Is big bank complexity irreversible?

Reading time: 8 – 12 minutes

In the article “Some banks have become too complex to manage”, I say that simplicity is the essence of good banking and describe the management structure of Citibank in 1956, when that institution was known for financial stability and prudent banking.

I also suggest that Citicorp today no longer resembles Citibank of the 1950s and has become lost in its own complexity.

Re-simplifying an organization

If the root problem with big banks today is organizational and product line complexity, the question is what, if anything, can be done about it?

Large organizations that have become overly complicated over many years are notoriously difficult to re-invent and simplify.

Take the case of General Motors.

In 1956, GM sales were almost double those of the second largest US corporation, Exxon. Reported profits were $1.1 billion. Alfred P. Sloan, who had streamlined GM management, was retiring. Four years earlier, the famous line, “What is good for the country is good for General Motors, and what’s good for General Motors is good for the country.”, was uttered by GM head, Charles Wilson.

Today, fifty years of mis-management have turned GM into a financial nightmare of extraordinary complexity.

To many, bankruptcy or government life support are the only solutions … and even then?

In 1956, General Motors had profits of $1.1 billion

Over-complexity may be insoluble

Re-simplification of huge organizations that have grown too complex over many years is often impossible:

• Current management has no understanding of how to run a simplified organization;
• Simplification involves firing people, closing departments, throwing away or rewriting operations manuals, reprogramming computers, closing down product lines, hiring new people — all measures that are vigorously opposed by current management.
• If current management is all fired to bring in new management to restructure the organization, there is no one left that knows where the old bones are buried. New management will be flying blind.
• Current management, over the years, has built up political support for the status quo, both within and outside the organization. The arguments for not changing are well honed.
• After fifty years or so, those who might remember how the organization was in its “glory days” are all gone. The institutional memory has been erased. The argument, “Times have changed” trumps attempts to “Turn the clock back”.

General Motors is a case in point.

How Citibank got on the wrong track

Understanding how Citibank got too complicated is important.

• First, the process of making the bank complicated was deliberate and well-documented. We know exactly what happened and why.
• Second, because Citibank was at the time the world’s premier banking organization, what Citibank did was eventually copied by Chase, Bank of America, and other large banks throughout the world.

The virus of complexity was implanted in Citibank by Walter Wriston in 1967 when, on a suggestion by the management guru Peter Drucker, he contacted McKinsey & Company to undertake a restructuring of bank management.

The motive was innocent enough:

Large clients, like the big oil companies, didn’t like to deal with branch managers who also served small clients and individual depositors. Big corporations wanted to be treated with deference. It was a marketing problem.

The solution was a complete reorganization of the largest international bank. The McKinsey study took fifteen months and implementation began on Christmas Eve 1968. The process lasted for years and changed Citibank forever.

The McKinsey recommendation

The essence of the McKinsey recommendation was simple enough:

• The bank should be reorganized along marketing lines, with different divisions for each major “product line”. (Before McKinsey, no one in Citibank referred to loans or deposits as “products”. After all, a bank wasn’t a manufacturing plant.)
• Because different kinds of clients used the commons services of the bank, like its branch network and back office processing, the “product line” organization would have to be imposed on top of the existing structure. This called for a “matrix organization” in which bank officers reported to different “product managers”. In effect, bankers now had multiple bosses.

The results of the McKinsey heresy

The change that the McKinsey recommendations brought about in Citibank are documented in the book, Wriston: Walter Wriston, Citibank, and the Rise and Fall of American Financial Supremacy.

Here are some relevant quotes from this book that describe what happened to Citibank:

“The overhaul did more than reshuffle names and boxes on an organizational chart. It eliminated what was left of the genial banking culture and replaced it with a new, youthful, profit-oriented psychology that demanded an entirely new approach to management.” — Page 245.

“…Something was certainly lost with the demise of the geographic organization. Now no single individual in the United States had a complete picture of how Citibank was performing in a particular part of the country,” — page 250.

“Employees no longer said they worked for Citibank. When asked who they worked for, they almost always gave the their bosses’ name. … Employees who earlier would have been inclined to blow the whistle on dishonest or incompetent bosses now thought twice,” — page 246.

“The reorganization marked the beginning of the end of the era of old-time relationship banker and gave rise to a corporate culture in which officers were branded either as transactors or administrator-managers. As the managerial cult took hold, Citibank placed a higher premium on management skills than on traditional banking skills. The best manager was now more valued than the best banker,” — page 246.

“The new managerial cult embraced the notion that managers were interchangeable and could be moved from place to place and from job to job,” — page 247.

“The ‘matrix’ organization dovetailed perfectly … with the new profit center concept introduced by young John Reed. Each new customer-oriented business center was to be a profit center run by a manager responsible for executing a profit plan that would produce earnings growth of 15 percent a year,” — page 245.

“The shift in employee loyalty from the institution as a whole to the profit-and-loss statement was almost instantaneous,” — page 245.

“By manipulating the numbers, a profit center manager could show a streak of improved earnings long enough to earn a promotion to another area of the bank,” — page 247.

“Everybody who got responsibility tried to strip assets and overturn what the previous guy did to make a good showing. … By the time the underlying weaknesses of the changes revealed themselves, the new officer would be long gone, and the problems he’d caused in the unit would be blamed on his successor. This process became known among Citibankers as the art of FUMU — ‘F*ck up, move up’” — page 248.

It took about a decade for the McKinsey recommendations to be implemented.

In the process, thousands of old-line Citibankers left or retired.

The Citibank tradition of creating bankers with lifelong loyalty to their profession and to the bank was dead. Citibank had become a marketeer of industrialized financial “products” dedicated to short-term profits, run by managers rather than by bankers.

New products and finessing Glass-Steagall

Soon enough, profit-oriented Citibank managers discovered another way to get ahead — they could invent new products that could be transformed into profit centers that they could manage.

Since Citibank was an international organization, Glass-Steagall Act restrictions against engaging in investment banking could be circumvented in offshore operations.

This provided an even greater variety of financial products to market and added more complexity to the matrix organization.

Finally, Sandy Weill took over Citibank and the culture of the old-time professional banker was gone forever. The bank had now become, in part, an insurance company and much more, with even more products to add to the matrix organization. On top of organizational complexity, the bank now had problems with mismatched computer systems and conflicting organizational manuals.

By adding new products and focusing on short-term profits, Citibank inspired other large banks to follow their leadership. By adding new products and accepting ever greater risk, the bank grew and drew others down the same path.

By the 21st century, the original McKinsey banking heresy, which had started as what seemed to be a simple marketing makeover, had infected the whole world.

No way back for the big guys

Citibank is infinitely more complex than General Motors, as are the other major world banks.

These large banks must manage many more product lines and are far more highly leveraged.

As financial operations have become longer term, the lag between today’s apparent posted profit and the eventual discovery of a sour deal has become greater.

In 1956, Citibank liabilities consisted mainly of demand and time deposits that were guaranteed by the government.

Today, this is no longer true.

However, the government in declaring certain large banks “too big to fail” has issued an implicit guarantee. The cloud of “systemic risk” panics the government into action.

So far, there is some talk of banks being too complex to manage. But a solution to the problem is not yet on the table.

Too big to regulate?

If some banks are too big to manage, it would seem that they also would be too big to be regulated effectively.

The solution to overly complex banking organizations may indeed by nationalization.

This would be less expensive than pumping money into “bad assets”, while allowing the causes of the problem to fester.

Nationalization of certain big banks would not be the end of capitalism.

In fact, a deathly fear of nationalization might just be the medicine needed to get private sector “bank managers” to once again become “bankers”.