Asian bank executives are fixated on retail banking. That’s where the big money is, they say, because as living standards improve in Asia, more and more consumers need banks to help them manage their financial affairs.

Retail banking may be the cool new thing for some Asian financial institutions, but they risk losing out on a big source of potential profit from its underperforming counterpart, corporate banking. While it may be mundane and long in the tooth, corporate banking accounts for 60 to 70 percent of their asset base; in other words, this is their main business. And it is likely to stay so because the vast majority of commercial borrowers in Asia—corporate, midsize, and small businesses—will remain dependent on banks for financial capital and transactional and risk-management services. Alternative sources of debt financing have been slow to develop, and only the top corporations in Asia have access to them. In short, when it comes to serving the financial needs of companies in the region, Asian banks are the natural owners.

Instead, the region’s banks have been pouring money into retail marketing budgets, product development, and customer relationship management. The reality is that few banks can build scale and skills fast enough to generate new profit streams quickly. This approach will take years, and in markets such as Hong Kong and South Korea, with their rising credit card delinquencies and other problems, retail banking is hardly a bed of roses.

The lesson many earnings-hungry CEOs are missing is that a well-designed set of improvements in corporate banking can add 40 to 50 basis points to a bank’s return on assets in 12 to 18 months. A lender with $10 billion in assets, 60 percent of them in corporate loans, for example, would see an additional $25 million to $30 million in profits every year. To get the equivalent result by expanding into the retail business, the same bank would have to generate $1 billion in new assets and capture an impressive 2 percent return on them.

Moreover, the reason senior executives are chasing distant profits in retail rather than trying to fix their corporate-banking businesses speaks volumes about the state of Asian banks. Many of their corporate loans are either underperforming or outright money losers, and taking action would force them to confront long-standing failures in the design and execution of their business models. Until recently, corporate banking was the earnings anchor for many Asian banks. Market restrictions gave local institutions an advantage over foreign competition in corporate lending, and they earned handsome returns from it. This advantage is eroding fast, however, as Asian financial markets open up to foreign players and economic growth slows from the rapid pace of the 1980s and 1990s. Local banks have responded by underpricing their loans to protect market share, a practice that has led to falling profit margins on corporate banking in most Asian markets and to returns on equity well below the cost of capital. And asset quality remains problematic: from 1998 to 2001, bad-loan provisions ate up, on average, 60 percent of all operating earnings for banks across Asia—the equivalent of $180 billion in lost earnings.

Many Asian banks don’t know which of their corporate-banking customers are profitable or why

If the problem in corporate banking is so apparent, why are Asian bankers closing their eyes? There are numerous reasons. The first one is simply information: many Asian banks don’t know which customers are profitable or why. Second, pricing rationally to reflect the cost of capital and risk could reduce a bank’s market share and slow top-line growth, which local stock markets value. Third, shedding the value destroyers would also defy the culture of directed lending that runs deep in many Asian markets. Regulators and policy makers may fear the political and social cost, as well as the loss of face, if high-profile corporations can’t obtain sufficient credit or if their loans are declared nonperforming and their lines of credit cut off. A fourth reason is relationships—this is where all the bankers’ corporate friends and clients are.

Examples of this abound. The tacit and not-so-tacit political pressures that make it hard for banks to base their decisions solely on the facts and to protect their shareholders are on display in South Korea. The government there has compelled banks to provide large industrial-restructuring loans to certain borrowers at preferential rates, often several percentage points below commercial levels. At the behest of the Japanese government, major banks have twice bailed out the retailer Daiei despite its continuing financial problems. It is also easier to avoid taking action when the corporate-banking department is the abode of the employees with the greatest tenure and when senior banking executives, believing that they are the experts, resist bringing in new blood.

Some Asian banks have already begun to extract the money hidden in their existing corporate businesses. They are putting profitability first and abandoning a mind-set rooted in relationship-based lending and volume growth as well as the performance system that promotes it. Two important changes to the business model can help banks move toward more profitable corporate banking.

The first is to focus on select business segments. Many Asian banks must jettison the uniform model they typically employ: large and midsize companies are served with the same relationship-based approach and a common set of products, in which credit is the centerpiece. As corporate-client segments with distinct needs and buying behavior emerge, the days of this one-size-fits-all offering are numbered. In Hong Kong and Taiwan, for example, large corporations want tailored solutions—customized products that go beyond credit to include risk-management instruments. By contrast, midsize and small businesses, which lack the resources and expertise to wade through a host of choices, tend to favor bundled offerings centered on credit. Banks must therefore concentrate on the most profitable and fastest-growing segments in which they have the ability to compete. This course will require them to make a thorough assessment of the buying behavior, the product needs, and the competition in each segment. For most local banks, such an analysis will drive the necessary mind-set change by exposing their money-losing accounts, and it may well lead them to focus on second-tier corporations and on midsize and small businesses.

Having established narrower client segments, Asian banks must then make a second big change: within the segments, they must expand their scope beyond credit to offer lucrative fee-based services, such as cash management, trade finance, and treasury and risk management. Unlike lending, fee-based products typically incur minimal or no charges for capital, making the returns far more attractive. But fee-based offerings are not well developed in many local markets: in Japan and South Korea, for example, they account for only 25 and 17 percent, respectively, of total bank earnings. By comparison, these offerings make up 75 percent of the earnings of leading US banks. As a consequence, fee-based business in Asia makes up for only part of the profit gap created by the underpricing of credit. Asian banks have been slow to develop fee-based business because of a mind-set that treats credit volume as the critical performance metric and bases compensation systems on it.

The shift to focused segments and fee-based services also requires Asian banks to achieve operational excellence in fundamental aspects of the business. The most important target areas are loan underwriting and pricing, account planning, and information-management systems. By strengthening the underwriting process and tying pricing to risk, Asian banks can get on top of their asset-quality problems and ensure that credit produces its share of profits. By developing a systematic account-planning process and getting basic customer data in front of decision makers and relationship managers, banks will be able to determine which customers to protect, upgrade, or shed.

To break out of the corporate-lending trap, one Indian bank decided to concentrate on specific market segments (rather than treat all of its customers alike) and on improving its ability to generate profits from fee-based services. First, it shifted its focus from the 5,000 customers in its corporate portfolio to the top 500, selected on the basis of total wallet size and growth potential. The bank then further narrowed its sample to the top 200 as reckoned by the alignment of the clients’ needs with its own product capabilities and by competitive intensity. These 200 customers account for approximately 50 percent of the bank’s assets and 70 percent of its revenues. The bank has invested in an information-management system that assesses the profitability of the 200 customers individually and tracks the top 30 daily—information it uses to devise account plans and prepare for client meetings. In addition, it has made a concerted effort to develop a cash-management product to distinguish itself in the marketplace, resulting in increased turnover and profits.

It seems a tall order for most Asian banks to match the achievements of this Indian one, but for those that can, the first-mover payoff will be worth the short-term pain. Banks can make their corporate accounts profitable and leave behind the money-losers by recognizing the lucrative segments and moving in on them before the competition does. Those that fail to make this transition could eventually be swallowed by rivals. Although retail banking may be alluring, lenders that retool their approach to corporate banking will help ensure their long-term survival.