An address by Charles S. Sanford, Jr.
November 14, 1996
Delivered as part of the 1996-97 Musser-Schoemaker Leadership Lecture Series at the Wharton School, University of Pennsylvania

My thanks to Richard J. Herring, Vice Dean and Director, The Wharton School, University of Pennsylvania, and Dwight B. Crane, The George Gund Professor of Finance and Banking, Harvard Graduate School of Business Administration, for their assistance in the development of this lecture. — Charles S. Sanford, Jr.

As a breed, bankers of the 1960s were naturally conservative, bureaucratic not a particularly innovative bunch. But this lack of innovation was not surprising, given that commercial banking had hardly changed since 1930, when the government placed the industry under strict regulations. Perhaps Lord Brand of Lazard best summed up the prevailing view of commercial bankers when he said: "We, the merchant bankers, have the brains; the commercial bankers, have the deposits."

I joined Bankers Trust in the early 1960s, shortly before a wave of subtle but fundamental changes began that would effect the very foundations upon which commercial banking -at least wholesale commercial banking -relied.

Bankers Trust capitalized on the opportunities and eventually transformed itself in a way that caused The Wall Street Journal to name it one of the world's best wholesale financial institutions. This is how we did it.

Back in the '60s

The changes hitting banking in the 1960s looked like just about the worst possible combination for the industry -especially for the money-center banks. The liability side of balance sheet was being deregulated, but not the asset side. Where banks could do business, what products they could sell, and what markets they could enter into continued to be restricted. But investment banks and non-bank lenders were allowed to enter the business - and they were not bound by the 1930s-era banking regulations. The banking business changed drastically as banks were stripped of their basic franchise, the lowest cost of funds. In addition, credit information on corporations - which used to be available exclusively to banks - became available `to everyone. As a result short-term loans to investment-grade clients, the bread-and-butter business of commercial banks, began to atrophy. Investment banks and non-bank lenders snapped up the business of funding these investment-grade companies via commercial paper (negotiated promissory notes sold in the open market): this became known as disintermediation. Because banks were unable to lend profitably to investment-grade customers, they had to make riskier loans to non-investment grade customers. The risk profiles of banks' loans rose in proportion to the cost of funding those loans. The downward spiral of credit within the loan account had begun.

The Greenwich Surveys presented an objective snapshot of Bankers Trust during the 1960s and '70s. What Greenwich was telling us was that Bankers Trust had few top-tier corporate relationships. We did score highly, however, in aggressive credit extension and cheap pricing of credit products. (This latter business came to haunt us in the mid-70s, when the real estate market collapsed and we had to sell our marginally profitable retail business.)

Bankers Trust's earnings in the mid-'60s came predominantly from the United States - mostly from the loan account and the investment account. (But the return on equity for our loans was only 5%!) Our Trust Department, once a crown jewel of the franchise, was -like trust departments at every commercial bank - unable to keep up with the changing realities of the marketplace as pension funds shifted their investment management to specialized investment managers and boutiques throughout the 1970s. And we had a marginal balance sheet - if we had had to value the bank at the end of every quarter according to the price its holdings would fetch on the open market, what's known now as market-to-market accounting, it would not have been pretty. According to a Salomon Brothers report, between 1974 and 1977, BT's ROE was 9.58%, versus the peer group average of 12.55%.

By the mid-'70s, clients and prospective employees perceived us as a second-tier commercial bank. And, I'm sorry to say, they were absolutely correct. Lacking the skills for any complex advisory-type products and/or innovations, we were reduced to selling off-the-shelf commodity products - lines of credit, loans; money transfers, and the like.

Of course, we were legally prevented from offering a full line of products - Glass-Steagall saw to that - but that did not excuse the fact that we were not always competitive with the products we were able to offer. We not only lost business to investment banks, we lost some of our best people to them as well. And we had difficulties attracting the best new recruits. Most of the more talented people who came to us left after only a few years. Conventional wisdom at the time had it that commercial banking was a good place to start one's career but a bad place to end it.

It was clearly time for a change at Bankers Trust, as well as in the industry. However, senior management - trained as commercial lenders - stuck to the wholesale commercial lending strategy with only a few investment banking products; thus opting for the status quo and its consequent second-tier status. So, since senior management wouldn't change the bank, we started the change in one department. Eventually that inclination toward change and the values that accompanied it would spread to the firm as a whole.

Values, Purposes and Goals

Management's vision of Bankers Trust was probably not that different from the visions BT's competitors had of themselves. After all, it was a time when uniformity was prized. No one wanted to stick his head above the foxhole. The main element of the "vision," — if I can even call it that — was to hold your ground.

I joined Bankers Trust's Resources Management Department in the early '70s because I believed that the businesses of Resources Management — the bond and foreign exchange departments, the investment accounts, asset and liability management — were the businesses that would drive commercial banks' profitability in coming years. My change-minded colleagues and I felt that Resources Management could be fashioned into something more than what we saw as the empty culture of commerce that also pervaded commercial banking. We believed that we could make, it an exciting place to work, a place that would provide us not just with monetary rewards but with the psychological rewards that come from creating value for our customers, our firm, our industry and the overall economy. Yes, we were idealistic. We wanted to look back at the end of our careers and see something more than a "Wasteland" (to cite T.S. Eliot, who was himself a banker). In a nutshell, we wanted to create something positive, that would outlast our own careers. We were also mindful that the exchange of time for money only goes in one direction - and rarely in the direction we would like. Working together, in time we turned the Resources Management Department into a fun and satisfying place to be - as one part of a balanced life.

To begin to effect change, we developed our own set of values — not monetary values, but ethical values, a raison d'être — purposes and goals. We communicated them verbally within the Resources Management Department and then, in the late 1980s when our change spread to Bankers Trust as a whole, we articulated them in more formal statements — essays, speeches and in the Code of Conduct that every employee was required to read and sign.

Our values and purposes were fixed-constant, forever. And they remained constant when we rolled them out to the bank as a whole.


  1. Ethical behavior — honesty, and integrity
  2. Innovation/Creativity
  3. Be a leader not a follower — not hidebound by convention or by the past.
  4. Keep balance in one's life — family, cultural, spiritual interests outside of business


  1. To develop a sense of the value of a financial instrument as opposed to just its price — because this leads to more efficient allocation of resources
  2. To create wealth for society — because this leads to a higher standard of living (both material and non-material) for all people

While our values and purposes remained constant, our goals changed over time - moving always to at least a few steps beyond where we were. Resource Management's goals were to make Bankers Trust a top-tier dealer among all dealers (investment and commercial banks); to redefine how trading was done from a risk-management point of view; to utilize the new technology.

As our philosophy spread to the bank as a whole, our goals broadened: We wanted our people to stop behaving as though the bank were simply a regulated utility. We wanted to create a bank that thought of itself as a free enterprise business. We wanted to create a great company, not just a big one. We wanted to make Bankers Trust a top global wholesale bank by the end of 1990's. This last goal seemed beyond reach to most outsiders at the time-and, I'm sorry to say - to many insiders as well.

Changes in Resources Management

Resources Management hardly appeared on the radar screen of Bankers Trust's management in the mid-'70s. At the time, Bankers Trust was having major problems with its earnings and its capital. And although Resources Management wasn't profitable, at least it wasn't causing serious trouble. Management had more pressing concerns.

We figured that if Resources Management started to make some money, we'd be able to show the rest of the bank that we were on the right track. And, by the end of the 1970s, that's exactly what happened.

The first thing we did in Resources Management was adopt a new strategy. We replaced an assembly-line mentality with a sales team that used insight and judgment to deal with their clients. We differentiated ourselves by what we could do, built our skills rather than our balance sheet.

In doing those things, we began to shift the culture of first the one department and later the whole bank from a utility to a business mentality, from an institution where tenure and politics unduly influenced promotions and pay into a meritocracy.

A major part of the Resources Management business was trading. We persuaded the traders to change their philosophy, to think of what they did as a business, rather than a "craps shoot" or a brokerage. BT went from being unprofitable in its trading and positioning business lines in the early 1970s to an average of $150 million after-tax earnings between 1993 and 1995.

We treated the market as if it were efficient over a two-week time frame. Inside that period, we (the dealer) could see supply and demand characteristics more perceptively than did non-dealers. We designed our customer base to be a sample of the market. Using the information we got from that base, we were able to assess value. At the same time, we began using the laws of probability on a much finer scale than they had been used before. This was the beginning of the risk management revolution that we brought to the fore in the 1980s.

It wasn't long after these changes started that Bankers Trust's trading and funding operation began to develop a reputation as an innovator; within a few years we were known as one of two or three top quality firms. Customers and potential customers felt they should touch base with us. Without a top-quality fixed-income trading function to give it a good feel of the wholesale market, a financial firm cannot provide customers with the sine qua non of a "sense of value." In the 1960s and 1970s many firms - including Morgan Stanley and Goldman, Sachs - did not have a very large fixed-income trading operation. They rectified this situation in the 1980s.

Once upon a time, if a trader got in and out of a trade at the same price, it was considered that he hadn't lost anything. I say "once upon a time" because that really is a fairy tale. But it used to be that the market didn't systematically factor in the risk involved in using capital.

When we started to look at the issue of risk, we discovered that one reason the market had not been very savvy about it was that there were few tools to assess risk accurately or to determine whether or not an investment was an efficient use of capital. So we created a tool, a formulation we called Risk-Adjusted Return on Capital, or RAROC.

Using RAROC, our traders had to risk-adjust their ideas. Risk-adjusting of assets and liabilities was a radical notion in the '70s when most banks managed their liabilities only at the level of their controllers. But it worked. In the first ten years that we used RAROC, our traders posted 38 profitable quarters out of 40 - an enviable result. And RAROC worked for other areas of the business, too — as we expanded its uses and applied it to all of Bankers Trust's businesses. I'll talk about those broader applications a bit later.

Since banks had all lost their franchise of lowest-cost funds, we had to fund ourselves with higher-priced money purchased in the open market via the certificate of deposit and the Euro-dollar. At Bankers Trust, we decided not to rely on investment bankers to sell our liabilities, as our commercial banking competitors did. As a result, we established direct contact with the customers who purchased our liabilities — which gave us a long-term relationship with them that helped in those instances where our credit was questioned. Closer contact with customers a1so helped us to learn about their other investment needs. We were comfortable enough with our customers that we became the first bank to seek financing from them - establishing lines of credit with some of the larger pension funds and other new market participants that the bank could draw on in the event of a market shock. Having this back-up funding allowed us to invest all of our assets profitably - introducing the concept of marginal liquidity from the liability side of the balance sheet, not the asset side. Because RAROC restructured the asset side of the balance sheet, BT attained additional liquidity as a by-product.

Beginning in the late '70s we organized the Resources Management Department — and later the entire bank — so that each discipline reported to one worldwide manager, not to a number of regional managers, which meant that all of our people within each discipline around the world were connected and working to achieve the same goals. A regional structure tends to keep information within the region. Our global management style led to our developing a global technology infrastructure. So not only did information get out across borders, it got out instantly. For example, BT was the first firm with global online trading, which enabled traders in all of our offices to see our positions instantly.

By organizing globally we were able to match buyer and seller more efficiently than firms with regional organizations. Integration of functions eliminated competition between traders, and global communication and common incentives allowed us to take quick coordinated action to capture pricing anomalies in different markets. This structure also allowed us to take positions in the markets based on better information on global market flows and trends — information that we used to assist our customers — banks and corporations — in funding and positioning themselves.

And the numbers of those customers were growing — to over 2,000. Our practice of selling our CDs and Eurodollars ourselves gave us an insight into the buying and selling predispositions of a large investor base, producing a real advantage over investment banks in the short end of the market. All of these changes were considered radical at the time - and were looked on with suspicion by our competitors. Today they are standard industry practices.

And as our people proved that we could achieve excellence, their morale improved. They began to believe — to see — that Bankers Trust could be a first-rate firm. By the latter 1970s, Bankers Trust was recognized as the outstanding bank dealer and funds (liability) manager. Correspondent bankers sought our guidance and attended our seminars.

So first we changed our philosophy. We changed the way we measured our own results, we adapted to new market conditions (globalization) and to the new competitive environment, that affected the way the traditional businesses needed to be transacted. And then we pushed the envelope. We decided to get into a "new" business — or rather an old business that for half a century bankers had assumed they'd been "regulated" out of.

Having lost our short-term, investment-grade loan franchise, we needed a way to recoup lending relationships with investment-grade corporations, which had turned to the commercial paper market via investment banks. Glass-Steagall had regulated banks into a niche in the 1930s, but changes in the markets and in the industry since then — especially the introduction of other financial service providers in the late '60s — meant that that niche was no longer profitable. We set out to convince the authorities that they also should adapt to new conditions. The goal was to allow a variety of "banks" to thrive in old and new fields (like selling commercial paper and other loans), while insulating the system from individual failure by mandating, among other things, a realistic capital structure consistent with risk taken.

In 1978, Bankers Trust became the first bank in nearly half a century to place commercial paper - thus providing our clients with the same service offered by investment banks. It was the first break in the Glass-Steagall law, and we fought for nearly l2 years and made two trips to the Supreme Court to sustain that authority. But we needed to be in the commercial paper market in order to finance customers to their — and our — advantage. In addition, monitoring the commercial paper market helped us to identify corporations' other financing needs so that we might find other ways to meet them, and further out relationships.

We really broke out of the pack when we placed that first commercial paper. It was a clear signal to the market - and to our employees - that Bankers Trust was prepared to take the lead on strategic issues.

We also changed market conventions for a number of other products, creating two-way markets in dealer loans, acceptances, and certificates of deposit; establishing a new market in time Fed funds; and trading Euro-dollars in New York, not just London. All of this added to the efficiency of the market and thus created value for everyone who participated in it.

Changing Bankers Trust

As a corporate bank, Bankers Trust had a weak client base. We lacked the long-standing advisory relationships with top-tier clients that one needs to sustain a traditional investment banking business. So one of the first things we did in Resources Management, and later in the whole firm, was to define a broad client strategy.

Of course the foundation of all of our dealings with clients was a code of ethics. All of our corporate values emphasized that integrity had to be paramount. So whatever the relationship we developed with a client — whether they were private banking clients or corporations who needed access to our research and advice, or whether they were primary dealers who just needed our services as an intermediary to quote a price — we would be honest and forthright. That philosophy formed the basis of everything we did.

Beyond that, we wanted to eradicate the myth that financial institutions could either offer products or serve clients. We wanted to do both. Some of our clients merely needed us to quote prices and place trades; others wanted a fuller relationship — ranging from casual advice to full discretion in managing their money. We created relationships to suit the needs of all types of customers.

We created new products that fit precisely our clients' needs. We offered a full range of products in developed countries around the world and we provided local merchant banking services in developing countries. For non-investment grade customers we specialized in leveraged buy-outs and later underwrote bonds and equity offerings. For investment-grade customers, we offered cross-border mergers and acquisitions and access to the commercial paper market. All of our customers were served by our processing and investment management units. We had long since established our reputation as a provider of cheap credit to investment-grade customers. But customers don't think of you as a primary provider if you don't offer something more than price quotes. Customers want the added value of insight, advice; something new.

So innovation became our mantra — but not all innovations work. And those that did were soon copied. So we needed to diversify our earnings streams. Where once we relied on one business — credit products — for 80% of our earnings, now we shifted to five businesses:

  • Client Finance — meeting the credit and capital needs of clients
  • Client Advisory — providing advice and structuring transactions designed to implement client financial strategies
  • Client Financial Risk Management — helping clients to manage their financial exposure
  • Client Transaction Processing — providing operating and administrative services to clients
  • Trading and Positioning — proprietary activity involving securities, derivatives, currencies, commodities and funding transactions, as well as positions assumed as part of client risk management activities

We expected relatively equal earnings contributions from each of these businesses — but if any of them had a bad year, we expected that the others could pick up the slack. By the late 1980s, we diversified geographically. Where once we had generated 90% of our earnings in the United States, by the late 1980s, we expected the Americas, Asia, and Europe/Middle East/Africa each to contribute one-third of our earnings every year.

Underwriting and Final Sale of Loans

One of the businesses we developed and relied on was a new one - underwriting and then selling our loans. Well, it wasn't a new business for the financial industry - the corporate bond market had been in existence for years - but it was a radical new business for a bank to enter. The fact that Bankers Trust did enter it - and thrived in it - created a fundamental change in the banking business in the United States.

Buying and holding loans as we had in the past, yielded only a 5% ROE, which was below our cost of capital. So, utilizing information from our sales and trading units, we changed our loan business from "buy and hold" to "buy and sell."

Not all of our loan clients were happy about these changes, and our relationships with some of them suffered. They felt that syndicating loans was their business. They wanted "their" banks to hold as many loans as possible so they could exert more pressure on those banks when it came to pricing and the other terms of the loans. So the way we treated a client on the loan side could - and would - affect the amount and profitability of other business the client might give us. Today, the loan sale concept is accepted by all but the most conservative chief financial officers.

Selling loans not only improved our financial health, it also gave us another product for our investor base and made our advice on the market more important to our clients. Later, Bankers Trust became the first bank to underwrite high yield bonds and equities, as well as loans for non-investment grade clients - a business in which we still lead today. Thus, we gained another advantage over commercial banking and investment banking by being able to handle the entire liability/capital side of a client's balance sheet.

Selling loans also freed our capital for other uses which, once other financial institutions followed our lead, proved to be a great benefit to the market (increasing liquidity for all loans). The diversification produced by our "buy and sell" policy added liquidity to our balance sheet. It's said that there's no such thing as a free lunch - but for a bank that has diversification and liquidity in its loan portfolio, that saying is not true. Diversification of risk is the only "free lunch" available in economics.

We became the leader in the bank credit part of leveraged buy-out financing - even though we had less capital than our largest bank competitors — in part because our distribution/hold policy required less capital for each loan syndication and gave us lower capital-to-loan ratios than our competitors. Globalized trading and distribution operations gave us a wider market to tap and, thus, another advantage over our competition. Without such a global buy-and-distribute strategy the leveraged buy-out business would never have deve1oped into the vitally important business it is today. By 1995, the Client Finance business was producing $140 million after-tax. That year, BT led the leveraged finance league tables (loans and bonds) with a volume of $18.5 billion. This was after Chemical and Manufacturers Hanover, two of the top four banks in the market, had merged. In 1996, Chase Manhattan, another major competitor, merged with the Chemical conglomeration and BT dropped to second — but a close second.

These changes benefited Bankers Trust; they also benefited the industry by democratizing capital and allowing entrepreneurs to compete for capital with established old-line firms. And they benefited society, as LBOs started the trend of restructuring to increase productivity. Perhaps the greatest benefit of our buy/distribute loan policy was bringing diversification of credit risk to individual banks, the industry, and ultimately the whole economy.

Selling loans was but one way in which we profited by approaching an old business in a new way. We did much the same thing when we turned our "back office" operation into a processing company, a business with its own client representatives and infrastructure — we called it the Client Processing Business. Within a few years, processing went from a break-even business to a business with a high P/E and a dramatic ROE — generating 15% to 20% of our profits. The Client Processing Business also adopted the mantra of creativity and were credited with numerous innovations. But the major new ground they broke was in making the back office a business.

RAROC and Risk Management

The RAROC system that revolutionized the Resources Management Department's management of risk in the 1970s was, in time, moved into the whole bank — and, in particular to the loan account.

RAROC ignored book accounting and looked through to the underlying value of an asset or liability — the market value. Our primary concern was economic and financial reality, not just arbitrary bookkeeping rules. This was a radical idea in 1980, and still is in some places.

Bankers Trust became the first financial institution to explicitly quantify risks in a framework that allowed management to make better risk/return tradeoffs in a real business setting. By using models driven by duration, probabilities and mark-to-market values, we could treat all assets and liabilities — on and off-balance-sheet — consistently. in the same language and metric. For example, RAROC was perfectly suited to capture off-balance-sheet risks (like swaps) that most accountants and bankers preferred to ignore. One result of our using RAROC is that Bankers Trust has a pristine balance sheet; another is the superior ROEs Bankers Trust has generated over the years.

RAROC affected important decisions (loan hold vs. sell; investment account; trading policies; funding strategy; etc.) and became part of the core culture of the institution as a whole. RAROC became a common language to talk about all kinds of risks within BT.

The Federal Reserve and the Bank of England followed our implementation of RAROC very closely. Eventually, they and the Bank for International Settlements moved in good measure from the equity/asset ratio of measuring risk to requiring banks all over the world to use a concept more like RAROC in preparing their balance sheets.

Other banks adapted RAROC for their own internal risk management. And our competitors created RAROC look-alikes to sell as risk management services (e.g., JP Morgan Risk Metrics).

RAROC and its imitators have given banks better tools to allocate and price capital fairly to clients, so clients benefit. Society benefits, too, because less capital gets wasted in the banking system. And the banking system itself is more stable because extreme risk positions are less likely to go unnoticed by management and regulators.

But RAROC was just one of the tools we used for risk management. Another class of tools was derivatives. Bankers Trust was the undisputed leader in both risk management and derivatives.

Bankers Trust began using derivatives as a way to test new tools for our own risk management. And experiments we made on our own behalf became solutions our clients could use.

Bankers Trust did not invent derivatives or options, but we were among the first to see their true potential and to introduce many innovative structures in the early days. We did more than anyone to make them a staple in today's financial markets.

We were pioneers in combining our risk-management and trading skills. Early on, our trading units - housed on the same floor as derivatives - suggested that they could hedge one side of a transaction until the permanent investor was found. So we had no need to find the offsetting side before we booked the first side. Of course, today that's a routine practice. But at the time, Bankers Trust was the only firm doing it - and this changed the market from a brokered market to a dealer market and greatly expanded the potential size of the derivatives business.

We became the leader in crafting innovative structures to solve difficult and complex problems (and we are among the leaders in that area today). Just as a fine tailor takes many measurements of a client before crafting a garment that fits like a glove, our derivatives experts have learned to examine a client's businesses, goals, and liabilities in minute detail before creating a risk management solution - which may or may not include derivatives.

RAROC, risk management, and derivatives have given clients a far greater ability to control their risk profiles. Society benefits, too, because capital is used more efficiently and companies are insulated against extraneous risks that could derail a sound business strategy.

It was technology that made a broad-scale derivatives business possible. Without computer modeling, we couldn't price derivatives, control risk of derivatives, or design new products.

When we began our derivatives business, the industry worked off of mainframes. That was the way everything was done. People thought personal computers were a flash in the pan, a novelty for the consumer, inappropriate for business. But we saw PCs as the easiest and quickest tool our people could use to create new products. Instead of signing up for time on the mainframe, people with ideas could sit down at their desks and work them out.

And so we did with personal computers in our derivatives business the same thing we did with our global offices — we gave our people permission to be independent within the framework of their localized networks and — of course — within corporate controls. They could operate in whichever way they felt was appropriate to the culture (in the case of offices) or to their particular clients (in the case of our derivatives team), as long as they shared their innovations and information with their colleagues in our global network. Our derivatives business and trading could not have flourished if it had been forced into a mainframe environment (with the stultifying effects of centralization and standardization) as many then thought it should be. Indeed the technology architecture we introduced into the firm in the mid-'80s was ahead of its time and remains in place today, in largely the same configuration.

Combining RAROC, derivatives, and our market orientation resulted in a new and powerful way to manage an enterprise - any enterprise. And, indeed, the risk management industry we pioneered has been one of the fastest growing among all financial businesses.

Our risk management philosophy works like this: Any enterprise can be viewed as a portfolio of risks (strategic, operating and financial) that produces some expected return.

But risk management allows one to be much more explicit about these risks and their interplay. It provides practical tools to shift the enterprise's risk profile from where it is to where its managers want it to be. This discipline cuts across and enhances financing, asset management, mergers and acquisitions, all the other traditional financial services - and some not-so-traditional services. For example, Bankers Trust and a large multinational oil company established a separate company to jointly manage their natural gas purchases and sales. And in our Client Processing Service business we run the risk management "back office" for several banks - again using our risk management philosophy and accounting and valuation skills.

The CEO, who is the risk manager of any enterprise, now has the means to see many disparate and potentially confusing activities in a coherent context. This is achieved by eliminating peripheral or inadequately compensated risks and acquiring unusually rewarding risks and valuable strategic options - all of which contribute to a prudent, well-balanced enterprise risk portfolio that fits, and reinforces the mission of the enterprise.

Companies and institutions are now much better-managed, with the result that more wealth is created for society.

Innovation Risk and its Repercussions

Without risk, there is no reward — so all businesses have risks. As we learned when we were developing the RAROC techniques, some — indeed, these days, all — risks can be analyzed to one degree or another. Responsible businesses can then decide which risks they want to take, which they want to avoid, and which they want to try to mitigate.

Innovation is one of the activities that carries risk. But since innovation is an activity that can also carry great rewards for a firm's reputation and earnings, innovation risk is often the kind of risk that a business will and should be willing to take. As Schumpeter pointed out, all significant economic growth has been based on innovation — think of the automobile. Without innovations, the economy would be dragged into recession or depression.

Innovation risk is unique in that the same thing that makes it valuable — an innovation's newness — is also the thing that makes it risky. The greater the newness of an innovation, the less likely that it will be understood (at least at first) by the market, by the media, by the public. Sometimes not even the firm that creates the innovation understands all of its ramifications. And this misunderstanding can lead to problems.

Before rolling its new product out of the market, the innovating firm must try to imagine all of the possible ways in which it could be misused and develop controls to prevent those hypothetical circumstances.

Every firm, every market has a system of controls. The majority of those controls have been developed after the fact, after the system has uncovered some problem. This type of control development has been around for ages — for so long, in fact, that it's got its own pre-industrial metaphor: It's known as "locking the barn door after the horse has already escaped." Most of the controls in today's financial markets are barn doors that have been locked after problems arose.

So that it might seem reasonable to expect that every innovation — no matter how carefully examined by lawyers and accountants and the managements of financial services companies — has the potential to add a new layer to the controls that have been accumulated over time. It might seem reasonable to expect that when problems arise with an innovation, the markets and the customers who have utilized the innovation would take the problems in stride. But historical perspective is often hard to come by when one is facing the prospect of having to explain a financial loss to one's shareholders. People, especially in our society with its adversarial legal, media, and regulatory systems, look for someone to blame. And the person they blame most often is the innovator. BT ran into this problem in the mid-'90s when some of our customers became unhappy about leveraged derivatives contracts they had entered into.

Regulators assume, not without justification, that the innovator's controls should have prevented the problem. An aggrieved customer may feel misled. Members of the media, who help the public to form their opinions on the controversy, may pick up extreme positions from either side and feed them to the general public — and to employees who, being told that their innovative employer has hurt a client, no longer know quite who to believe.

Eventually new laws will be made, new precedents established, new regulation formulated. But until the innovation and the problems that arose from it are fully understood by all parties involved, the innovator is going to have to endure some reputational risk.

In time — time that seems to move at an almost glacial pace — the innovation will be absorbed into the culture and become an accepted part of doing business.

The Mechanics of Creating Change

Making the changes we made at Bankers Trust was a difficult juggling act, if I may call it that. It began in Resources Management and then, after the success there, it moved to the firm as a whole. The biggest source of difficulty was that we had to keep doing business while making these changes.

When a contractor makes renovations at your house, he may tear up your kitchen for three months. But you can move the microwave down to the basement and still cook something resembling a meal. But we couldn't jury-rig a solution like that when we did our renovation. We had to keep serving clients, providing as much value as before — and make money for the firm. So rather than the renovation metaphor, let me compare our experience to having to change a blown-out tire — while the car is still moving.

The first thing we had to do was overhaul our staff — involving both the people who were already here, and the people who would be joining us. The latter group was easiest to change — we simply redirected our recruiting effort.

People with good imaginations will create all the products you need. So rather than focus on technical knowledge of the business, we looked for innovative people. We got the best athletes — and chess players — and taught them finance. We attracted many people who might never have gone into banking without our interest in them.

Creativity must be encouraged at all levels of an organization. Many, if not most, creative ideas come from those who are dealing with customers day in and day out and know customers' real and perceived needs. The financial industry can't do research and development in a laboratory. It needs the involvement of line people in order to grow.

We elevated the importance of recruiting — had our best people do it, not just for the big-ticket jobs, but for all jobs. It's a time-consuming process, but if it's a choice between doing the best deal you've ever done or hiring the best person, I've always believed you should take the best person.

Since we had no track record, they had to believe in our vision and not worry that we didn't have the image of more established firms. And since experience teaches fear of change, we looked for young, impressionable people — people with a leadership mentality, self-starters who could make things happen. We found that our best new employees joined the company directly out of school or after only one job.

The people we looked for in Resources Management in the '7Os and throughout the bank in the '80s had to be idealistic and real entrepreneurs. Innovators, inevitably swim upstream and are not politicians, so we had to find a way to protect them from the slings and arrows of business, to give them space to create. Some of your best innovators turn out to be pretty idiosyncratic. In fact, in a lower tax bracket they might be called "eccentric."

When we began making these changes, the vast majority, of our employees — clerical and managerial — were from the firm's old culture. If we could not convert them to our new philosophy, we had at least to bring them to a "sullen but not mutinous" state. We did this by never maligning the "old culture" as bad. We made sure people understood we were keeping the best of it — like encouraging employees to live balanced lives.

We had to bear in mind that changing the social contract, as we were, was in a sense, unfair — especially for the older employees who had fewer options. And fairness is always important. Some employees wanted to leave; we helped them find jobs via outplacement services. Others were moved to jobs that better fit the culture they were raised in . For example, we moved many into the processing service business and to parts of the Trust Department. They became very productive, most often more so than their competitors. It was a win for them as well as for our stockholders. Some employees moved to Investment Banking and were successful; others adapted extremely well to the new strategy and did better than they ever dreamed would be the case.

In making our changes in Resource Management and throughout the bank, we moved from the elaborate chain of command, layers of authority, and highly structured, top-down decision-making of a regulated utility to the decentralized, flexible, flat organizational structure of an innovative business.

The transition from a command-control model to an owner/operator mentality, a partnership, wasn't easy for everyone. Being in a participatory culture, in a decentralized structure, requires a commitment to reaching goals, not just to following orders. In such an environment, intellectual honesty is mandatory. We knew that the character of our employees would be the most important control. After all, the point of sale is where problems can most often arise.

One way that we exerted this control was by having a flexible compensation policy, as opposed to offering people a straight salary with little regard for production. We reinforced our message regularly, through informal conferences with managers on the floor and later by formal speeches given by senior management. Our compensation policy gave every employee a share in the innovation risk we were undertaking — as well as our reputational risk. These were reinforced by having each employee sign the Code of Conduct every year, through one-on-one conversations, speeches and off-site visits by management.

Another difficulty in the personnel changeover is that you can't hire the first-tier right away — you need to build a reputation first. So you go halfway and then make another change. But after you've built the reputation you need to make sure that you're still hiring true innovators — not just people who want to join you only because of your success. People like that will not help in a down cycle because they haven't withstood the adversity and don't identify with prior progress.

Teamwork is of the utmost importance. Each of us adds to the sum total of knowledge. Building on each others' tiny steps forward, we make progress. Rarely does a brilliant new idea come out of the blue from a solitary thinker.

Some people believe innovation is a lonely, meditative business — and so it is in its first stages, before an enterprise matures. We tried to take the loneliness out of it by having our people sit in open spaces, close together. We would call out to each other, communicate, publish to enrich the idea, as I illustrated earlier when I talked about our ability to book derivatives transactions before both sides had been concluded with permanent investors.

The problem with having innovation and ideas at the center of your business as opposed to, say automobiles, is that your capital is made up of people rather than physical inventory. Your assets walk out the door at the end of every day. And there is no copyright or patent protection available to ensure that employees cannot take their ideas and talents to another firm and start competing with you. This is especially easy on Wall Street because changing jobs often doesn't mean uprooting your family and leaving your friends. It simply means walking across the street.

So compensation is an important component of building a successful business. Bankers Trust was behind the market in compensation during the 1970s, and internal politics stood in the way of our catching up quickly. But Resources Management was given a special dispensation to add bonuses to its compensation mix. Later, we instituted that change in the rest of the bank as well. And, although at first we still lagged the industry in terms of overall compensation, the changes we were making did provide some psychological rewards.

People who enjoyed being with an underdog, challenging the established firms, bought in despite what was at the beginning a relatively low pay scale. Where once bankers had assumed lifetime employment, we instituted pay for performance — or, rather, pay for the team's performance, since we didn't want to encourage the Darwinism of a commission mentality. We made sure people knew that the better the company did because of their team's efforts, the better each of them would do. Unfortunately, some did not believe us and continued to act as if compensation were a zero-sum game.

Unlike the "internal equity" model, our system maintained a relatively free and open market. In other words, if you were a lending officer and had the confidence to take the risk of starting over in a trading environment, for example, you were given a chance. Some succeeded, others failed.

People's personal circumstances affect their perception of compensation. Older employees will opt for less hassle and sometimes less prestige — maybe because they have friends at the firm, maybe because they know what can happen in a down market. Younger people — or people with less perspective — want to better their standard of living immediately — even at a cost in the future — and are more susceptible to dollar offers and fancy titles. Everybody has a different value system.

When we revamped our compensation system, managers did not necessarily get the highest pay. The salespeople and traders on the line could, if their performance warranted it, do better than a manager. We tried not to make the common mistake of elevating the best salesperson to a managerial role. Too often, you end up with a mediocre salesperson filling in on the desk and a mediocre manager overseeing the operation. We promoted people according to their capacity for teamwork and their other strengths, or their potential strengths, not just their production numbers. We wanted to eradicate the commission mentality.

Changing a Culture

In the mid 1970s, those of us then in Resources Management believed we could make Bankers Trust an exciting place to work, a place that would provide us not just with monetary rewards but with psychological rewards that would come from creating value for our customers, our firm, our industry and the overall economy. Today, in 1996, we can say we have accomplished what we set out to do. But innovators always believe more can still be done. And doing it — making changes — requires leadership, whether you're at a second-tier company that wants to innovate its way into the top tier or a company that has risen to the top and recognizes that it must keep adapting to stay there.

As future business leaders, you must have a vision to motivate employees as well as recruits and to attract the positive attention of clients as well as other constituencies, such as regulators.

The defining characteristic of a leader is the ability to deal with the vagaries of human nature. Other skills are important, but nothing surpasses the ability to motivate people. This is true of any organization — private, public, for-profit, or not-for-profit — in any society or culture. Various leadership styles can work, with the exception of manipulation, which is dishonest and will work only in the short run.

You must develop and instill purposes, goals, and values. They must be your values and goals — not a staff exercise. In articulating them you must balance the values of continuity against the changes inherent in your proposed goals and values.

How do you accomplish this?

To lead, you must convince people that they can be top tier (not in terms of market share but in terms of brains, quality) and those they, want to be. The odds are against success, though, so logic alone will not make the case. You must be prepared to use emotion as well. Employees must believe that you will be there for them even if the weather gets rough and you must also convince the outside world of this. One very important way to reinforce your message is to get your competition to believe that you are serious about the direction in which you're taking the company. In the end, the vision, values, purpose must ooze out of the leader's pores. He or she must live and breathe them.

In articulating your vision, you must be specific enough so people will be able to make decisions consistent with strategy. But you must not be so detailed that you derail local autonomy and innovation.

While there must be one "leader" to personify the firm, there must also be a group of leaders within the firm who share the same dedication. Most of the employees will watch, wait, and follow success. Do not think you will capture the hearts and minds of everyone, or even of a majority, or you will be disappointed. And anyway, you don't need to — if you are correct, they will follow you eventually.

It's rare for a company to succeed in making such a radical change to its culture. Transforming one department is difficult enough; transforming the whole organization is an enormous challenge. But Bankers Trust did it.

We changed not just the overall culture of the firm, but the many different cultures that make up the firm our commercial bankers, our investment bankers, processing, trading, staff in 50 different offices, most of which are outside the United States.

There is a law of physics: Every action has a reaction. The same is true in business: every change has a consequence, some unintended and unforeseen. And all solutions are imperfect when we are dealing with the caprices of human nature.

The underdog mentality is a great bonding tool, but when you reach the top tier, the people who bonded as underdogs get nervous. They feel more responsibility, too much pressure. The more the press and analysts reinforce your success, the more of the problem this gets to be. Most adjust over time but some leave, even for start-ups or second-tier firms. Once you're firmly in the top tier, you won't have a problem with the underdog's particular pressure anymore. The problem then will be overconfidence.

Innovation is exhilarating and financially and psychologically rewarding if it works. If it doesn't work, then you'll find that everyone "knew" it wouldn't. But even if it does succeed, it does not do so immediately. An innovator is, by definition, always out of step with conventional wisdom. If you make an impact, you will have detractors. Innovators don't get elected to office or enjoy uniform good public relations until some time has passed. Think of all of the scientists who are honored postmortem.

At the conclusion of your business careers, your personal satisfaction will be a function of what you did, not your social position. I encourage you to be someone who "does" things, rather than someone who "is" things.

Rewards of Change — for BT and for Society

Bankers Trust today is not the same institution I joined 30-some years ago. We brought in new recruits to innovate and challenge the status quo of banking. We broke open the traditional management structure and gave talented managers all over the world the resources to run their businesses as entrepreneurs. Today, our talented staff has the skills to compete with any wholesale financial institution.

There was a lot of internal stress on the organization. There was also external stress as we expanded our businesses to meet more of our clients' financing needs. As I said earlier, we had to fight all the way to the Supreme Court for the right to distribute commercial paper. We added securities powers. We broadened our reach with offices all over the world. We developed new methods for handling traditional banking products and services — methods, that created profits for us and created new liquidity in the markets. And we pioneered new ways of looking at risk and new kinds of financial instruments to manage it.

We transformed Bankers Trust from the traditional wholesale bank it was at the end of the '70s into a completely new kind of financial institution. . . A global risk merchant bank. Because we believed that it was the right thing to do for Bankers Trust and for its shareholders.

Our commitment to "do the right thing" extends also to our efforts on behalf of the communities where we live and work. It was that kind of commitment, not only adherence to the letter of the law, that earned Bankers Trust an "outstanding" rating from the Federal Reserve for our activities in compliance with the Community Reinvestment Act.

And our performance over the long term proves that we have been on the right track. For nine of the last ten years, the cumulative total return on Bankers Trust stock (with dividends reinvested) has exceeded that of our peer group, which is comprised of JP Morgan, Citicorp, Chemical, Chase, Merrill Lynch, Morgan Stanley, Bear Stearns, PaineWebber, and Solomon Brothers. And despite the fact that our disappointing 1995 return on equity pulled down our average performance, at 19% we still ranked third among our peers in that measurement over the last decade.

I should note than our disappointing performance in 1995 was not due to any fault of our philosophy. In fact, the majority of our businesses did just fine. Without the losses that hit us through the first four months of that year — from some positions we held in Latin America — our earnings would have been competitive (although admittedly not up to our high standards). Financial results for the last eight months of 1995 and the full year of 1996 confirm this.

As we transformed Bankers Trust, we kept two goals in mind. We wanted to have a positive impact for our clients, and we wanted to have a positive impact for our shareholders. The list of loyal clients and the fine long-term returns we have posted, prove that we have succeeded.

But the changes that we've made have also had an impact far beyond this one company. The changes Bankers Trust has made have affected financial institutions and financial markets all over the world.

By pushing the limits for ourselves, we expanded the powers of every bank. By improving opportunities for our clients, we improved opportunities for everyone who participates in the capital markets. By questioning, by innovating, by never accepting the status quo, we created not just a new kind of financial institution, but a new environment for it to operate within.

Earnings by Business Model

Brittain and Newman adopted the traditional wholesale banking model.

Brittain Sanford Newman
Year ROE Earnings A/T Year ROE Earnings A/T Year Earnings A/T
1974 11.3 69 1987 17 462 1996 766
1975 9.5 62 1988 21 647 1997 866
1976 7.2 55 1989 29 620 1998 (73)
1977 7.6 60 1990 27 665 1999 (1603)
1978 8.7 815 1991 23 667   (44)3
1979 13.5 113 1992 20 639    
1980 18.6 213 1993 26 1070    
1982 14.5 239 1994 13.5 615    
1983 15.7 261 19954 4 215    
1984 16.2 306   20 56606    
1985 16.6 371          
1986 16.3 428          
  12.9 2445          
1989   (1600)1          
1987   (636)1          
  Less than 1%2 2092          

1 Charge-off for LDC credits; a business discontinued in 1983. Regulators did not allow LDC charge-offs until 1987.

2 Business Week reported BT's ROE and earnings began jumping in 1977 due in large measure to the "stunning success in the securities trading and investment areas." (Resources Management Department). Without these earnings, Brittain's era would show a loss!

3 Newman gets credit for the two years of 96 and 97, even though his policies did not take effect until late 1997.

4 At the end of 1995, BT was reserved for all contingencies from the Sanford years. No additional reserves were taken to cover Sanford era problems.

5 In 1978, Brittain sold BT's unprofitable branch system and, unfortunately, BT's credit operations to First Chicago for $80 million premium. First Chicago recaptured $80 million from receivables, previously charged off by BT. A few years later, the credit card operation was valued at $2 billion, which was approximately the total of BT's capital then.

6 BT's annual report 1995; annual reports, proxy statements and internal information from Goldman Sachs.

Charles S. Sanford, Jr., a 1958 graduate of the University of Georgia, is the retired chairman and chief executive officer of Bankers Trust Corporation. In 1997, the Terry College of Business dedicated Sanford Hall in recognition of the significant contributions made to the Terry College and the University of Georgia by Charles and Mary Sanford. He has served as a trustee of the University of Georgia Foundation since 1986, and his family's association with the University spans many generations, dating as far back as 1835.