The McKinsey firm appears to develop academic theories for banks to use in clinical trials on their customers. Dr Evan Jones reports.
McKinsey is a household word that has acquired generic status for its product — like Hoover and Panadol. Here is a super-self-confident firm that implies super competence. Your firm is in the doldrums? Whatever its industry, we go in, transform its character and put it on the rails to a glorious future.
Such is its self-confidence, McKinsey openly publicises its wares in its bulletins and articles on the web. Thus, in the Autumn 2009 issue of its Quarterly, there are two articles of interest — ‘Understanding the bad bank’ and ‘The hunt for banking capital’.
McKinsey and the Commonwealth Bank of Australia
These articles are of interest because of their chronological and substantive proximity to the explosive event surrounding the Commonwealth Bank (CBA) takeover of Bankwest in December 2008 — the subsequent CBA foreclosure of around 900 Bankwest commercial property borrowers.
Then CBA Chief Counsel David Cohen claims that the CBA belatedly discovered, after their hasty purchase, that these loans were all underwater — thanks to lousy Bankwest procedures exposed by the GFC. Foreclosed Bankwest borrowers who have gone public deny the claim — with supportive evidence.
Lacking disclosure by the CBA, Bankwest victims have had to speculate on the CBA’s modus operandi. The Banking Royal Commission, supposed to get to the bottom of things, has so far declined to do so.
McKinsey offers us two plausible possibilities.
First, separate out the bad parts of the portfolio into a “bad bank” — whether held internally or externally. McKinsey had especially in mind the toxic derivatives packages manufactured and acquired in massive quantities by its major Trans-Atlantic banking clientele, but it included purported troubled business customers in the mix.
Claims the McKinsey “bad bank” article:
'Into the bad pile go the illiquid and risky securities that are the bane of the banking system, along with other troubled assets such as nonperforming loans. For good measure, the bank can toss in non-strategic assets from businesses it wants to exit, or assets it simply no longer wants to own as it seeks to lessen risk and deleverage the balance sheet.'
Understanding the bad bank | McKinsey & Company https://t.co/uzRRV0r3tA— Suyash Sengar (@suyash_sengar) February 11, 2017
Second (a possibility already raised by Bankwest victims), rationalise your capital needs to increase the bank’s capital adequacy ratios. The object was to keep the investors and ratings agencies happy, rather than having them desert you.
The CBA's Bankwest borrower takedown can be interpreted via both of these scenarios. First, the CBA created a “bad bank” of commercial property loans but its separation took the form of ready dismantling of this loan book. The process was labeled Project Magellan and it was built on fraud. The CBAs involvement in Storm Financial was also added to the “bad bank”.
Second, the bank increased its capital to risk-weighted assets ratio by diminishing the denominator in the equation — that of the risk-weighted assets.
Were senior CBA executives apprised of the latest McKinsey fashions? Better still, they brought them in-house in the person of Ian Narev.
Narev joined McKinsey in 1998, after a stellar achievement at university and working in corporate law, specialising in mergers and acquisitions.
The CBA website noted:
'He joined McKinsey New York as a consultant in the firm’s financial institutions practice working in strategy and organizational change engagements for four of the United States’ ten largest financial institutions.'
Narev was hired by CBA from McKinsey New Zealand Asia in May 2007. He had never worked in a bank but was claimed to be an expert in 'strategy and organizational change engagements'. Narev spent the next 18 months as “Group Head of Strategy”, from which position he oversaw the takeover of Bankwest. After the takeover, Narev became head of “Group Executive, Business and Private Banking”. Narev became CBA CEO in December 2011 after the retirement of Ralph Norris.
Is it not highly probable that Narev and his underlings (including Jon Sutton, installed at Bankwest) applied, seemingly uncritically, the ideas then fashionable at his old consulting hothouse?
McKinsey’s spotty record
In 2002, the New Yorker’s Malcolm Gladwell penned a long exposé of Enron’s McKinsey-led indulgence of the “talented” individual. Enron followed McKinsey’s pressure to “hire and reward the smartest people”, which turned out to be mostly people straight out of prestigious business schools.
'… the link between, say, I.Q. and job performance is distinctly underwhelming.… What I.Q. doesn't pick up is effectiveness at common-sense sorts of things, especially working with people …'
Which would include working productively, not merely with fellow employees, but with clients, not least business borrowers.
Gladwell cites psychologists to the effect that for organisations to function properly requires an intangible understanding simply labeled “tacit knowledge”. McKinsey’s grand transformations are some distance from the subtle implications for organisational coherence, integrity and effectiveness of tacit knowledge.
An article on McKinsey in Business Week in July 2002, ‘Inside McKinsey’ (behind a paywall since taken over by Bloomberg), noted:
'… many of the intellectual underpinnings of Enron's transformation from pipeline company [utility] to trading colossus [qualitatively distinct financial corporation] can be traced directly to McKinsey thinking.'
That article also cites a partner at another consulting firm (here’s the crux):
"McKinsey seems to have partners who develop academic theories and then run clinical trials on their clients."
Enron wasn’t McKinsey’s only large scale failure. At that time, there was Swissair, Kmart, Global Crossing all filing for bankruptcy after implementing bad advice. Some McKinsey hotshots left the company to create their own startups during the dot-com boom and failed spectacularly.
'It often goes unmentioned but McKinsey has indeed offered some of the worst advice in the annals of business. Enron? Check. Time Warner's merger with AOL? Check. General Motors' poor strategy against the Japanese auto makers? Check. It told AT&T in 1980 that it expected the market for mobile phones in the U.S. by 2000 would amount to only 900,000 subscribers. It turned out to be 109 million. The list goes on.'
The McDonald reviewer also notes:
'You can’t get fired for hiring McKinsey & Co.'
Or, indeed, for bringing them into the fold, as per Ian Narev.
The CBA and McKinsey’s Narev
Narev as CEO presided over a succession of scandals — not least those involving Commonwealth Financial Planning, Comminsure and large-scale money laundering. The adverse fall out for various categories of customers has been immense.
When questioned in hearings or in the media, Narev was wooden, often with an absurd grin. He was either completely out of his depth or playing dumb. Yet this was a man feted in the media as leading the CBA successfully into a new age.
A gushing editorial in the AFR in June 2012 has it that:
'Mr Narev's life experiences [marked by family tragedies] have clearly helped mould his character. Former CBA chairman John Schubert noted that what impressed him most when the New Zealand-born Mr Narev first joined the bank was the combination of his intelligence and his ability to empathise and care about people.'
As for empathy and care, there is no evidence whatsoever — on the contrary.
Narev was forced out of CBA in April 2018. Ultimately, he has been a scapegoat for collective responsibility for successive crimes. With respect to the Bankwest customer takedown, Ralph Norris as CEO until late 2011 is the man formally responsible. Yet this vastly over-paid and over-rated man has been allowed to disappear from view in the questioning of the Storm Financial fiasco and the large scale foreclosure process.
McKinsey opens its bank account with the NAB
It turns out that McKinsey has been a not uncommon port of call for Australian bank management seeking to give their company some new zest.
McKinsey Australia was established in 1962 by Sir Roderick Carnegie (employed at McKinsey while completing his Harvard MBA). With the banks, the relationship begins as early as 1967 when the NAB calls in McKinsey. In late 1968, the bank followed McKinsey’s recommendations to de-centralise operations.
The position of regional manager was created to be a local source of dynamism and each branch was turned into a profit centre. The concept of a “delegated lending authority” was invented, whereby lending managers acquired discretion regarding their loan book up to a certain limit.
If a DLA for a loan proposition was determined as within the most solid category – “Category A”, with an acceptable loan to valuation ratio – then it did not have to be submitted for evaluation by superiors. Some loan managers started to fudge the figures, in particular the value of customer assets, to bring the proposition into Category A and proceed without higher approval. Other deceptions could be practiced, such as the means by which guarantees were obtained. Regional managers became complicit in the rorts.
Quantum limits of branch manager DLAs were increased during the 1970s and multiplied dramatically during the 1980s. Thus, the upper limit for branch manager discretion went from $10,000 in 1968 to $1 million in 1988. CEO Nobby Clark’s instruction to those on the front line was to get out there and “lend lend lend”.
An important instance of where a branch manager exercised local discretion liberally led to the 1987 Nobile case against the NAB, where the court decided for the joint parental guarantors against the bank. Rather than being sacked, the manager was hidden from view in made-up positions to keep the lid on the bank’s dysfunctional procedures.
The worst manifestation of this schema in operation is that of the fraud committed against Ned & Joy Somerset at NAB Toowoomba Branch Queensland in the mid-1980s. The branch manager, in several steps, arbitrarily increased the market value of a worthless strawberry farm from $210,000 in January 1984 to $575,000 in January 1985 to facilitate the farm’s sale to the hapless Somersets. The story is outlined comprehensively here. In this case, the NAB got away with the crime.
In principle decentralised discretion and DLAs were good ideas, but contemporaneously the culture was being debased, facilitated by lending manager status and remuneration being linked to the manager’s loan book. Moreover, many lending managers did not have the skills to deal with the extravagant loan limits delegated to them by the late 1980s. The "tacit knowledge" factor was in abeyance. The system was belatedly revised in the early 1990s, with much greater central control established over local lending discretion.
Nevertheless, by the late 1980s, the NAB had become addicted to corrupt practices. The bank claimed a reputation for ensuring credit quality, but its approach to “risk management” was to act as if (correctly) any losses through litigation by aggrieved customers would be sufficiently rare as to be of marginal significance for its unrepentant agenda.
Sir Roderick Carnegie (Image via ABC The Business, 2 April 2013)
Rod Carnegie was interviewed by the AFRs BOSS magazine in July 2000. Carnegie saw only successes.
Thus for the NAB consultancy (not named), we hear:
'New practices that significantly improved the competitive performance and the profit level of all the branches were built into each of them.'
Not quite. Even though McKinsey was involved with the NAB in the late 1980s, nobody was monitoring the parlous outcomes of the 1967 McKinsey initiatives that Carnegie was still celebrating decades later.
During the 1980s, the ANZ was another guinea pig for McKinsey-inspired decentralisation, with then CEO Will Bailey convinced of its merits. With the rush of blood in intemperate lending during this period, Bailey had the occasion during the early 1990s recession to rue the loss of central control.
McKinsey resurgent in bank land
In the late 1980s, McKinsey also advised the NAB on jettisoning its stockbroking subsidiary AC Goode (successful) and on its errant Custom Credit finance subsidiary (unsaveable).
In 1992, Westpac brought in McKinsey to save it from collapse. In 1993, newly hired Bob Joss continued with McKinsey in what looked like a re-run of McKinsey’s revamping of Joss’ old bank, Wells Fargo. McKinsey’s assistance in reconstructing Westpac appears to be the only clear cut case of a success for McKinsey in Australian bank land.
In late 2001 the NAB, under the benighted Frank Cicutto, brought in McKinsey again. This time to oversee a major restructuring in dismantling structures that had been put in place by previous CEO Don Argus. McKinsey had helped Argus in his global ambitions, not least advising him on acquisitions in Michigan and Ireland. Now McKinsey was advising on how to fix up the mess that it had helped create.
The change, under the rubric “positioning for growth”, was expected to result in a retrenchment of up to 5,000 full time staff. A key thrust was to be “a heavier focus on cross-selling of financial services”. Ah yes, a root cause of customer rip-offs down the track.
Simultaneously, the NAB hired Mark Steyn, who had spent years at McKinsey lookalike Booz Allen Hamilton 'specialising in large-scale business transformation in the financial services sector'. More of the same. We also learn that Steyn had previously advised the NAB on the roll out of a new banking platform for the Clydesdale and Yorkshire UK subsidiaries. And what a comprehensive disaster that turned out to be.
RGL Management has accused Clydesdale Bank & NAB of acting fraudulently & dishonestly in their selling of Tailored Business Loans (TBLs) to small businesses & individuals who have since suffered alleged collective financial losses of £1bn. Read more: https://t.co/DjfSKBkGez pic.twitter.com/KhLzJkaeqV— RGL Management (@RGL_Management) July 6, 2018
Cicutto thought that 9/11, the catastrophe occurring two months prior to the McKinsey-led initiative, would induce a global recession. He arbitrarily directed that the plug be pulled on loans to select sectors, with much pain for businesses therein. This mentality of management by whimsy was evidently conducive to having McKinsey turn the place upside down.
As it turned out, the McKinsey endeavours resulted in a retrenchment quantum of 3,000 and (nominal) savings of $370 million per annum. But this clean lines stuff didn’t prevent Cicutto from hiring a bunch of rogue traders from CBA who proceeded to lose a comparable sum on crazy foreign exchange trading — trashing once again the NABs reputation. Goodbye Frank Cicutto and positioning for growth. Where was McKinsey when the going got tough?
McKinsey also advised Westpac again in 2002, on “reducing bureaucracy and duplication”, resulting in the retrenchment of 200 middle managers.
The CBA joins the McKinsey bandwagon
In May 2003, the CBA hired McKinsey in an ongoing “benchmarking” exercise to cut costs and appeal to investors. In essence, CEO David Murray was cleansing the bank of its public ownership cobwebs, complementing the massive branch closure process of the previous decade.
The ambition was to cut another 600 staff from the retail banking division, with $500 million in new savings. For the five financial years from 1998 to 2002, CBA had retrenched 6,200 staff, of a Big Four total for the period of 26,300.
A Finance Sector Union spokesperson was not amused, claiming that no consultation had taken place, yet Murray had proselytised how much he valued staff and their input from “the front-end”. On the contrary, central command was driving the rationalisation. The purported orientation to “customer service” was all about flogging the package of financial products now created under the CBAs wing following the acquisition of Colonial Mutual in 2000.
By late 2003, the CBA project was being known as “Which New Bank”. Ironically, a Macquarie Research Equities review claimed that all this slavish cost-cutting and retrenchment was evidently not attractive to investor sentiment — the latter was more attuned to revenue growth.
Moreover, with massive branch closures and large scale staff retrenchment, how was the bank going to assertively cross-sell more products without depending more on third party brokers, which puts the customers at arm’s length?
The ANZ returns to the McKinsey fold
The ANZ also called in McKinsey in mid-2003 — this time for another push for decentralisation. Decentralisation was anew to be the path to vigorous growth, linking staff rewards to staff satisfaction, customer service, etc.
The insider motivation came from a former head of strategy, who just happened to be previously a McKinsey principal. But how were these objectives to be measured? We learn that, while the devolved units had considerable autonomy, it was dependent on their performance and that to be gauged by revenue gained.
What happened to customer service and staff satisfaction?
To repeat an outsider’s evaluation noted above:
"McKinsey seems to have partners who develop academic theories and then run clinical trials on their clients."
But where is the monitoring, feedback and adjustment of strategies according to experience?
There is an ongoing disconnect between bank management rhetoric (all about customer service) and contrary outcomes. Certainly, there has been a profit bonanza for the Big Four, with net profit on equity consistently around 15 per cent on a growing revenue base. Even so, are these profits a product of McKinsey-driven rationalisation?
By the mid-2000s bank senior management were thinking that perhaps the huge ongoing consultancy bill wasn’t worth the candle. Was its extraordinary growth a matter of fashion rather than hard-headed rationality, indeed common sense?
Meanwhile, the customer casualties over these decades when the banks were calling in McKinsey and comparable consultants have been on a monumental scale. McKinsey et al have pushed transformational change, ensuring ongoing institutional churn. Yet malpractice against customers has become a constant.
Who amongst all these drivers of transformational change is going to assume the mea culpa and take the rap?
Dr Evan Jones is a retired political economist.
This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 Australia License
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