PARADISE for HSBC, the world's third-biggest bank by market value, can be found at Juhu Beach, a suburb in north Mumbai favoured by Bollywood stars. After negotiating a security guard snoozing on a plastic chair, you climb some grotty stairs past a placard begging, “Choose RBS business banking for your leather business.” Inside is one of the two dozen or so branches that Royal Bank of Scotland, a bailed-out firm in retreat, is selling to HSBC, which is one of the biggest foreign banks in India. Its annual pre-tax profits there are approaching $1 billion.

Despite the entrance, the branch has potential. A lone customer is well-heeled and probably lives in one of the apartment blocks nearby, which are full of the sort of affluent folk that HSBC targets. Mumbai's commercial centre of gravity is shifting north, which should mean more business clients to plug into HSBC's global network. The staff are bright and keen. Run properly the branch could be a gem. And HSBC can run branches properly. Its existing outlet in Juhu, a few blocks away, is smart and busy.

Although HSBC has huge operations in America, Britain and France, it thinks of itself as an emerging-market specialist, with a tradition stretching back to its foundation in Hong Kong in 1865. And by its own legend it is also the bank that keeps its head when all about it others lose theirs. It is the quiet predator that grows by buying all or parts of those firms that are stupid enough, or too clever-by-half enough, to fail. For almost a century and a half, HSBC's strongest beliefs have not been in a product, person or geography, but in its own culture and in the folly of its rivals.

The legend no longer fits reality, though. The past five years should have been glorious for HSBC: there should have been lots of deals like the RBS India one (which awaits regulatory approval). Instead it is one of only three piddling acquisitions made in emerging markets since the financial crisis began in 2007. By contrast, other top banks, including JPMorgan Chase and BNP Paribas, have made big strides in their key markets. Furthermore, HSBC has lost market share in many countries, mainly to thriving local firms (see chart 1). One explanation for the bank's passivity is that some failed rivals, such as Citigroup, were bailed out rather than dismembered and forced to sell their crown jewels. But the lack of activity also reflects HSBC's losses in America, which weakened its balance-sheet, and a simple loss of nerve.

HSBC had a relatively good financial crisis. It did not need a bail-out. It enjoys a reputation for transparency and commanded enough investor loyalty to conduct a giant rights issue during the crisis and swat off criticisms from an activist fund, Knight Vinke. But opportunities missed in emerging markets have dimmed HSBC's aura. Like its adverts found in airports around the world, in which a single photograph is accompanied by two contrary captions, a firm esteemed by insiders is often slammed by its competitors. Citigroup bigwigs claim HSBC has still not joined up its operations in Asia. Local Indian rivals say the firm is nothing special. British competitors say its position there has slipped. Brazilian financial chiefs are known to tap their temples and say that HSBC is, in their considered view, nuts.

HSBC is not a mediocre firm in crisis. It is a great one slipping towards mediocrity. Its new targets, reset in February, appear confident. At their lower end they suggest the firm should aim to make a return on equity of about 14%. This is decent and roughly in line with the goals of JPMorgan Chase (these calculations use tangible equity for both firms, assume the tougher incoming “Basel 3” capital rules are already in place, and presume that both firms run with a 10% core capital ratio).

Yet HSBC starts from a weaker position. By the same measure it made a return of just 8.6% last year, compared with JPMorgan's 10.3%. Higher interest rates and lower bad debts will boost HSBC's profits. But regulatory headwinds are becoming stronger, particularly in Britain. This week the Vickers commission, a body of wise men set up by the British government, proposed new measures that will dent returns (see article).

Everywhere and nowhere

It would be nice if today's lacklustre results reflected difficulties just in America, where HSBC is winding up the consumer-lending business it bought in 2003. Underlying losses there have wiped out one-fifth of the rest of the group's profits over the past four years (see chart 2). But the broader picture is also disappointing. HSBC makes fantastic returns in Hong Kong, lousy ones in America and mediocre ones elsewhere.

An analysis by The Economist, based on a new breakdown by HSBC of its regulatory capital by geography and division, reveals the problem. (These calculations use underlying profits, assume a core capital ratio of 10% and the existing, softer, “Basel 2” rules, and remove from the picture HSBC's minority stakes in Chinese firms, which it does not run).

By this measure, an estimated 42% of the equity in operations run directly by HSBC made a return last year below the bank's cost of capital, which it reckons is 11%. About half of this idle equity sat outside America. There was considerable weakness in Latin America as well as pockets of sogginess in the Middle East, Europe and Asia. Several other parts of the firm—European investment banking in particular—only just made the grade. Set the bar higher, at HSBC's target return of 14%, and 63% of the group underperforms. These figures do not reflect the incoming, tougher, “Basel 3” rules, which will make things look worse.

The man who must tackle all this is Stuart Gulliver, who became chief executive at the start of the year, after a messy succession in which Douglas Flint, the firm's long-standing finance director, also became chairman. (Mr Gulliver refused to be interviewed for this article, citing an upcoming strategy presentation to investors. Two directors of The Economist Newspaper are also directors of HSBC; they were not approached for this article.) Mr Gulliver is a former star trader who has been loyal to the bank for 31 years. Although preoccupied with profits, he exudes pride when he speaks of the honour of running HSBC. Mr Gulliver also personifies the firm's double identity as a bank that is both British and Asian. He has an official residence in Hong Kong, spends much of his time on the road and pays tax in Britain.

In an interview with The Economist in 2010, before he was appointed boss, Mr Gulliver offered the company's past as a guide to its present and future. HSBC's history is certainly remarkable. It is one of only two mega-banks that have remained independent for more than a century, avoiding a bail-out or state control (the other is Santander of Spain). HSBC has endured despite, or perhaps because of, a turbulent environment. For most of the bank's history Hong Kong lacked a central bank or a state safety net. HSBC has witnessed a Japanese invasion, revolution in China (where it once made over a quarter of its profits), the demise of sterling and silver (in which its reserves were once held), the post-war wave of Asian economic nationalism, numerous bank runs, the move of the firm's domicile and headquarters from Hong Kong to London in 1993 and the territory's return to China in 1997.

But a glorious history often seems to impede clear thinking at HSBC. Romantics say that the bank used to prosper by deliberately not having any strategy at all. It just sat making money in Hong Kong, waited for the world to blow up, then picked up the pieces. This isn't accurate: three of the firm's four big, successful acquisitions between the 1949 revolution and 1992 were chewed over for years.

Still pining for the East

Institutional memories of the glorious Hong Kong years also help to explain the bank's ambivalent attitude to Britain. A traditional HSBC man walks, talks and drinks like a Brit—or, better, a Scot—and likes the City of London. But in his heart he suspects Britain is full of intellectually vain officials and is doomed to stodgy decline.

The prospect of a move of headquarters back to Hong Kong grew when Michael Geoghegan, Mr Gulliver's fiery predecessor, shifted his personal office there early last year in what now looks like an expression of frustration. As British regulators have become more hostile HSBC has dropped more hints about a move. One retired bigwig believes the threat is hollow. The logistics of moving are more daunting than when HSBC moved in the other direction in 1993. Two-thirds of the firm's 280 highest-paid employees are in Britain, at least half of its directors are based there and in the past two years about a quarter of recruits for its elite corps of international managers were British.

A senior Hong Kong official speaking to The Economist in November dismissed the idea of an imminent move, and his spokesman recently confirmed his view had not changed. A move by HSBC would make more sense if it yielded more lenient supervision and the opportunity to turn the bank's leading position in Hong Kong into a really powerful one in China. The first is possible—a lead regulator in Hong Kong might not demand the group-wide capital surcharge that Britain will. And a Hong Kong-based HSBC could try to shift activity away from subsidiaries facing unfriendly local regulators—such as investment banking in London. Yet this would be a daunting undertaking.

A great leap in China is no easier. HSBC has played its hand on the mainland better than any other foreign bank. It has the largest branch network, with 162 outlets. And it has an array of stakes in Chinese financial firms worth a hefty $27 billion at the end of 2010; the capital gain on and profits from these have partly offset the debacle in America. Its key holding is 19% in Bank of Communications (BoCom), China's fifth-biggest lender. HSBC does not have much sway over BoCom, but the agreement struck in 2004, uniquely among Western deals with Chinese banks, envisioned that the stake could rise to 40%, which would give it influence or control.

Yet the investment climate in China has changed. The boss of one of China's big state banks says that no foreign firm will be allowed a significant direct market share in China (foreign banks' share of the system's assets is only 2%). The state now classifies BoCom as one of five major banks, a label that signals it is not for sale. Few think HSBC will get control unless there is a banking crisis in China that prompts a change in the official line. That fits the mantra jokingly muttered by HSBC types since the deal was struck: “We'll have BoCom in the end, but it'll go bust first.”

Mr Gulliver is well known in China and Douglas Flint recently met Wang Qishan, a vice-premier and an outside contender for the Chinese premiership, in a ceremonial engagement that seemed to reflect the bank's special stature in the country. HSBC continues to lobby for a listing of its shares in Shanghai. Absent a crisis, though, the suspicion remains that the price of full admission to China would be not just a return of the firm's headquarters to Hong Kong but a “Sinofication” of its executive ranks and the imposition of some state control. That would be cultural suicide for HSBC's current, largely Western, top brass. And the perception that the firm was under China's thumb might damage its business elsewhere.

Nostalgia for the East has perhaps prevented HSBC from taking stock of the pile of other acquisitions since 1993 in places like France, Brazil, Mexico, Argentina, New York state and Turkey (see table 3). Veterans argue that the bank has picked up some bargains over the years. But successful expansions are about coherence as well as price. Before 1993 HSBC often left purchases to run themselves. Today, thanks in large part to the acquisition splurge, it is a federation present in 87 countries, often through subsidiaries with their own governance structures. They typically have local market shares of below 5%.

The idea of a “network bank” with a light presence in many countries is not, in itself, foolish. Such a bank can finance trade, organise transactions for multinational companies and sell common products to an increasingly homogeneous global middle class. But running a network bank is complex and expensive. After decades of drift, Standard Chartered, a largely Asian outfit headquartered in London, has begun to thrive, mainly by tilting more towards investment banking. Citi, by contrast, has had a terrible decade. Having lost money in investment banking, it is slimming down and hoping that its presence in lots of countries will be an advantage.

HSBC posits the benefits of its global network as if the facts spoke for themselves. Sometimes they do: “Premier” and “Advance”, two global retail-banking products aimed at well-off people, have been big successes. But often they don't. The bank does not make better returns than its local peers, except in Hong Kong where it is dominant. It is a leading global credit-card operator but still managed to lose money in Mexican cards in recent years, just like supposedly less savvy rivals. Its transaction-services activities, which provide global financial plumbing for big companies, contribute just 12% of net operating income and have shrunk since 2008. And HSBC doesn't benefit much from geographically pooled funding. It gathers lots of excess deposits in Hong Kong, but local regulators, sensibly, limit the amount that can be farmed out to other bits of the group. The bank's initiatives to create global business lines in investment banking and consumer finance in the past decade were half-hearted and sometimes seemed like post-hoc attempts to justify the geographical spread that it had acquired.

Making a ton of money in Hong Kong, under any flag

Mr Gulliver is a strong believer in global reach. To make things work better he will have to improve the bank's economies of scale. One option is simply to lend more over the same fixed cost base. But loosening underwriting standards now to recapture market share lost three years ago is a risky approach. HSBC executives privately question the risk that Standard Chartered, which has outpaced it in Asia, is taking. The alternative to a lending splurge is to try again to push global product lines. The obvious one is investment banking, although the firm's chequered past and those British regulators may make that difficult. More promising may be a push into private banking, which needs less capital.

Chop chop

If HSBC cannot grow into something more coherent and profitable it will have to do what almost all tired conglomerates do at some point: take a hard look at its portfolio and cut off the rotten bits. The bank has been brutal in shrinking its American consumer-finance and subprime business, for which it always had distaste—its assets have almost halved since 2007. Yet HSBC has been remarkably tolerant of failure elsewhere. Mr Gulliver plans a round of cost-cutting, but he probably needs to go much further by simplifying the firm's federal structure, tackling the vested interests that seem to have allowed underperforming businesses to be tolerated, and killing off or selling those bits of the group that cannot be brought up to scratch.

To the contemporary HSBC staffer all that may sound barbaric. Yet by re-establishing a culture of accountability and discipline Mr Gulliver would not be betraying the bank's traditions but acting entirely in accordance with them. HSBC has lost its reputation as an astute buyer of banks. Its dream of being a leading firm in China is subject to the whim of that country's nationalistic government. The alternative vision, the only one that unites HSBC's disparate assets, is of a globally integrated bank. This is alluring but has proven hard in practice. Mr Gulliver is probably the last HSBC boss who will be given a chance to deliver it.