Interbank

Journal of Banking and Finance 7 (1983) 355--382. North-Holland

INTERBANK A Bank Management Simulation Exercise Lawrence C. GALITZ University College of North Wales, Bangor, Gwynedd LL57 2DG, UK Received September 1982, final version received January 1983 Management games and management simulation exercises can be used as extremely effective educational tools. As they grow in sophistication, their application in high-level education and management development is spreading. While a variety of company simulation exercises have been available for many years, very few are intended specifically for use in banking applications. This article reviews the use of management games in banking, and analyses one particular exercise - - InterBank.

1. Introduction Management gaming exercises are becoming an increasingly important component of education and training programmes, whether for students, new employees or for experienced staff. If there is a single factor which explains the growing use of these exercises it is probably the simple fact that people learn more effectively by discovering and experiencing something for themselves rather than by being taught about it through formal instruction. A management game provides the ideal vehicle for mounting such an educational expedition. Motivation is another important feature behind the success of management games. A good game will result in a high level of involvement and commitment from the participants, and this can be channelled into learning about the situation being simulated. The motivation arises for a number of reasons. First, normal human nature is stimulated by the competitive element built into many exercises. Second, many exercises exhibit varied and dynamic behaviour as they respond to the participants' particular decisions, and this helps bring the exercise to life. Third, the gaming environment itself provides an interesting and compelling set of activities; the participants present ideas, arrange meetings, take part in discussions and arguments, conduct research, prepare tables and graphs, and make decisions with wide-ranging effects. It is common to find that participants will immerse themselves completely in the exercise, and will carry on working into the small hours of the morning without any extra encouragement. 0378--4266/83/$3.00 © 1983, Elsevier Science Publishers B.V. (North-Holland)

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With this amount of interest generated, participants are eager to succeed in the game. If it is well designed, learning to play the game successfully will be the same thing as learning for real life. The management gaming exercise can therefore provide an inexpensive but highly effective educational tool. Company gaming exercises have been commonplace for the past two or three decades. Whilst they cover most aspects of company operations, they are almost invariably orientated towards a typical manufacturing operation where the company purchases raw materials, performs a number of production processes, and then markets and sells the product on a competitive market. The need to finance these operations is a common requirement, but is not usually a centrepiece of the exercise. Banks are different from most companies. They deal mainly with financial assets and liabilities rather than with tangible goods, and they are more highly geared. With manufacturing companies the production process is a major activity; with banks it has a correspondingly minor role while marketing and finance are key functions instead. Management gaming exercises for company operations are therefore not easily applicable to bank activities. For this reason, a management game to teach banking operations must be specifically designed for this purpose. To the author's knowledge, there are just four such exercises in existence that are generally available. The oldest one is the Stanford Bank Management Simulator (SBMS) [Parker and Carroll (1978)] designed by Robichek in 1965, and regularly updated since then. The SBMS is an exercise designed to simulate the behaviour of a US commercial bank operating mainly in the retail market, but with some wholesale activity. The second exercise is one which was designed in the midseventies by the American Bankers Association and the Federal Deposit Insurance Corporation and is called BankSim [American Bankers Association (1977)]. This exercise is an extremely complex and detailed simulation requiring the players to make literally hundreds of decisions every operating period based upon some forty pages of printed computer output. The third exercise was produced at about the same time in the UK and is now administered by the Institute of Bankers (n.d.). Unlike the first two, which simulate the operation of a whole bank, this exercise is a simulation of a single branch of a large UK domestic clearing bank. This article describes the fourth and most recent banking exercise, InterBank, an advanced gaming exercise that has evolved since its original conception in 1977, and which now makes use of the more advanced computational, analysis and display facilities available nowadays. The major objective of an InterBank exercise is to enable the participants to appreciate and understand the complex links, relationships and trade-offs that characterize banking today. By taking key decisions in the areas of lending, deposits, investments, branch networks, dividend policy and the

L.C. Galitz, lnterBank

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managing of the capital base, the participants can manage all the main operations of a large bank. Experiencing the effects of these decisions enables them to learn how to make better decisions in the future. There are, in addition, a number of subsidiary objectives. The exercise provides a unique overview of overall banking operations that is experienced by very few people in real life. This gives a valuable insight into the way a bank works as a total entity, and allows participants to put their individual areas of specialization into a bank-wide perspective. In dealing with many detailed aspects of banking operations the exercise also enables participants to reinforce and enlarge their understanding of specific banking functions; this is extremely useful for specialists in one area who want to gain some knowledge of other banking activities. InterBank usually involves participants working together in small teams; interpersonal behaviour and the problems of working to time deadlines form another component of the game. Finally, InterBank exploits the latest forms of computer technology to process the teams' decisions and present the results; this gives an element of computer appreciation and shows how computers can help nowadays in high-level management decision-making. The article now starts by describing how InterBank developed from an initial idea into its present form. Following this, it explains how a practical InterBank exercise is run, a n d - l o o k s at both the participants' and administrator's viewpoints. Next, a number of technical aspects of the game are discussed in some detail. Finally, the concluding section provides one suggestion for future developments in bank management simulation exercises. 2. Evolution of lnterBank

In September 1977, the Department of Economics at the University College of North Wales, Bangor admitted its first students onto a new course leading to a BA degree in Banking Insurance & Finance. This combination of subjects was and still is unique within the United Kingdom. The author, who is one of the lecturers concerned with the new degree scheme, had experience with the operation of management games used on the degree in Accounting, which is run within the same department. These games were extremely successful in helping students bring together the separate components of their company finance courses, and enabled them to see how the different aspects of company operations fitted together to produce the whole company working in concord. The effectiveness of these company management games suggested that a similar exercise should be available for students of Banking. None of the games then available were really suitable for the application in mind. SBMS and BankSim were both heavily slanted towards the U.S.

358

L.C. Galitz, lnterBank

banking environment, while the Institute of Bankers game in the UK simulated just ~ single branch, not the entire bank. A further problem with the BankSim exercise arose from its sheer complexity. Apart from the fact that prospective players had to invest a substantial amount of effort to master the working of the game (the manual is well produced, but spans nearly 150 pages), there was a real fear that the volume of information presented to the players would be quite literally overwhelming and would obscure the underlying principles being demonstrated - - the players would not be able to see the wood for the trees. It was decided that a new game should be developed to illustrate the general principles of bank balance sheet management rather than the particular characteristics of a specific country or type of bank. This new exercise would allow participants to explore the inter-relationships and tradeoffs between profitability, liquidity and solvency, between profits and volume of business, and between retail and wholesale banking business. The exercise would also cover other areas of bank management such as marketing and the development of a customer base, investment policy, and representation through the branch network. The new exercise - - called InterBank - - was developed at the Institute of European Finance, a research organization linked to the Department of Economics at University College, Bangor. In December 1977, the author wrote a working paper setting out a detailed specification for the exercise. The paper was discussed within the Institute and, after the third draft, was ready for the next stage. In January 1978, a second working paper was produced providing a specification for the computer implementation of the exercise. Programming then started in earnest, with some assistance being given in the earlier stages by two research assistants who were temporarily assigned to the project. By the early summer of 1978 a first working version of the exercise was ready. 'Working' means that the computer programs ran without failing, but this was only an intermediate stage. Although the programs accepted decisions from hypothetical players, and produced results which moved in the right direction, much work still had to be done to get the exercise to function properly as an educational tool. To explain what this means, we must delve a little into the theory of operational gaming. In most management gaming exercises there is a well defined 'cycle of play' as depicted in fig. 1. Participants will receive a statement of results depicting the situation at the start of the exercise. This will provide a description of their current position and of the operating environment. This information must be analysed carefully so that the players can evaluate what their present position is in relation to their desired state. They must formulate general strategies and specific decisions in order to move their current position to one that is more desirable in terms of their stated goals. The participants'

359

L.C. Galitz, InterBank

Participants receive I results from previous ~ ~ period

(

[

Results are analysed

I Decisions are I analysed by umpire L & results prepared

]

I

strateg,iesand make newdecisions I

(

Fig. 1. Cycle of play found in most management games.

decisions are analysed and a new set of results prepared to show how their position has changed as a result of their decisions. The essence of this cycle is feedback. Players take decisions, obtain results, see where they went wrong, and learn to make better decisions in the next round. For this process to be effective, the feedback must have three qualities: (i)

the feedback must be recognizable q players must be able to distinguish from the results those features which were a consequence of their decisions and those which are extraneous or due to other causes, (ii) the process must be controllable q it must be possible to alter the current position by taking the right decisions; while random events add interest to an exercise, their effects should not dominate the players' decisions, (iii) the feedback must be acceptable - - for the exercise to remain credible, the behaviour of the process must appear acceptable to the players. Here a distinction must be .drawn between a model used for management decision making, and one used within a management gaming exercise. The aim of the first kind of model is to produce answers which are as close as possible to real life, so that the model can be used to determine what would happen in reality if particular decisions were taken. The second model must also bear close resemblance to reality, but there is a different aim. For the model used within a management game, the results produced must be arranged to maximize the effect of the feedback given to players, thereby ensuring that the learning experience is effective. For this reason it is often found necessary to introduce some 'gamedesigner's licence' into the construction of a management gaming exercise. The effects of some decisions must deliberately be exaggerated to ensure that the results will not be obscured. Time scales must be accelerated to make sure that the effects of a decision will be realized during the course of the exercise. A compromise must be found between realism and credibility on the one hand, and educational effectiveness on the other.

360

L.C. Galitz, lnterBank

In addition to this, the behaviour of the game must be 'tuned' very carefully. On the one hand, the exercise must be a challenge to play, but must not defeat the players, especially at the beginning. On the other hand, the exercise must not prove too easy or obvious. Furthermore, the behaviour must be adjusted so that it feels right for the players, and performs correctly as a learning device. Work continued on the InterBank project through the second half of 1978, and it was not until the end of that year that a robust and properly functioning version of the exercise was ready. The exercise was first used on student groups on various banking-related courses at the university, and as a result of these a number of improvements were made to the workings of the internal models. At that time it became apparent that there was a wider market for the use of the InterBank exercise, and in May 1979 the game was launched for commercial use. A number of exercises were run towards the end of 1979 for several banks, both national and international. These exercises produced invaluable feedback, because they provided the first occasions on which the internal models within InterBank received exposure to participants having practical banking experience, sometimes at a high level. Many of the ideas and suggestions made by commercial bank participants on these early courses were incorporated into InterBank at the beginning of 1980. The resulting enhancements, improvements and additional facilities led to a considerable increase in the realism of the InterBank exercise. Currently, InterBank is used by six banks operating within the UK and Europe, and this number is expected to grow. Participants on these courses vary from graduate recruits right up ~o senior management level. InterBank is suitable across the entire spectrum of participants' backgrounds because the complexity of the exercise can be adjusted to suit the level of expertise of those taking part. On courses involving graduate recruits, InterBank comes at the end of an intensive two month induction course, and serves to tie together many of the separate aspects of banking and commerce that they will have studied during that time. For senior management, InterBank is often run for participants who currently manage the overseas territory of an international bank, or for those who are shortly to assume this role. The overseas operations of international banks are often self-contained and semiautonomous, so that running an overseas territory in real life is directly analogous to running the whole bank simulated within InterBank. This factor largely explains the popularity of InterBank with large international banks. InterBank is still used on banking courses at Bangor university, and the exercise has also been run for some non-bank commercial organizations and for other educational establishments. While minor enhancements are still being made, particularly to keep up with the ever-changing world of banking, InterBank became a mature exercise in mid-1980, and now embodies the experience of handling the decisions from many hundreds of participants.

L. C. Galitz, Inter Bank

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To give a better impression of the way an InterBank exercise is run, the next section describes InterBank in practice.

3. lnterBank in practice As with similar exercises, InterBank can be run in two ways. Either it can be run as an intensive event lasting between three and five days, or it c a n be run over an extended period with players taking decisions once a week. The first method is strongly preferred because it gives a chance for the participants to really immerse themselves in the exercise, and to concentrate on their various tasks without distraction. The game administrator can ensure that the environment in which the exercise is run allows the m a x i m u m gain to be made from the learning opportunities available. In contrast, if the exercise is run over an extended period, the participants usually find it difficult to dedicate the time and energy necessary for the exercise to yield the m a x i m u m benefit. Running the game over an extended period does not necessarily save time either. It is often found that players need to spend considerable amounts of extra time getting back into the exercise each time they approach a decision period; playing the game without interruption means that all the relevant information is carried in their heads. InterBank is almost always run as a team exercise. Although the exercise could be run for individuals competing against each other, grouping participants into teams adds an extra dimension to the exercise for a number of reasons: (i)

The volume of work necessary to make successful decisions is too much for a person to carry out on his own in a reasonable time. (ii) A single player will probably consider only a limited number of alternative strategies, and cannot discuss their merits with anyone else. In a team, each member can put forward ideas for consideration by the group as a whole. A richer selection of alternatives can be considered and debated thoroughly before the team commits itself to a particular course of action. Teams almost always produce better results than individuals working separately. (iii) The participants can experience some of the problems which arise when people try to work together as a group. The team must find an efficient organizational structure (committee, hierarchy, or some other structure), they must be able to resolve differences of opinion or personality conflicts, and they must timetable their activities in order to meet the time deadlines set by the administrator. The teams are allocated by the game administrator at the start of the exercise. With three or fewer members to a team, the workload becomes excessive and m a n y of the benefits of teamwork are lost. With six or more,

362

L.C. Galitz, lnterBank

the group becomes unwieldy and the team will often separate into a dominant sub-group which does all the work, while the remainder do nothing and gain little from the exercise. Four is the optimum number. When selecting the individuals for a team, the administrator will try to obtain an even spread of age, background, experience and abilities among the teams, to ensure as reasonable a balance as possible. If time permits, the teams meet before the formal start of the exercise in order to get to know one another, to read through the InterBank Participants' Manual as a group, and to carry out some initial and informal discussions. The exercise proper starts with a detailed briefing session when the administrator introduces InterBank, sets out the objectives of the exercise, explains how it will be run, and then goes through the Participants' Manual page by page, emphasizing key points and answering any questions that arise. Three areas which receive special mention are: the importance of team management, preparing a corporate plan, and analysing the information available each period. At the end of the briefing session, the administrator will outline the economic environment that is likely to obtain during the first few operating periods (teams will receive updated economic bulletins as the exercise unfolds). This economic environment will have been programmed into the exercise by the administrator prior to the briefing session, and can be varied from one exercise to the next. The teams then retire to their syndicate rooms to undertake three specific tasks. First, they must formalize their team organization. They need to decide whether they are going to decide everything together as a committee, whether they are going to adopt a hierarchical structure with all tasks and responsibilities delegated to individuals, or some intermediate form of constitution. Whatever they adopt, a chairman is elected to act as spokesman for the team. Their second task is more difficult but is of crucial importance. The teams must each decide upon their individual goal. Sometimes there appears to be a conflict between those who simply want to 'win' by becoming the most successful and profitable bank, whilst others want to use the exercise as a means to learn as much as possible about managing a bank. These are not necessarily mutually exclusive, of course, but it is often found that the teams who do least well in terms of managing a profitable bank within the exercise end up by gaining more in educational terms than the more successful teams. Once their goal is decided, each team must decide on an appropriate set of strategies that will allow them to achieve their stated goal. Teams are briefed to distinguish carefully between strategies - - which are a means to an end and goals - - which are an end in themselves. All too often in real life, the two become confused. The statement 'we want to be the biggest bank' is

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363

perhaps valid as a strategy, but in most cases is not a goal in itself. A useful test is to see whether a statement purporting to express a goal invites the question 'Why?'; if it does it is most likely that the statement only describes a strategy as a means to get to some unspecified higher goal. In designing strategies, teams must assess the pros and cons of each alternative. For every decision that they can take there are several good effects and several bad ones. Teams must weigh these up and decide accordingly, taking into account the links that one decision area has upon another. Among the trade-offs facing participants are the following: (i)

(ii)

(iii)

(iv)

(v)

Lending - - should the bank's retail lending be spread across all the lending sectors open to it, or should it specialize in just a few? If specialization is chosen, how should the various retail sectors be compared in terms of their profitability, seasonality and risk? Should the bank compete in the market for wholesale loans, which are highly competitive and therefore result in finer margins? Deposits - - how will the bank control its deposit base? What are the relative merits of retail deposits, which have low direct costs but which require an expensive branch network to maintain, compared with money market deposits, which are more expensive in terms of direct costs, but which are easier to obtain? Investments - - should effort in this area be directed towards securing the maximum possible return from the investments portfolio (i.e., an active strategy), or should they just be managed to provide sufficient liquidity (i.e., a passive strategy), allowing the team to direct valuable resources elsewhere? Corporate operations - - what will the bank do about its branch networks? Will they stay at their current size, will they be expanded, contracted, or closed down altogether? If significant changes are planned, over what time span will they take place? Will there be a need to raise additional capital? If so, when is this likely to be, and what form of capital (debt vs. equity) is preferable? What is the bank's attitude on dividend policy? General - - how large will the bank become, and will sudden changes in size cause problems? How important is time? Will the team be content to sacrifice short-run profits for greater success in the longer term?

The second task is completed when the team has drawn up a corporate plan stating their goal or goals, and outlining a set of strategies that they hope will take them there. Teams are urged to make their corporate plan as quantitative as possible for two reasons: the figures can be used to indicate the magnitude of decisions that will have to be made, and the plan itself can be used as a quantitative yardstick for teams to measure their actual

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performance against their initial expectations. The plan itself should also have some element of flexibility built in, so that there are contingency measures available if things go wrong later on. When complete, a copy of the corporate plan is submitted to the game administrator. He may make some comments at this stage, but will not usually suggest changes unless the plan is seriously defective in some way. Several hours are normally allocated for these two tasks. The final task is for the teams to make a detailed set of decisions to carry their banks through the first period of operations, which has a simulated duration of three months. Participants often find that, despite the comprehensive briefing, and discussions before and after, there are several elements of the game that they have been so far unable to grasp. This is only to be expected. If the game were simple enough to be understood fully before the first period's decisions, there would not be enough content to maintain interest through a dozen or so operating periods. It is invariably found that participants become 'at home' with the exercise around the third operating period, but would nevertheless prefer the exercise to continue when the end is eventually called after ten or twelve periods. The teams' decisions are then submitted for processing on a computer, with the printed results being available after a delay of about twenty minutes. While teams can develop their strategies right from period one, the exercise is constructed so that nothing drastic can happen at the very beginning. Teams can get positive feedback from their first period's decisions, but it is unusual for there to be a wide separation in performance in period one. This is done to prevent participants becoming demoralized straight away if one team is shown to be performing very well, or another to be doing very badly. The results presented after every period provide a comprehensive statement describing how each team is performing, both in isolation and in comparison with other teams. The computer does not only print the basic figures, it also performs many other calculations for the teams thereby freeing them from the drudgery of having to perform routine arithmetic. This leaves them free to concentrate on the more important areas of analysis. Table 1 summarizes the main reports which each team receives, while table 2 provides an illustration of some of these reports. Every four periods each team also receives a set of financial statements giving the published accounts for all the competing teams; this provides additional information allowing participants to measure where their bank stands in relation to their competitors. Once the teams have the results from their initial decisions, the exercise really gets under way. The cycle of results-analysis-decisions, as shown in fig. 1, continues with teams submitting decisions every two "hours or so to begin with, this period becoming progressively shorter as familiarity with the exercise grows.

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365

Table 1 Management information available to teams each period. lending interest rates, averages and spreads; lending marketing expenditure, averages and spreads; new loans acquired; existing customers lost; bad debt losses. (All these on a sector by sector basis.) Retail lending performance review - -

Deposits performance review - - cheque account volume, discretionary charges waived, average

charges waived by all banks; saving deposit volume, interest rate paid, average rates and spreads; wholesale loans raised, interest paid; money market certificates of deposit issued, and interest rate paid. B a n k base rate - - own bank base rate; average base rate for all banks.

size of rural and urban branch networks for own bank; average size of branch networks for all banks.

Branch network - -

Confirmation o f market decisions implemented - - showing all investment, money market and capital market decisions effected during the past period. S u m m a r y performance statistics - -

key ratios and other useful ~tatistics summarizing bank

performance. Statutory ratios - - values of key regulatory ratios that bank must adhere to. Detailed profit and loss account - - breakdown of all items of income, expense, depreciation, bad

debt provisions, extraordinary gains and losses, taxes and dividends paid, and retention. Statement o f unrealized gains and losses - - showing position if entire investment portfolio were

to be liquidated at current interest rates. Percentage analysis o f profit and loss acount - - a breakdown of the P & L account expressed as

a percentage of total income, facilitating comparison of performance between periods. Detailed balance sheet - - showing all assets and liabilities. Cash f l o w report ~ showing inflows and outflows of cash during the current period. M a t u r i t y analysis o f balance sheet - - a breakdown of all balance sheet items having a fixed

maturity date, facilitating the production of cash flow forecasts. Portfolio breakdown - - a detailed listing of all items carrying a fixed date to maturity; includes marketable investments, money market deposits and debt capital. Wholesale loans analysis - - current portfolio of wholesale loans; loan losses; new wholesale loans acquired; announcements of new wholesale loans available. Economic bulletin - - statement of current figures and forecasts for: bank base rates, money

market rate, investment interest rates, unemployment, inflation, GNP, loan demand by sector, deposit availability; new regulatory controls or amendments to current controls.

While the exercise is in progress the administrator performs some vital tasks. Most important of these is the close supervision of each team's progress, something that is facilitated by a special administrator's report produced by the computer. This special report gives an in-depth analysis of all aspects of the teams' progress, and an extract from this report appears in table 3. After the results are produced and distributed to the teams, the administrator spends the first five or ten minutes of the next decision period reading his

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Table 2 Extract from team's printed reports. InterBank results Team 1

Page 5

Period 12

Percentage analysis of profit & loss account (total income = 100% = 725m) Income

Outgo

ENGR AGRI CLTH ELEC PERS LBID Loan commissions

10.79% 24.00% 4.24% 22.52% 8.49% 6.30% 6.52%

Loan marketing Loan administration Loan losses 7 DAY interest + exp. C U R R running costs CDFX interest W H O L interest

CURR charges Liq. inv. income Oth. inv. income

0.00% 11.35% 5.79%

Operating expense Other expense Total outgo Gross oper. income Total outgo + Goi

Total income

100.00%

0.41% 2.39% 4.61% 23.15% 18.96% 11.67% 6.76% 18.67% 3.23% 89.84% 10.16% 100.00%

Detailed balance sheet Liabilities

£ million

Assets

£ million

SHAR CRES RRES PROV DEPN CDBT TAXN DIVI CURR 7 DAY CDFX WHOL

235.000 214.050 622.083 41.533 87.592 513.156 156.180 23.500 9,366.680 8,971.410 0.000 3,818.950

CASH CALL TBIL ASCD GILT SDEP AFIX ENGR AGRI CLTH ELEC PERS LBID

1,107.850 0.000 0.000 0.000 3,815.760 219.913 574.545 3,604.600 6,139.610 732.848 4,529.120 1,773.390 1,552.490

Totals (TOTL)

24,050.100

No. of shares issued: 235m Cash flow report

Current Total

£ million 1,107.850

Last period Cash income Cash expense Maturities Level changes Current decisions

1,099.560 830.335 680.8841,890.740218.606 1,530.970

Totals (TOTL)

24,050.100

L.C. Galitz, InterBank

367

Table 2 (continued) InterBank results Team 1 Period 12

Page 6

Maturity analysis of balance sheet < 3 mth

3-6 ruth

6--9 mth

9-12 mth

1-3 yr

2700.000 0.000 2700.000 0.000 0.000 0.000

60.000 1256.490 1316.490 0.000 0.000 0.000

> 3 yrs

(a) Maturity-certain categories (based on par values) GILT LBID Total WHOL CDBT Total

130.000 50.000 180.000 3818.950 0.000 3818.950

0.000 0.000 0.000 0.000 0.000 0.000

0.000 150.000 150.000 0.000 0.000 0.000

930.000 96.000 1026.000 0.000 500.000 500.000

(b) Maturity-uncertain categories Retail deposits Misc. liab's Equity capital

18,338.100 308.805 1,071.130

Overdraft lending Misc. assets Fixed assets

16,779.600 1,327.770 574.545

Details of marketable investments, money market deposits and debt capital £ million. GILT Mat (I0

Par

Orig.Yld

Coup

BV

0.25 1.00 2.75 3.50 5.25 7.00 27.00 28.00

130.000 2,700.000 60.000 125.000 75.000 130.000 100.000 500.000

13.7500% 10.0625% 8.6875% 8.6250% 8.5000% 9.1250% 9.5625% 10.6875%

14.0000% 10.0000% 8.7500% 8.5000% 8.5000% 9.0000~ 9.5000% 10.5000%

134.552 2,698.430 61.389 124.536 76.577 129.173 99.399 491.703

Total par = 3820 Total book = 3815.76 WHOL Mat (D)

Par

I/R (est)

3,818.950

9.7500%

Mat (I0

BV

Iss. Rate

17.00 18.25 19.25 19.75

50.000 206.000 154.031 103.125

91 Total par = 3,818.95 CDBT

Total par = 513.156

7.0000% 12.0000% 10.7500% 12.5000%

MM Deps/TD Avg cst deps Mrg cst deps Loan-dep mgn

Rsv assets Capital Free assets NI/equity NI/assets Loans/deps

D E P S

R A T I O S

Capital gains Net income Divi's dclrd Ret'd earn's

EPS Share price B/S size Rural branches Urban branches

ENGR AGRI CLTH ELEC PERS

L O A N S

Period

2

3

4

31.63 **2.24 11443 1500 1000 0.000 15.817 0.000 15.817

46.44 **'2.19 10845 1250 1000

0.000 23.220 0.000 23.220

14.79% 19.64% 6.68% 6.46% 4.25% 4.08% 14.29% 9.40% 0.86% 0.55% 70.69% 72.47%

0.000 21.274 0.000 21.274

42.55 *'2.31 12192 1750 1000

21.05% 6.24% 3.94% 12.35% 0.70% 72.25%

19.36~ 18.37~o 14.37~ -- 2.41~o - 1.99~ -- 2.77~ 1.25% 1.25% 1.19% 5.04% 4.24% 5.25%

0.000 43.495 20.000 23.495

86.99 **2.38 13285 2000 1000

12.75% *5.90% 3.72% 24.49% 1.31% 76.98%

16.59~ - 3.42~ 0.38% 6.23%

89.6~ 81.8~ 80.4~ 79.5~ I01.5~o 109.2~ 127.4~ 145.4~ 92.6~ 80.2~ 7 3 . 4 V o 72.8~o 97.1~o 127.6~o 139.7~ 149.3~ 106.2V0 96.3Vo 9 0 . 0 ~ o 102.1~

1

0.000 58.651 0.000 58.651

117.30 ***2.77 14276 2000 1100

*12.38% 7.31% 5.16% 31.97% 1.64% 80.50%

22.44~ -4.02~ -0.88% 7.11%

59.1~ 172.7~o 68.3~ 159.2~ 103.5~o

5

7

9

10

26.1~ 3 8 . 4 ~ o 62.2~ 207.4~o 224.1~o 229.5~ 59.6~ 57.2~ 64.4~ 186.6~ 193.0~ 201.6~ 123.0~ 125.6~ 132.8~

8

12 65.0~ 87.1~ 233.7~ 234.6~o 5 2 . 6 ~ o 28.2~o 193.3~ 178.3~o 132.3~o 107.5~o

11

43.43 **2.74 15285 2000 1300 0.000 21.717 0.000 21.717

0.000 29.779 0.000 29.779

15.06% 7.16% 4.91% 10.56% 0.57% 80.23%

59.56 ***2.76 14324 2000 1200

16.85% 7.53% 5.26% 15.03% 0.83% 77.74%

68.91 **2.88 20726 2000 2000 0.000 34.453 0.000 34.453

0.000 27.465 20.000 7.465

0.000 34.480 0.000 34.480

68.96 **2.99 22645 2000 2000

15.61%14.37% 6.21% *5.87% 3.75% 3.66% 16.19% 15.57% 0.66% 0.61% 77.67% 80.24% 54.93 **2.77 17688 2000 1400

18.07% 6.26% 4.21% 13.02% 0.62% 74.83%

0.000 14.029 0.000 14.029

28.06 **3.04 23987 2000 2000

13.73% 6.40% 4.34% 6.10% 0.23% 81.23%

25.843 61.205 23.500 37.705

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14.02% 6.59% 4.56% 23.69% 1.02% 82.74%

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6

Extract from administrator's report.

Table 3

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L.C. Galitz, lnterBank

369

own report and making a detailed assessment of the new position of each team. He will then visit the teams one by one. Several things can happen during a visit. Participants will frequently ask questions. Where these involve simply issues of clarification, the administrator will answer them directly. If the questions involve the understanding of a basic principle, the administrator will perhaps give a mini-tutorial, or will show how the team members can discover the principle for themselves. The concept of self-discovery is an important one within management games; a concept discovered for oneself is appreciated and retained better than one which is simply explained. Sometimes a participant asks a question that invites the administrator to reveal more information than would be available in real life, and which would give too much away. This kind of question is not ignored but is used as a means to get the team thinking about ways to find an answer for themselves. Occasionally, the administrator will need to prompt a team into thinking more carefully about their decisions and the interpretation of their results. In all these cases the administrator's task is a delicate one. He must provide just the right amount of help and assistance. Too little, and the teams will not perform as well or learn as much as they might; too much, and the teams become lazy and expect their work to be done for them. Fairness must be maintained, to ensure that one team is not given more assistance than another. A team that is doing badly must be given sufficient help and encouragement so that they do not become demoralized and give up; they must not, however, be given so much assistance that they turn round and overtake the leading team if that is not within their inherent capability. In the end, the most skilful team should be the one achieving the best performance, and every participant must feel that the eventual outcome was just. To supplement the assistance which the administrator can give in person, a series of Help-sheets has been prepared, and these can be distributed to individual teams at critical stages during an exercise. The Help-sheet series currently spans the following topics: (1) (2) (3) (4) (5) (6)

Preparing a corporate plan. Key performance figures. Cost of deposits. Profitability of loans. Cost of capital. Capital gains and losses.

The administrator has several other roles to play. In addition to supervising the performance of the teams from an educational viewpoint, he must also supervise the condition of the banks for prudential reasons. J.B.F.-- C

370

L.C. Galitz, InterBank

Representing the regulatory authorities he must monitor the banks' statutory ratios, and impose penalties if these are infringed. He also assumes the role of the capital market, and teams wishing to raise additional equity or debt capital must negotiate amount and price with him. Finally, although the economic environment is established by the administrator prior to the start of the exercise, he can manipulate the teams' periodic economic bulletins and can thus affect their perception of what will happen over the next few periods. A unique and important feature of the InterBank exercise is the annual review. If the game were played without a break from beginning to end, many teams would soon find themselves making sterotyped decisions without really thinking about the reasons behind them or the consequences. To prevent this, the exercise is halted every four periods for an annual review. The purpose of this is to get the participants to stop and think about their progress to date so that they can improve their performance in the periods that follow. At the beginning of the review, all the teams are given a handout which asks searching questions about their performance so far. If they have not been doing so already, the teams are encouraged to set up a proper management information system to track and highlight key measures of their performance, and to arrange this information (using visual aids like flip charts and graphs) so that it is readily accessible to all team members. These measures are all available from the regular printouts, either directly or after a small amount of manual calculation, but presentation in the right format can make a considerable difference to its utility. The novel part of the review comes when each team in turn is invited for a consultation with the administrator aided by a specially designed graphics display system controlled by a microcomputer. This system is loaded with every piece of information about all the teams for the entire exercise so far. The administrator can call up any part of this mass of data and present it on a graphics display screen in the form of cross-sectional or time-series graphs and charts, all in colour. By displaying the information in this graphical way, relationships between decisions and results, and between different aspects of a team's performance, all become readily apparent when before they might be hidden within a wealth of tabular data. During this stage of the review, the administrator can use the display to illustrate vividly those areas where a team is doing well, and those areas where it is performing badly. When the teams resume their decision making activities, they are aware of the reasons behind their previous mistakes and can take rectifying action. Fig. 2 depicts two graphs which many teams find illuminating; 2a shows the inverse relationship between the average cost of deposits and the loan deposit margin, 2b shows the strong links between the loan-deposit margin and total profits. Both are taken from the

371

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figures of a real exercise, though it is not possible to reproduce here the full colour visual display that the teams will see. The annual review sessions undoubtedly provide a significant contribution to the success of an InterBank exercise. When the exercise resumes after the annual reviews, it is normal to find considerable improvement.s in performance. The results-analysis-decisions cycle continues until the time comes when the administrator judges that teams have gained the maximum learning benefit. The exercise is then halted and the teams are issued with a set of guidelines to herp them prepare presentations. These presentations are in two halves. The first half is general in nature and covers such issues as the setting of initial objectives, the organizational methods that teams adopted, adapting to changing circumstances, and an assessment by each team of what it perceived was its biggest mistake. The second half of each presentation is more specific, and each team is allocated a topic that falls within one of their particular areas of specialization. The presentations are a mixture of formality and informality. Participants are encouraged to prepare and give professional presentations, as they would to senior management. At the same time, the occasion provides the first opportunity for teams to reveal secrets and to ask questions of one another. Finally, an InterBank exercise finishes with a debriefing session. Here the administrator brings up any topics still unresolved, and ties up any loose ends. The computer graphics system is used to advantage here as well, because the administrator can select and display important aspects of each team's performance and use these to illustrate and confirm many key principles. This technique has greater impact than conventional teaching methods because it draws on the participants' own experience. In addition, there is a range of other teaching packages using computer graphics which the administrator can use to illustrate other principles. Examples include a graphics display of loan loss experience, and one which demonstrates the behaviour of bonds under changing interest rates. Participants hold the key to their own success within the InterBank exercise. This success depends mainly upon their ability to set goals, decide upon strategies, devise plans, analyse current information, make decisions and analyse the effects. The administrator acts as a powerful catalyst to ensure that the learning opportunities are exploited to the full, and that all runs smoothly. Enthusiasm is never in short supply. Taking part in an InterBank exercise provides a wealth of experience for the participants. They will learn many new concepts, and their understanding of existing ones will be strongly reinforced. Among the many topics that are covered are the following:

L.C. Galitz, lnterBank

373

--calculating weighted average costs, --marginal costs/revenues versus average costs/revenues, --fixed versus variable costs and the volume/profit trade-off, --calculating profitability and comparing profitability in different periods, - - t h e problem of expanding too quickly, --operating in a competitive market; the advantages of obtaifiing a headstart, and the problems caused by falling behind, --cash flow planning and the management of liquidity, - - t h e effect of dividend policy on share price, --managing the capital base, --the behaviour of investments under changing interest rate environments, - - t h e importance of a well-designed management information system, --the effectiveness of graphical presentation techniques, - - t h e need to manage the separate components of a complex organization in harmony, - - t h e need to observe safety, particularly in an uncertain environment, --the ability to identify and extract information from a mass of data, --the interpretation of statistics, their use and abuse. The InterBank exercise embodies a great deal of technological development and innovation, and the next two sections describe just some of the banking and computational aspects that are involved.

4. Bank simulation aspects Within the scope of this article there is only room to discuss one or two of the many components which together form the workings of the InterBank exercise. This section selects some of the more interesting features. One problem that sometimes arises in management games occurs when one team takes extreme decisions. If the exercise simulates a closed market, this can have the undesirable effect that the team in question grabs a dominant share of the market at penal expense, puts itself in jeopardy, and spoils the exercise for the other teams. One way to get round this difficulty is for each team to compete in a separate simulated market, but this removes the element of direct competition between teams that is an important part of many management games. InterBank surmounts this problem in two ways. First of all, the InterBank exercise is never played with just the human participants in competition. Within the simulated market there are always a number of background teams managed by the computer. These background teams are programmed to run their banks in a mildly aggressive fashion. They do not go so far as to observe the detailed decisions made by the human players, and deliberately take counter measures. They nonetheless

L.C. Galitz, InterBank

374

provide a general background of competition, and the participants must take this into account. There are two significant benefits obtained by having these background teams. First, it prevents a strategy whereby most or all of the active teams get together and establish an interest rate cartel unfavourable to customers; if they were to try this, the teams would all lose business to the background teams. Second, the presence of a number of background teams dilutes the impact of extreme decisions taken by one or more active teams. Instead of that team acquiring a large market share solely at the expense of the other active teams, it obtains part of the increase from the active teams, and some from the background teams. The net effect is that each active team will have a competitive influence on the others, but this will not be so great that the decisions of one team can completely wreck the opportunities for another. The second feature within InterBank that prevents a single extreme decision from having an extreme effect arises as a consequence of some of the techniques used to process teams' decisions. Every decision that a team makes in a closed market is transformed into a competitiveness factor CFi, where CF~ is the factor for ith decision and is scaled so that a neutral stance has a CF of unity. These factors are not used in their raw state but are passed through a special function S(CFi, P~). Fig. 3 illustrates a family of Sfunctions having different values of the parameter P. The S-function is designed to have several specific properties. First of all, the function approaches asymptotic values for extreme values, of CF~, with

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limits defined by the following expressions: lim S(CF~,P~)=5.2,

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No matter how competitive a team's decisions are, each one cannot result in a value of S greater than 5.2. At the other extreme, the worst S that a team can have is 0.2. The S-function serves to limit the influence that a single isolated decision can have, and defines at the same time a law of diminishing returns. The purpose of the parameter P is to control the sensitivity of the Sfunction. If P is set to 4 or 5, S becomes extremely sensitive to very small changes in CF, and subtle movements in a team's competitive stance can have a significant effect. If P has a small value of 0.1 or 0.2, S will respond little to wide changes in CF. In most cases this parameter is set to a constant value which will govern the impact that a particular decision will have on the bank's competitive position. In some cases, however, the parameter is made dynamic, and will change through the course of the game. A goo d example of the use of competitiveness factors is the case of interest rates charged by banks for retail loans. The CF derived from a bank's interest rate in a particular sector compared with that of its competitors will be a major influence on market share. A low rate will lead to a higher market share and vice versa. The magnitude of this relationship is made to vary with the state of the simulated economy. In boom periods, customers are affected more by a bank's marketing and are less sensitive to interest rates. In times of depression, interest rate differentials between banks become highly significant, and especially so for those retail lending sectors with traditionally finer margins. This effect is achieved by linking the P parameter to economic indices available within the model. Fig. 4 illustrates a family of CF curves for the interest rate and marketing factors under different economic conditions. The modified CFs are used multiplicatively to determine the cumulative effect that many separate decisions will have upon an aspect of bank operations. To get the total factor F from three component factors, a typical expression will take the form

F=S(CF~,PO" x S(CF2,P2) b x S(CFa,Pa) ~,

(3)

where a, b and c are used to further modify the behaviour of the separate CF components. Complex and dynamic circumstances can be modelled with this technique. For example, the sub-model used to determine the interest rate a bank will have to pay if it raises wholesale deposits on the money markets

L.C. Galitz, InterBank

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includes four factors: the volume of deposits bid for in relation to the bank's size, the total demand by all banks for these deposits, confidence in the bank as measured by its quoted share price, and the bank's reputation as users of the money market. The interplay among these factors will result in teams experiencing a U-shaped curve for wholesale deposit rates depending upon the volume they wish to raise. A small volume will often result in a relatively high rate if the market is unfamiliar with the bank's paper. As more is issued by a sound bank, the interest rate will drop until a minimum point is reached; after this the rate will rise as the volume in issue becomes a significant component of the bank's liabilities. This behaviour is demonstrated in fig. 5. 11,8 11.6 11.4 11.2

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Loan losses are another interesting aspect of the game. For retail lending bad debts are computed for each retail lending sector in turn using the following expression:

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L.C. Galitz, lnterBank

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This expression takes the basic percentage loss rate for each sector Lk, introduces a stochastic element whose magnitude increases with the riskiness of the sector, modifies this depending on prevailing economic conditions, and adds a further factor whose value depends upon the interest rate charged by the bank to that sector. (The final term is simply a scale factor.) The effect of this is to worsen loan losses when times are bad, and when the bank charges excessively high interest rates, and to add a chance element that is particularly uncertain for those sectors with a high intrinsic bad debt rate. Fig. 6 illustrates the resulting probability distributions for loan losses.

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Not only does this formulation provide a realistic feel to the behaviour of bad debts within the exercise, it also demonstrates very powerfully the true meaning of risk. Risk in lending is not the presence of a high bad debt rate as such, but is the unpredictability of losses. Loan losses for wholesale loans are sampled from a random Poisson distribution. Much more could be said about the way InterBank simulates other aspects of bank and market operations, such as the behaviour of the retail loan market (acquisition of new loans and turnover of existing customers), generation of yield curves for investments, the provision of separate economic forecasts to each team, the competitive bidding process for

L.C. Galitz, lnterBank

379

wholesale loans, calculation of team share prices, and so on. Unfortunately, this would require an article of considerably greater length. Instead, we turn now to consider some of the computational aspects that underlie the InterBank exercise.

5. Computational aspects Eq. (4) above is an example of just one of literally tens of thousands of calculations that need to be performed for each team each period in order to generate the detailed set of operational results. This task would be unthinkable without a computer system. InterBank comprises a suite of programs that are designed to afford the administrator the maximum help with the least fuss. Within the tight schedule of an exercise, there is no time to deal with computer generated problems. A great deal of effort has therefore been expended to ensure that the computer system is easy to use, that it will detect and report operator errors before they cause difficulties, and that it is completely bug-free. There are four systems that are responsible for the main processing, and their function is summarized in the following paragraphs. (i)

DECSYS - - this is an interactive screen-based decision entry system. It allows the administrator, or his assistant, to enter the teams' decisions in any order, to inspect the decisions entered so far, and to make any corrections that are necessary. The screen display presents a facsimile of the teams' decision input form for easy comparison with the original. When all the decisions are entered, DECSYS will perform a detailed validity check to ensure that no errors still remain. (ii) PROCES - - this is the main processing system. The work is split into two k e y stages. Stage one deals with all aspects of inter-team competition. The entire set of team decisions are loaded into memory and are processed in parallel so that all the interconnected aspects of team behaviour can be handled simultaneously. Stage two carries out all the detailed accounting calculations for each team in turn, and prepares the reports ready for printing. The operator is kept informed of progress as the processing proceeds. (iii) LISTER - - is a utility system that allows the operator to print out any of the reports that have been prepared by the PROCES system. (iv) BACKUP - - provides a safety facility to back up all files after each period's processing activities are complete. A separate set of four systems is responsible for providing the graphics display facilities that are an integral part of the InterBank exercise. The main program is called IGDS - - InterBank Graphics Display System - - and is a

380

L.C. Galitz, InterBank

custom-designed interactive package which allows the Administrator to extract any item or time-series and display it on the screen using any one of three formats. Up to four sets of data can be displayed simultaneously in full colour, with all scaling and descriptive labelling of graphs being done completely automatically. There are currently 115 time-series maintained on file for each team. IGDS operates rapidly, and a completed display can be ready within eight seconds of the operator's request. IGDS is used extensively in the annual review sessions, and at the final debriefing. Originally, the main processing was done on a timesharing bureau connected to a data entry terminal and fast character printer via a highspeed portable data link. Whilst this arrangement was satisfactory, there were problems of variable response speed, line noise and heavy timesharing costs,

In the summer of 1981, research was undertaken to see if the suite of programs could be transferred to a mini- or micro-computer. It transpired that this was indeed possible, and an extensive amount of work was undertaken to transfer and convert the suite of programs from the large mainframe to a small microcomputer. A certain amount of rewriting was found to be necessary, and skill had to be exercised in order to fit several gallons worth of program into a pint computing pot. The conversion has been a success, and fig. 7 depicts the current computer configuration, which is entirely self-contained and portable. Although the overall processing speed of the microcomputer is some ten times slower than that of the mainframe, the timing is completely reliable. Moreover, with time savings in several other areas, notably in data entry/verification and reliable printing, the total elapsed time from submission of decisions to final printing is in fact less under the new system.

6. The future

InterBank probably represents the state-of-the-art in bank management simulation exercises, but there is always scope for developments in new directions. Experience has shown that the amount of work involved in undertaking the InterBank exercise is just about right. If there were any more decisions to take, participants would find the initial effort involved to learn the game too daunting when compared with the perceived rewards. Also, there would be the danger that decisions would be taken on impulse rather than as a result of careful analysis, and that feedback would not be clear enough for participants to perceive the underlying principles. For this reason, the temptation to go on adding extra features and options has been resisted once the exercise became mature. This means, however,

381

L. C. Galitz, Inter Bank

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that there are opportunities for the other exercises to cover aspects of banking that are not part of InterBank. One example of bank activity that is not covered within InterBank is the multi-currency dealing operation. Here, dealers must make rapid decisions involving large sums of money in a rapidly changing environment. This seems an ideal application for a computer based simulation exercise, possibly run in real-time using linked terminals and a shared database. Not only would a decision made by one player affect all others, it would affect everyone else immediately, and the other participants would have to take appropriate action straight away if they were not to lose out. Current advances in computer technology make such an exercise entirely practible, and growing competition between financial institutions makes it all the more desirable to have staff with a clear understanding of the principles underlying their work, and experience of its practical implementation. Management gaming provides one of the most effective means of combining the acquisition of theoretical knowledge with practical experience, and achieves this in an atmosphere of motivation and enjoyment. They are very much the training tool of the future.

382

L.C. Galitz, lnterBank

References American Bankers Association, 1977, BankSim II decision manual. Elgood, C., 1981, Handbook of management games, 2nd ed. (Gower, Famborough). Galitz, L.C., 1982, InterBank participants' manual, 4th ed. Institute of European Finance. Institute of Bankers, n.d., Banking Game Participants' Manual. Parker, G.G.C. and D.I. Carroll, 1978, Stanford Bank Management Simulator - - Version VII, Graduate School of Business, Stanford, CA.