth. This can happen through pricing arbitrage, creation of multiple product lines that generate overall more profit, and getting access to market information more quickly than your competitors.

I'm all for global financial regulations, incidentally, as long as they are meaningful. (That last caveat might be the sticking point.) Frankly, Africa and China did OK in the financial crisis, while the US and Europe - chief architects of Basel II - tanked. Something was missed. Credit, reserves, and their interplay got more intricate and smoky with securitized assets and a hunger by many organizations to sell-sell-sell mortgages during the real estate bubble. Many were, indeed, competing to see who could be stupider with their credit risk. 

In the customer experience management context, the same issues arise. Differences among cultures and countries can be key sources of competitive advantage. If you're Carrefour, you are more adept than Wal-Mart at adapting to local country norms, aspirations, supply chains, product strategies, and so on. The Carrefour "wet market" in China is an attempt to fit the cultural need for seeing your fish alive, not cleaned and neatly wrapped in cellophane. But as a global citizenry develops, thank to instantaneous communications, international education, frequent travel, and a brand ecosystem that's increasingly familiar everywhere, will the "glocal" strategy begin to lose value?

Perhaps, but really the "glocal" strategy was still a pretty ham-handed way to address your customers' needs. Micro-segmentation will prevail. Customer-defined services, products and experiences will generate a micro-segment containing just one person, over time. And I would argue that supporting such innovations will create more value than will be destroyed. 

Is there a parallel in global capital markets? Can products be so customized that the credit risk and financial profile of each individual can generate a unique product? 

Why not? 

Recall Egg, the online bank in the UK that Citi just about hacked to death. It moved from a customer-centric, happy bank with loyal customers to a shell of its former self, when Citi "fired" customers in part because they paid their credit card balances off on a regular basis. That makes sense in the old school way of optimizing customer profitability. It costs money to deal with customers who pay off their credit cards, but if they don't borrow money from you, costs exceed revenues. They're money-losers. Fire 'em by uninviting them to the party, closing their accounts, and calling them names. (Citi essentially accused them of being poor credit risks. What?)

Citi - and global banks - could have done this differently. But they needed first to see that their way of accounting for customer value (current, not future) was fundamentally flawed. Customers who pay off their credit cards can afford more debt. Keep 'em. If you ignore people with future value (as Citi did), and embrace people with future liabilities (as subprime mortgage sellers did), you're just asking for trouble.

So, to banks - and to other industries likely subject to future global laws - I say, fix the regulatory system, but make sure the real opportunity is still in your sights: create value the best way possible. No, not with interest rate arbitrage. I'm talking about the future spending capacity of your loyal customers. 

Comments

[Kwame Som-Pimpong]

I am concerned about the implications of global regulation for African countries, negatively affecting the banking industry which is really starting to gain traction by leveraging the booming mobile industry. I recently read a piece a Foreign Affairs piece on the need for agricultural development on the African continent. The author highlighted the shift in agricultural policy during the green revolution, a shift that prevented African countries from reaping the benefits of countries like Brazil and Russia. I don't want global regulation to make it even more difficult for African countries to realize their collective economic potential.

[Paul K. Ward]

I think in general that banking regulation are positive globally, as they seek to create a balance between reserve policy and investment behaviors. I think the biggest issue is the level of integration internationally among banks when it comes to actual leverage, securitized instruments, and currency exchange risks. I would want to study this some more, but I am working under the hypothesis that Africa has recovered nicely from the global economic meltdown precisely because of a relative lack of integration with major developed country banking and financial markets. When America sneezed, it was "too far away" to catch our cold.

This is going to change, and I believe it is time for Africa to make sure it is training the next generation of bankers to deal with those risks. Of course, right now most African banks are scrambling just to train its staff on classic credit risk, and having to deal with unbanked and under-banked customers whose credit history is non-existent or spotty, even though they may well be "credit-worthy" in the African context. However, this is a tactical problem that I believe can be overcome through programs that (cough, cough) I hope to be bringing into West Africa in 2011. The strategic issue will remain: How will Africa's banks remain healthy as they integrate into the world economy?