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Financial institutions are under pressure from a weak operating environment and seemingly unending regulatory change. The scale of the challenge is prompting an unprecedented level of soul-searching among FIs. As Peter Jameson, head of GTS FI product and network strategy, EMEA, at Bank of America Merrill Lynch, notes: "Banks are shifting from trying to be all things to all people to focusing on what they do best."
As a result, the global transaction banks that meet FIs’ cash management needs have had to up their game. "We increasingly find that clients want to hear about alternative business models and gain insights into what their peers are doing," says Jameson. "As global players, we can add value and help FI clients find cost-effective solutions that still allow them to meet their clients’ needs."
There are no right or wrong answers to the challenges of regulatory change and the backdrop of moribund growth. The unique circumstances of every FI must determine how they re-shape their organizations to face the future. That does not mean that FIs have to face these challenges alone. Global transaction banks are falling over themselves to proffer advice and solutions to help them. However, it is the FIs that must decide their strategic direction.
The world might have pulled back from the abyss of the financial crisis, but the global economy remains precarious. "FIs are navigating a low-growth environment across many of the most developed markets," explains Lewis Warren, global client executive for financial institutions, healthcare and federal government, treasury services at JPMorgan. "EMEA continues to be complex while growth is decelerating in China and India."
Institutional investors are seeking a certain level of return to invest in FIs, driving firms to seek top-line revenue growth that contributes to higher profits. "As a result, there is increasing interest from clients in M&A, either to expand product capabilities or geographical footprint," says Warren. "In addition, FIs are looking to expand in growth markets and are targeting specific market segments where they expect growth."
Necessarily, growth is unlikely to come from the developed world, given the economic situation. "Therefore, to get growth in earnings there is an increased focus on emerging markets," says Warren. "If you look at the leading FIs in any sector, you can see that they have identified growth markets in regions where there are opportunities: for example, many are looking to major markets in Latin America, or are trying to target the growing middle class in China."
Companies wanting to expand in emerging markets need international solutions for payments and liquidity that enable them to centralize functions for easy access, control and visibility – creating a big opportunity for global transaction banks that have capabilities in emerging markets. At the same time, FIs are seeking solutions in developed markets to improve efficiency to pay for their expansion in emerging markets.
"FIs are increasingly implementing treasury service centres for the regions they operate in and are looking for appropriate technology solutions," says Warren. "For example, in sophisticated markets such as Hong Kong or Singapore, they want to use mobile technology to reach their end clients. To meet those needs, transaction banks that serve FIs need to invest in technology."
Although the fragile economic backdrop inevitably informs every decision made by FIs, it is the regulatory onslaught that is the primary driver of strategic change in the sector. "While regulation concerning our clients – as well as ourselves – can be broken down into global measures such as Basle III," notes Marcus Sehr, global head of cash management FI product at Deutsche Bank: "semi-global measures such as Vickers or Volcker, and local or regional measures such as Sepa, Dodd-Frank and Fatca, they all result in three outcomes: more investment, more effort and less profit."
Complying with these many measures is challenging for FIs and is prompting increased interest in sourcing solutions from global banks or technology providers rather than building them in-house.
One particularly pressing issue is Dodd-Frank section 1073, which has been introduced to address a perceived lack of transparency in consumer payments from the US to the rest of the world, particularly in relation to the costs associated with payments. Specifically, it applies to electronic transfers of funds (via Swift MT103) from a consumer in the US to any designated recipient in a foreign country and requires banks to itemize costs for consumer cross-border payments.
"Smaller, downstream banks want to continue to serve their customers’ cross-border payment needs but might not be able to invest in the technology required to comply with rule 1073," says Warren at JPMorgan. "Therefore they are turning to alternative solutions."
When the guidelines for implementation (set for October 28, 2014) were published on April 30, the originally proposed measures had been relaxed. The changes were welcomed by FIs. However, the relaxation highlighted the risks for smaller banks of developing their own solutions for regulatory compliance. "Regulation has a tendency to change even close to its introduction deadline," says a senior transaction banker. "FIs can easily get burnt."
Regulatory reforms, in addition to requiring large amounts of investment for compliance, have huge implications for FIs’ business models. For example, Basle III and the Capital Requirements Directive IV (which will implement Basle III in the EU) will change the attractiveness of deposits as liquidity buffers increase costs. "Roll-out of the legislation is planned from January 1, 2014 onwards to 2019," explains Paul Thwaite, global head of transaction services, FIs, at RBS. "With FI deposits of less than 30 days attracting 100% funding versus a 40% buffer for corporates, this is going to materially impact cash management and is likely to drive changes in behaviour."
Thwaite believes that FIs are likely to switch to holding more operational balances and deposits with a maturity of over 30 days. "This is currently at odds with existing client risk policies, which mainly seek immediate or short-term liquidity for deposits," he notes. "FIs will also be expected to manage and monitor their intraday liquidity positions in a more focused way."
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| Tom Isaac, EMEA FI sales head and global head of intermediary sales at Citi |
Although regulatory changes are in many cases onerous for FIs, transaction banking – and especially cash management – continues to offer certain attractions. "With the exception of trade finance, transaction banking consumes a generally low level of bank capital and can therefore produce high returns on equity, which compare with single-digit percentage rates that have become commonplace in other disciplines of banking," says Deutsche Bank’s Sehr. Consequently, "FIs don’t want to have to exit the business," notes Tom Isaac, EMEA FI sales head and global head of intermediary sales at Citi.
However, the increasing regulatory burden combined with the economic situation – and demands from banks and their clients to have the same kind of technology that they use in their everyday lives – is focusing attention on the limited discretionary technology spend that banks have available. "Budgets are predominantly taken up by regulatory spend," notes Isaac. Sehr agrees: "There’s very little, if any, budget left over for product innovation to enhance client satisfaction and ultimately increase revenues."
To stay in transaction banking, banks are therefore becoming more open to partnering and white-labelling to meet their clients’ needs, according to Isaac. For example, the pooling of liquidity is an increasing requirement by end clients, so banks are demanding it from global transaction bank providers. "We make as much of our technology and infrastructure available as possible because we do not see such business as being in competition with Citi," says Isaac. "Small banks serve a different client base and their flows simply give us economies of scale."
In recent decades, the transaction banking market – for both corporates and FIs – has consolidated inexorably to an ever-smaller number of ever-larger players. According to Deutsche Bank’s Sehr, the financial crisis and its repercussions have accelerated this process.
"In 2012 and early 2013 we noticed a considerable shift in the competitive landscape – especially in emerging markets," Sehr notes. "Several providers struggled with risk management issues while others, in the face of rising costs, pressure on revenues and limited resources, needed to adjust their coverage models. Some players were forced to reduce their footprint by withdrawing from certain customers and markets."
Sehr says that these events have led to a change in the mindset of FI clients. "The question is not just who can provide the best products and services – which are vital – but which provider is going to stay long-term in this business."
A commitment to transaction banking, which is reflected through investment in new solutions and customer services, now trumps everything for FIs – including price. "Five years ago, some clients may have been as concerned about pricing as they would have been about relationship management or customer service," says Sehr. "That is clearly not the case any longer."
Of course, service alone is not enough to win business. As Isaac at Citi notes, reciprocity and credit appetite (both on the part of the FI in terms of concentration risk and on the part of the transaction bank in the provision of nostro services) also remain important. However, few would disagree with Nadine Lagarmitte, global head of financial institutions, payments and cash management at HSBC, that in a business in which clients can move their provider almost overnight, "service is what distinguishes a transaction bank from a commodity provider."