Banks are in deep trouble with investors, not so much because of rising interest rates but because their business models are fundamentally flawed.

Veteran observers say the industry's central operating strategy has gone stale and warn that basic investment is lagging and efficiency levels are at their peak.

Also, while the search for a new approach is on, there is a dearth of visionary leadership. Richard M. Kovacevich, chief executive of Wells Fargo & Co., is one of the few CEOs cited by analysts as capable of leading the industry to a new approach.

The upshot, they say, has been poor bank stock performance in the past year, despite more than respectable profits. This trend continued Tuesday as the American Banker index fell 2.71% amid fourth-quarter earnings reports by a dozen major banking companies that met or beat expectations.

"It appears to investors that the end of the banking tunnel is blocked by a landslide," said Richard X. Bove of Raymond James & Associates Inc. in St. Petersburg, Fla. "Bank managements remain clueless as to how to create value for their shareholders."

Mr. Bove said he thinks the industry's standard business model of the past decade is being rejected by investors because it is strikingly at odds with the practices of Internet companies, which are the market's darlings.

Another analyst, Michael L. Mayo of Credit Suisse First Boston Corp. in New York, pointed out that efficiency gains in banking have grown much harder to achieve and a return to cost-cutting efforts is too often the response.

"It is easier to close branches or 'streamline management,' which has already taken place at most banks, than it is to create new and innovative ways to attract customers," said Mr. Mayo, who has taken an overall negative stance on the industry since last spring.

Lawrence W. Cohn, research director at Ryan, Beck & Co. in Livingston, N.J., said he thinks crucial investments needed to stimulate new revenues - which could lead to greater profitability - have lagged because expense reduction has become ingrained as a guiding precept.

"The supposedly ideal combination of rising revenues and falling expenses ultimately turns out to be a mathematical impossibility," he said.

To be sure, the impact of higher interest rates is real. Bank stocks posted gains in every year of the past decade except 1994 and 1999 - both years of rising rates. And the industry's earnings growth rate is slowing, though earnings have remained good by historical standards.

But the overriding fact is that bank stocks, especially on a relative basis, finished last year dramatically far back in the pack.

According to data from Keefe, Bruyette & Woods Inc. in New York, superregional banking companies sold on average at 10.5 times their expected 2000 earnings. Banks overall ended the year selling at a very depressed 49% of the S&P 500 "market" multiple.

This dismal performance has caused some to reexamine first principles.

"The banks are driving customers away daily," Mr. Bove said in a recent interview, "as a result of policies that demand that the customer be profitable or be gone."

For instance, banking fees have clearly reached the point of diminishing returns, as demonstrated by the recent uproar over ATM surcharges and some credit card levies. Meanwhile, securitization of mortgages and other loans may be fine for the balance sheet but has the effect of separating the institution from the customer, who often sees only the name of the servicer. Cross-selling opportunities are lost.

By contrast, companies in the technology sector like America Online, the largest Internet service provider, or Yahoo, the largest Internet portal, have been willing to take on initially unprofitable customers against the prospect of selling them more products or making the customer relationship profitable in other ways.

Despite the criticism that companies in the Internet sector are money losers, their strategy of emphasizing growth has clearly been embraced by investors, Mr. Bove pointed out.

He said the 15 leading Internet companies recently had $42 in market capitalization for every dollar of revenue, while still losing money as a group. The top 15 banks, by contrast, have $3 in market capitalization for every dollar of revenue "and a pitiful $16 in market cap for every dollar in earnings."

Current bank operating methods, he said, are rooted in the industry's trauma of the middle and late 1980s. Then, growth in banking was synonymous with bad loans.

Cost-cutting, asset securitization, and enhancing fee income became cardinal precepts, along with capital base shrinkage. Repurchasing stock became the rage. The primary avenue of growth was acquisition of less efficient banks, where this regimen could then be imposed.

The primary exponent of this strategy was Carl E. Reichardt, chief executive of Wells Fargo, Mr. Bove said. His policies contrasted with the high-growth agenda of the 1970s and early 1980s that was identified with Citicorp chief executive Walter B. Wriston. Mr. Reichardt's efforts were widely emulated and helped banks post record earnings the past eight years - with a ninth possible in 2000. But Mr. Bove said he thinks the Reichardt strategy is not viable in the longer run for several reasons.

"Ultimately, a bank maximizes the yields from the existing balance sheet," he said, "and the available cost savings are all utilized."

In addition, acquisitions can no longer be made that will have a meaningful impact on overall results - since the acquirer has gotten too large from prior acquisitions. Finally, and not least, the decision to persistently reduce capital rather than expand the balance sheet "changes the fundamental nature of the business," he said. By packaging loans they originate for sale to other portfolios rather than their own, banks transform themselves into brokers.

"This means they accept lower profits per transaction and become more cyclical in nature by reducing their recurring income streams," Mr. Bove said. "Yet they still have their huge balance sheets, making them neither 'fish nor fowl'."

The lack of clarity in the business, the uncertainty about revenue, and lack of top-line growth have alienated investors and caused price-to-earnings multiples to decline, he said.

The selloff has been so deep that the market value of banking companies is effectively less than the net present value of their current customer base, he said, further underlining the notion that they are worth less than the sum of their parts. This means outsiders could step in and force changes in outlook and operations, Mr. Bove said.

For the industry overall, a new direction is needed, along with a new "leader of the genre" in the mold of Mr. Reichardt, Mr. Wriston, or Bank of America founder A.P. Giannini, he said. A possible candidate, he said, is Mr. Kovacevich, Wells' chief executive since its merger with Norwest Corp.

But primarily, banks need to develop "achievable growth strategies" under which they compete to attract customers "at all levels of the income strata."

In addition they must seriously try to capture Internet customers. "This means offering value to the customers and not cost-cutting techniques to the bankers," Mr. Bove said. "They must pass cost savings along to clients."

Finally they must think about "disaggregating" their businesses into efficient and profitable units, he said, reversing the trend of "buying companies, then firing the employees and chasing away the customers."

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