The global financial crisis highlighted the attractiveness of transaction banking. Although businesses such as deposit and payment services, cash management and trade services were not unscathed by the downturn, they fared relatively well. Over the full economic cycle, these businesses often provide reliable fee and spread revenues, rich deposit volumes, and high profitability. Return on equity is typically above 40% for best practice institutions. Moreover, proprietary research by The Boston Consulting Group (BCG) has shown that ‘transaction champion’ business models – those that generate a diversified mix of credit, treasury, cash management, and payment revenues, as opposed to those dominated by credit-related revenues – can be pivotal in gaining competitive advantage across customer segments.
In the post-crisis era, transaction banking will remain a significant opportunity for financial institutions. Wholesale-payments volume is expected to post a compound annual growth rate (CAGR) of 9% globally from year-end 2010 through 2020, and total wholesale payments revenues are expected to increase from US$169bn to US$471bn. Moreover, leading global institutions are elevating transaction banking from an organisational perspective. They are refocusing sales efforts and making significant investments in improving overall capabilities, client coverage, and regional scope. They are taking these steps in the belief that an increasing emphasis on transaction banking will bring long-term benefits.
Why Transaction Champions Outperform
Benchmarking by BCG demonstrates that transaction champions have continued to outperform other types of banks, despite adverse trends such as narrowing deposit spreads and lower volumes. The reason is a relatively resilient revenue mix consisting of spreads earned on deposit balances and fee income earned on transaction and value-added services. In 2009, among banks focused on serving midsize corporations (those with between US$25m and US$250m in annual sales revenues), transaction champions posted revenues per risk-weighted assets of 600 basis points (bps), compared with only 250 bps for credit-heavy corporate banks – and their return on regulatory capital was 31%, versus 8% for credit-heavy banks.1
Since 2007, return on equity has risen for most transaction champions and has fallen for all credit-heavy banks in our benchmarking survey. What are the dynamics behind these trends? Generally speaking, transaction champions exhibit a comprehensive approach to building their franchises along dimensions such as the following:
Commercial, corporate, and investment banking businesses are fully aligned and have transaction banking objectives. Cross-silo product development, pricing, and bundling (such as foreign exchange (FX) risk hedging) are encouraged and supported. In addition, a collaborative model exists between the front office (the business units) and the back office (IT and operations).
A distinct coverage model exists, including appropriate incentives, which enables effective teaming between relationship managers and specialists in treasury and other product areas. Strong emphasis is placed on fully understanding customers’ present and future needs. When serving large corporations and multinational corporations (MNCs), global product groups team with relationship managers as well.
Excellence in the core products and services needed by target clients is provided, ultimately enabling clients to optimise their working capital. Cutting-edge pricing models, superior bundled-service packages, and the ability to offer short-term credit (such as supply chain financing) is the norm. The greatest challenge is in serving MNCs, which require sophisticated, integrated, cross-border payment services.
Customer service and product delivery
Both on-site and remote support is robust, enabling swift problem resolution. Online cash management and treasury services are user-friendly and efficient. The execution of transactions is automated, accurate and fast. We have observed that banks with relatively deep online portal penetration rates tend to have higher transaction-banking revenues.
Core systems are reliable, secure, scalable, and easily integrated with customers’ systems. In addition to having a sophisticated online treasury management platform, transaction champions serving large corporations and MNCs must be able to offer their clients access to the bank’s treasury and payments applications via the clients’ own enterprise resource planning (ERP) and treasury systems.
The above attributes contribute to transaction champions’ frequent ability to gather more deposits and generate more revenues than banks whose focus lies elsewhere. Yet the sales forces of transaction champions are not necessarily larger, nor are their overall product ranges always wider. Their secret lies simply in achieving the virtuous circle of cross selling: sell more transaction services, increase deposit balances, and win more cash-management mandates. As account revenues gradually become more important, an increasing share of a client’s deposits will be a critical revenue driver.
Most banks, however, are not transaction champions. Our benchmarking has revealed that a majority of banks are leaving potential revenues on the table, with only a small minority exploiting the transaction banking possibilities presented by their deposit and loan clients. Moreover, even those banks that excel at transaction banking can improve their performance. But in order for all banks to raise their game in this area, they need to review – and potentially retool – their business and operating models.
Building a Transaction Champion
Despite the strengths of transaction banking businesses, there are multiple challenges to be overcome before the full opportunity can be captured. For instance, getting different silos within the bank – such as the corporate-banking sales force, the cash management and trade-service specialists, and the operations and IT groups – to align around making transaction banking a top priority can be a tall order.
What’s more, some institutions struggle in defining their core target markets (both from a segment and geographic perspective) and in smoothing out uneven customer experiences across channels and regions. A winning strategy in North America or western Europe, for example, might not be optimal in Asia.
In addition, price pressure is becoming more severe as the competition for market share and scale heats up – a dynamic complicated by the tightening regulatory climate. Traditional operating models are being tested as wholesale banks face increasing tradeoffs between efficiency and standardisation on the one hand and service excellence and customisation – both across borders and across segments – on the other.
In our work with clients, we have observed that building a transaction champion depends on making the right decisions and investments along multiple dimensions. These dimensions include geographic footprint, product breadth, product quality, product and service innovation, distribution infrastructure, customer service and support, and credit capacity (along with the related risk appetite). For example, banks aspiring to be transaction champions for small to midsize corporations (as opposed to large corporates or MNCs) should focus on getting product breadth, distribution and customer support right, as well as assuring that sufficient credit capacity is available.
As for product breadth, many banks have pursued an ‘everything to everybody’ strategy. As a result, they are supporting an unwieldy range of products, some of which are subscale, negative- to low-profit products. Yet our benchmarking shows that banks can achieve above average cross selling (measured by revenues per client) without a full product set – and that other factors are important drivers. In our view, banks should home in on core, profitable products, ensuring that their offering remains competitive, while jettisoning or ‘white labelling’ (using generic versions of) non-core, low-profit products. White labelling has become an increasingly viable proposition as top-tier banks build multibank product platforms and offer interesting terms. Our recent discussions with banks reveal that many see partnering in global transaction banking as an increasingly important part of their growth strategy.
Regarding distribution, most banks have room for improvement in achieving a collaborative organisation structure between relationship managers and transaction product specialists, with a commensurate opportunity to increase their share of customer wallet. A useful place to start is to undertake a ‘wallet sizing’ exercise. Such an initiative should be aimed at understanding each client’s revenue composition, current product use, and future potential with regard to client segment, region, product, and relationship manager. Wallet sizing methodologies tend to vary by segment.
Customer service and support is another critical area. Indeed, poor customer service is the root of most attrition. If a bank is to maximise the lifetime value of its customers, sharp distribution infrastructure must be coupled with customer service excellence. Best-practice players are developing centres of excellence to support specific products and services and ensure that service level agreements (SLAs) are met and improved upon. Such institutions establish delivery teams (both physical and virtual) to assure quick customer onboarding, and they designate client-specific support teams for the largest, most profitable customers.
Of course, banks must be willing and able to provide capital-intensive products, including corporate loans, lines of credit, and (to a lesser degree) trade finance. For the latter, a bank may find that partnering with another bank is optimal. The ability to provide credit is critical to maximising transaction banking revenues from midsize to large corporations. As one of our clients said, “It is impossible to divorce the conversation about credit from cash management.” The reverse is true as well. Transaction champions often will not renew a line of credit for credit-only customers unless the customer shifts some of its transaction banking business to the bank. As Basel III capital requirements adversely affect the return earned on credit products, cross selling to credit clients will become critical to improving performance.
Although crisp execution along the above dimensions requires a sizable commitment in terms of financial and human resources, the investment will likely result in a sustainable business model and profitable growth. Not only do transaction champions increase customer retention through superior service and credit offerings but they also tend to attract the best customers of other banks as well.
Finally, a transaction champion must be able to design and implement appropriate business and operating models for its target segments. This task often involves balancing a ‘design to cost’ perspective for the small and midsize segments with a ‘service excellence’ perspective for large corporations and MNCs. A bank must have a flexible operating model that allows it to achieve scale and low costs within an infrastructure that supports all client segments. At the same time, the model must support the separate platforms required to deliver customised services to MNCs. Banks that achieve this balance will have not only a sustainable cost (and pricing) advantage but also a service advantage. These benefits will be the growth drivers of the future.
This article is excerpted from “Winning After the Storm: Global Payments 2011” by The Boston Consulting Group.
1 Based on the worst three-year average of actual or expected loan losses.
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