The global banking industry faces the constant challenge of addressing a variety industry pressures. Regulations. Compliance. Customer demands and their increasing expectations. Technology developments. Market consolidation and the rise of merger and acquisition (M&A) activity. All banks, regardless of their size and location, must contend with these dynamics on a daily basis and how they do so – in terms of investment and priorities – underpins their market strategy.
Growing Importance of Market Strategy
According to Dave Robertson, partner at Treasury Strategies, there are currently two philosophies in the market when it comes to banks and their investment decisions. “While some banks are heavily investing in order to generate revenue and growth opportunities, others are focusing on boosting short-term profits with minimal investment,” he says.
Robertson argues that, for many banks, short-term profit drive is constraining them from pursuing strategic investment opportunities, such as developing their technology architecture in order to make them more scaleable and efficient. “Banks must balance short-term profit pressures with investing for the future otherwise they may find themselves caught in a downward profit cycle where they continue to cut costs and miss out on growth windows, which may ultimately lead to them exiting the business,” he warns.
An effective growth strategy is even more crucial in the current climate of M&A activity as a result of increasingly vocal shareholder activism. gtnews attended a European banking seminar hosted by Standard & Poor’s last month which highlighted the fact that activist shareholders have become more vocal when voicing their discontent, which could press underperforming management teams into considering merger options more proactively than was comfortable in the past.
“Target banks [for merger or acquisitions] are no longer just the financially weak but banks that are perceived to be under-delivering,” explained Michelle Brennan, director, regional financial institutions criteria officer at Standard & Poor’s. “Today, even large groups with solid fundamentals but unconvincing growth strategies could fall prey, while the ability of management, national regulators and politicians to oppose such bids diminishes.”
According to the ratings agency, despite the regulated nature of the European banking industry, activist shareholders are willing to weigh in when companies define their strategies. “More banks might come under closer scrutiny if shareholder discontent is reflected in share price underperformance relative to those of their peers and perceived opportunities, thus making them suitable takeover candidates and more attractive for certain investors,” claimed Brennan.
In the face of mounting pressure from vocal shareholders and other industry forces, what are the current investment priorities today and what factors should banks take into consideration when they define their growth strategy?
Technology is a Priority
Investment in technology is always a key component of any bank’s market strategy and this section looks at the priorities and developments in this area.
Build or buy?
One key decision that all banks need to make in terms of their technology strategy is whether they want to concentrate on their core competencies (i.e. the service offering) and buy technology from third-party vendors, or develop technology themselves in-house.
According to Judd Holroyde, senior vice president, head of global product management and delivery at Wells Fargo, customer experience should drive any technology approach. “Since customers’ needs – along with government regulations and technology capabilities – keep changing, it is critical to have a technology infrastructure that is flexible and adaptable,” he says.
Holroyde believes that whether to build or to buy technology is a fundamental, philosophical decision for any financial institution and each one has to consider certain key questions before they make their choice. Do you consider technology a core competency or not? Do you want to own a technology group or rent someone else’s? Building technology requires a major commitment of resources; do you have other priorities for your resources, such as supporting mergers and acquisitions?
Each bank will have a different answer to these questions depending on its overall market strategy, geographic footprint, customer base and resources. For instance, Treasury Strategies’ Robertson says smaller banks are white labelling and forming partnerships, which has recently taken on more urgency. “Some of our clients who are processors are incredibly stretched at the moment – this is a boom area,” he affirms. “At the same time, larger banks are taking some of their platforms back in house and perhaps we will see them invest in their own proprietary wire system or low-value automated clearing house. Non-banks are also merging in order to bulk up and create the scale to support the largest banks.”
Integration and flexibility
Enhancing integration and flexibility within bank technology architectures is another key trend in the industry today with a focus on investment in web-based technology and information. Global integration has become more significant, such as integrating capabilities on a global basis, as well as integrating FX and trade into the domestic and international payments platform. “Banks are also gearing up to integrate and extend their third-party solutions,” says Robertson. “They are either reactively or proactively trying to set up a technology architecture that allows them to ‘plug in’ easily with their partners.”
To some extent, this trend is driven by the phenomenon of borderless banking, which is certainly shaping technology decisions across the industry. As Holroyde at Wells Fargo points out, since technology is already making the need for ‘a bank down the block’ obsolete in the developed world, integrating domestic and global financial solutions is an essential part of any financial services technology developed for businesses. “US-based companies with international operations generally prefer the control centralised payables and receivables afford. They need multi-currency accounts to enable them to receive and pay out foreign currencies without incurring foreign exchange fees. They need balances in US demand deposit accounts, multi-currency accounts, and foreign bank accounts in a single online report to give customers an integrated picture of their global cash,” he explains.
The inefficiencies of existing bank legacy systems, however, are a major stumbling block in terms of improving flexibility and integration of solutions, and this issue is explored by Andy Thorn, at PA Consulting, in his article IT Investment in Banking: Where’s the Smart Money?. “With most banks, the complexity of their applications and systems inhibits their ability to make rapid changes to suit the business drivers,” he explains. “Even given the impact on timescales to effect change, there can still be a huge cost for even simple system upgrades.”
His article outlines the importance of IT investment in both existing functionalities, such as business process optimisation, the second wave of offshoring and ITIL process management, as well as investment in new functionality to enable improved services including product enhancement and technology-led innovation.
The value of technology investment as a way of improving efficiencies is also underlined byWilliam Sampson, at Surecomp, who says: “It is hard to say for certain which technology will thrive and which will fall by the wayside, but we have plenty of evidence about how technology has increased efficiency in the marketplace.”
In his article, The Latest Banking Challenges, he takes the example of international trade finance where letters of credit have given way to open account trading. “Banks are keenly interested in how new technology solutions will help them avoid disintermediation and remain a valuable link in the global supply chain,” he claims. “With the commercial availability of SWIFTNet Trade Services Utility, that transition has begun. And, with the emergence of Java Enterprise Edition and service oriented architecture, new applications built around these standards will help banks maximise the return on their technology investment while minimising their cost of ownership and time to market.”
Challenge of connectivity
One area of technology that would certainly benefit from improved standardisation is bank-to-corporate connectivity. As Joergen Jensen, at Wall Street Systems, says in his article, Bank-to-corporate Connectivity: The Next Stage, bank-to-corporate connectivity has often proven to be the biggest hurdle in enabling straight-through processing (STP) in treasury and cash management across organisational boundaries, as a result of manual processes that are still involved in getting payment instructions to the bank and the lack of standardised message formats.
This is a technology area that is undergoing transformation, however, with bank opinion changing and significant industry developments. For instance, Wall Street’s Jensen acknowledges the fact that many banks now openly admit that they no longer consider formats and connectivity as a competitive space but instead want to co-operate in this space, and use standards to reduce costs for their customers as well as themselves.
Robertson, at Treasury Strategies, who believes that banks are trying to integrate more with their corporate clients in order to manage information better, supports this view. “Banks are considering how to make it easier to do business and there is a technology component to this in terms of improving the speed and ease of implementation,” he says. He refers to ‘strategic architecture’ where banks are trying to transform their existing ‘spaghetti-based’ systems, which currently manage and authenticate information, into single scaleable platforms in order to improve flexibility and consolidate scale.
The latest attempt to create an international format for bank communication – ISO 20022 – as well as SWIFT’s decision to further open access to SWIFTNet for corporates are both developments in bank-to-corporate connectivity that should be acknowledged as important milestones.
SWIFT’s new corporate access model is gaining traction among the corporate community since its launch last year. In fact, according to Robertson, most of the corporates who attended the Treasury Strategies SWIFT for Corporates Day last month brought their IT partners with them. “We are starting to see cross-functional partnerships growing,” he claims. “There is also a lot more awareness among corporates about connectivity options and banks are thinking about how to commercialise on this opportunity.”
Read more about connectivity issues in the article series, Why Connect? Why Now?.
Risk management and compliance also remain a constant priority and there are three major themes that regulators are currently focusing on that are influencing banks in their investment choices. Firstly, regulators are taking a more cross-platform view of risk and therefore expect banks to increasingly connect exposures across channels and payments. This is adding pressure to bank architectures where risk management has usually been buried at the platform level.
For instance, in his article, Impact of Basel II on Bank’s IT Strategies, Athanasios Papanikolaou at Ernst & Young, discusses the fact that new regulatory demands, such as Basel II or the Markets in Financial Instruments Directive (MiFID), have increased the pressure on the information systems function and encouraged banks to develop an integrated information systems strategy and consequently amend their existing IT infrastructure.
He examines how banks are investing heavily in information systems in order to adopt the Basel II approach and consequently meet regulatory requirements. “This costly compliance investment provides a great opportunity for credit institutions to design their future business strategy,” says Papanikolaou. “Credit institutions have great expectations in investing in IT infrastructure as this investment can provide reduced costs through standardised procedures, as well as new marketing strategies, improved risk management and finally a competitive advantage through the efficient and effective use of technology.”
The second significant focus for regulators are privacy issues where they expect banks to be able to identify specific data breaches quickly in order to limit any damage as a result of fraud. This is a particular concern when we consider the statistics highlighted by Gail Buerger Kerr and Sunil Ippagunta, from KeyID, in their article, Online Banking: How to Avoid the Threat of Fraud, which states that while the number of people who said they have lost money due to online fraud has decreased by 24%, the average loss has skyrocketed from US$257 in 2005 to US$1,244 in 2006.
According to Kerr and Ippagunta, some banks are resisting improvements to online security because they are looking in isolation at the losses due to security breaches. “They are not taking into account lost customer confidence that prompts the customer to change banks, the cost of servicing customers through branches, and loss of revenue by being unable to provide secure, high value services online,” they argue. “Because banks are inaccurately forecasting their total losses, too many believe that higher spending on security is not justified.”
In order to combat this challenge, their advice is that investment in next-generation technology and security solutions that incorporate functionality, such as mutual verification where the customer verifies the bank and the bank verifies the customer, should be a fundamental part of any bank’s market strategy.
The third area that regulators have identified is the growing number of non-bank processors in the marketplace who are generating numerous transactions within the banking system. “Regulators are scrutinising these third party arrangements much more closely to make sure banks understand the underlying commercial purpose and ensure that a bank’s operations are not hijacked for fraudulent purposes,” explains Treasury Strategies’ Robertson .
Read more about dealing with the threat of fraud and implementing effective prevention measures in the Risk section on gtnews.
Market Consolidation and Partnerships
As highlighted earlier, we are likely to see more collaboration, M&A activity and partnerships forming within the market in future. For example, Sachin Arora at Infosys, highlights the merits and challenges of partner banking in his article, Harmonising Global Partner Bank Payments. “The developing economies (especially BRIC countries) that are the focus of the future tussle for market supremacy are characterised by a rigid technology infrastructure, which does not support standardised value added products to corporate clients,” he argues. “Mergers and acquisitions, organic expansion, and collaboration with local banks are some of the key strategies employed by multinational banking corporations.”
Indeed, Standard & Poor’s predicts an acceleration of large M&A transactions over the next 12-14 months although it also points out that the European banking industry is likely to remain relatively more fragmented in contrast with the rapid concentration that took place in the US market a few years ago, which resulted in a handful of dominant players. The ratings agency does believe that bank industry trends in Europe continue to favour cross-border mergers, as many banks face difficulty delivering strong organic growth in their highly leveraged markets with limited ability for in-market moves.
This commentary has highlighted the industry developments and pressure points that are currently shaping the market strategies of banks today. Investment in technology remains a constant priority, as banks seek to update their existing legacy systems in order to embed greater integration, flexibility and efficiency across their systems and operations. Banks are also under the ongoing scrutiny of the regulators who keep a watchful eye on their compliance with regulations and prevention of fraud and financial crime.
For any bank, their market strategy for growth will be multi-faceted and unique but a universal consideration will be how to balance short-term profit pressures with strategic investment in technology and compliance. And the most pressing investment question for banks right now is whether to build or buy technology. The risks associated with either choice are still significant but we can expect the size of a bank to really determine the answer to this question. The key to success in technology investment, according to Holroyde at Wells Fargo, is to be able to anticpate what’s coming next and position yourself for it three to four years out. “None of us has a crystal ball, and we’re not right all the time,” he says. “But banks have to be proactive and willing to take risks because, by the time your customers come to you and say, “I need this”, it’s too late to develop it. They’ll go get it from your competitor.”
There has been an uptick of treasurers inquiring about interest rate risk management in recent months as interest rates in the US and UK have started to show a rise in momentum, said Chatham Financial at the annual Bellin treasury conference.
The global economy has seen about eight years of growth, but we are starting to see the end of this which is triggering some volatility in global markets, Stefan Bielmeier, DZ Bank, argued in his keynote speech at the Bellin annual 1TC conference. Other speakers discussed blockchain, cyber crime and netting.
A series of governments are now very worried about the idea of bitcoin and these currencies because customers would be able to make sustainable ongoing transactions and payments without having to ever introduce the use of a typical financial model or banking system. To combat this potential threat, several countries including major central banks like the Bank of England and the Bank of Israel will be launching their own version of a cryptocurrency. This could bring big advantages to customers.
Once there is KYC blockchain, the technology will be at the forefront of helping to identify those who present a greater risk of criminality, argues David Poltorak, chief technology officer at Fortytwo Data.