The launch of Lafferty Bank Quality Ratings (LBQR) has attracted great interest in the banking community worldwide — and in the worldwide media. Among the questions we have answered are the following:
What does the LBQR rating do?
The rating scores banks for their ability to deliver sustainable returns. Sustainable returns are the key driver of shareholder value. Our research shows that our ratings tend to correlate with price/book values.
Who is this service aimed at?
It is an ideal tool for chairmen, CEOs, CFOs, heads of lines of business such as retail banking or corporate banking, boards of directors and those directors who chair audit and remuneration committees — as well as regulators and others with exposures to banks.
Who do you see as your competitors?
We have no direct competitors.
Why do most universal banks have low quality ratings?
Usually because they are unfocused and generate relatively poor and unpredictable returns. They also find it hard to explain their strategies, often have clashing cultures and seem to face ongoing regulatory problems.
What is the difference between quality ratings and credit ratings?
Companies like Moody's, Standard & Poor's and Fitch rate corporate debt instruments. LBQR rates the overall bank. The two approaches are complementary.
How come you do not believe that macroeconomic conditions or market conditions in general are important for bank's quality ratings?
Of course macro conditions matter to banks. But good quality banks will come through cycles much better than banks reporting superficially attractive numbers. Icelandic banks, Northern Rock, Royal Bank, Dexia, HBOS and Anglo Irish all did poorly on our ratings system AHEAD of their failure.
In contrast rating agencies tend to downgrade banks after they get into trouble. The rating agencies completely missed the fact that banks would get into trouble: the downgrades started coming far too late to be any use.
Why do you focus on the annual report — which cannot possibly give the full picture?
We focus on the annual report because of its unique status as the primary vehicle for management of a bank to communicate and account to shareholders and other stakeholders. Furthermore, it is available in a broadly standardised format from every bank worldwide — and is the first (and often the only) document that an international investor will look at in making an investment decision between hundreds and possibly thousands of banks. It is here that one can reasonably expect to find reliable accounts, clear exposition of strategy and how the bank proposes to achieve its aims — and also where a stakeholder should gain valuable insights into the culture of the organisation, how it treats customers and the experience and qualifications of the management team.
Why have you included banking qualifications among your criteria?
The senior bankers, regulators and investors that we spoke to in our initial research were generally of the view that this should be one of the ratings criteria. We think that there is something special about banking that demands a professional qualification — and this was highlighted in the findings of the UK Parliamentary Commission on Banking Standards. We do not think that other business-type professional qualifications and business degrees are sufficient by themselves.
Is a master's degree in banking as good as a professional banking qualification?
A master's degree in banking will certainly equip a banker with a lot of valuable knowledge. However, we do not think it is the same as a professional qualification in banking (similar to a lawyer or chartered accountant) which brings with it an ethical code, discipline by peers and continued professional education.
How can one judge culture from a bank's annual report?
Culture comes from the top. Hence we believe that there are signals in the management statements about what kind of culture the bank has. We score banks for culture using simple rules of thumb. For example, signs of arrogance or hubris in annual reports are 'red flags'. There is a predictive power in these simple rules of thumb.
Why should a bank reveal sensitive information about customer satisfaction in its annual report?
The whole point is that banks like Lloyds do so — and even go further by publishing targets and their performance in delivering on them. Can you imagine if a bank said "We use profit to measure our activities, but we don't reveal what our profits are"?
How can the LBQR methodology be described as forward-looking?
It is forward-looking in the way that Piotroski Score or the Altman Z Score is forward-looking.
"In its initial test, the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years before the event, with a Type II error (false negatives) of 6% (Altman, 1968). In a series of subsequent tests covering three periods over the next 31 years (up until 1999), the model was found to be approximately 80%-90% accurate in predicting bankruptcy one year before the event, with a Type II error (classifying the firm as bankrupt when it does not go bankrupt) of approximately 15%-20% (Altman, 2000)".
"Altman Z Score", Wikipedia, Accessed: 27 April 2016
Why are unquoted banks not rated?
The constraint on the ratings system is not ownership, it is disclosure. The discipline of having to report publicly to shareholders typically results in far higher quality annual reports. For instance, although RBS was over 90 percent owned by UK Government it kept on reporting as if it was a publicly-traded bank — which allowed us to rate the bank.
Is it fair to compare banks in different countries by the same measures?
Yes. In the real world this is what shareholders and other stakeholders do. This is why we have international financial reporting standards, for example.
Why do you believe that deposits are more stable than mortgage funding?
Money markets can dry up — as they did in most countries during the recent global crisis.