Banks’ annual reports are groaning under the weight of new disclosure requirements. While their financial statements have become significantly more transparent and consistent, it is becoming more difficult to discern the overall message. Investors are presented with an abundance of financial data, but struggle to identify relevant information.
It is now time to take a step back to consider how annual reports could do more to help banks communicate their business story to investors; and to re-examine the most effective boundary between the contents of annual reports and other information provided to stakeholders (Pillar 3, analyst presentations, website disclosures etc.).
Aligning reporting with shareholder value is a challenge in every sector, but the volume and technical nature of bank reporting makes it especially difficult. The challenge is particularly timely when many in the sector are in the process of refocusing their business models to restore public and shareholder trust. In the main, this has reduced complexity in banking businesses, but the complexity of the message to investors has increased – partly in response to uncertainty over the regulatory agenda. Better business reporting is necessary to demonstrate how the changes banks are making to their business models are helping to protect and develop shareholder value and ultimately to enable financial capital to find those businesses that are most able to create value.
Bringing focus to reports
Annual reports are being asked to be more consistent across the sector while also becoming more tailored to the individual bank’s circumstances. In this situation, the value of simply adding more and more detailed financial analysis is increasingly limited. More attention now needs to be given to rationalizing overlapping disclosures and building on the recent (largely positive) disclosure enhancements more explicitly.
The decluttering actions being taken by many banks can help here by drawing out the most relevant financial information. Conversely, if the banking sector is able, over time, to restore trust in the relevance of the information it reports, there may be an opportunity to break out of the circle of tightening disclosure obligations. The focus of reporting development is now starting to shift beyond just the financials. In the UK, for example, impetus is likely to come from the Financial Reporting Council’s (FRC) guidance on preparing a strategic report and from going concern recommendations.
Initiatives like this may be seen in isolation as a fresh set of disclosure obligations or they can be viewed as the start of a wider evolution in the relevance of business reporting, based on a re-examination of reporting culture. This offers the opportunity for a different perspective in the report more closely aligned with a bank’s own business model and more relevant to an understanding of how its prospects have been developed and protected over the short-medium and long-term. Below are three ideas for evolving banks’ reports from data tables to documents that better support an analysis of shareholder value. These ideas build on recent reporting developments in the sector and the emerging area of integrated reporting.
They also draw on the wider reporting experience of other sectors.
The link between earnings and the financial risk decisions taken needs to be made more clear
More than any other industry, the risk decisions taken by a bank have an immediate impact on financial performance. They are essential context for an understanding of current earnings. Recent reporting initiatives by financial services regulators, securities regulators and industry working parties (e.g. the Enhanced Disclosure Task Force) have significantly improved the information reported on the risks being taken by banks. However, investors still need help to connect this information with its implications for current and medium-term business performance. A significant step would be to bring an earnings focus to the extensive balance sheet risk information now being provided. Linking risk reporting with earnings performance could help investors compare underlying profitability across banks following different risk strategies.
Focus on operational performance to explain business prospects
Analysis of earnings and balance sheet risk provides part of the story of how enterprise value has been developed and protected, but a broader perspective should address the key assets on which business prospects depend. For a retail bank, development of the customer base and the operating platform will be central to business prospects. For an investment bank, a key part of value may lie in its market position, staff base and product range.
The back-to-basics approach of many banks’ strategies has recognized these operational assets as key drivers of value. Bank reporting needs to catch up with these developments. Showing how key business assets, such as the customer base, have been developed and protected could support a more complete assessment of business prospects. This is an area that is beginning to evolve both in internal and external reporting. As it does so, banks need to look to the most relevant measures of performance, whether they be indicators of operational risk (such as key staff retention), indicators of progress in managing risks and opportunities (such as the status of retail branch refresh programs), or operational outcomes (such as customer churn rates). In some cases, the value of this information may lie in its comparability across the sector; in other cases, the bank’s track record over time may be most relevant.
‘Business as usual’ cannot be taken for granted – reports should reflect this
Like any highly regulated business, banks’ relationships with their customers, counterparties, society and government should be central to their long-term future. Financial reporting requirements will continue to evolve in the wake of the financial crisis. But one of the principal concerns of investors will remain ‘What are the long-term business vulnerabilities and how does the bank manage them?’ Reporting needs to provide investors with credible, objective information if it is to support their assessment of the actions taken to preserve the long-term prospects of the business. Banks are investing heavily in ‘citizenshiptype’ reporting. However, these reports tend to focus on ‘Why we are good for society?’ rather than ‘How we have protected shareholder value?’.
The result is that they can look simply like a list of good deeds and are failing to connect with shareholder needs. Investors need objective information on banks’ citizenship agenda to distinguish between organizations that are investing to protect and enhance long-term shareholder value and those that are prioritizing short-term financial performance. Crucial to this is understanding the fundamental implications of the regulatory uncertainties that banks are having to manage as they look to reshape their business models to meet society’s changing demands on the sector. Information on banks’ stress-testing can be a source of better understanding of such complex and inter-related risks.
Communicating the message
Investor presentations have developed as a means of providing the answers to some of the issues raised above. They can be more timely as they are not tied to the annual reporting cycle, but they still have a tendency to respond to short-term earnings over longterm value. Investors are looking for greater confidence that they are being provided with the complete picture. Good narrative reporting that is aligned with the organization’s business model should support the reliability and completeness of the picture presented in other, more timely, communications by embedding it in the organization’s formal reporting processes. Each of these ideas is at a different stage of evolution in reporting terms. Banks need to focus on answering the specific questions raised by all three rather than looking for a single magic bullet measure of shareholder value creation based on a single financial ratio or other metric.
Developing a better business report
These ideas can form a starting point for identifying ways in which banks could improve their dialogue with investors rather than the end point. Narrative reporting should reflect the unique features of each business.
For those looking to explore this further, we suggest three challenges to start the improvement journey:
- Tell your value creation story on your terms by building your reporting around your business model rather than starting from a disclosure checklist.
- Consider what constitutes a ‘good year’ for your business. If it is more than just meeting your earnings targets, are you giving shareholders the information to look beyond the short-term financial performance to see this?
- Ask yourself whether the information provided enables shareholders to form a view over the long-term prospects and value in the business.
This article first appeared in KPMG’s Frontiers in Finance April 2014