A whiter shade of profit

A whiter shade of profit
Heather McKenzie
1 April 2008
Banking Technology

Shrinking revenues are forcing banks to optimise operations in novel ways, including outsourcing non-core activities to rival banks while retaining their own customer relationships
Outsourcing used to be something of a dirty word in the financial services-industry. While other sectors grasped the opportunity to divest themselves of ‘non-core’ tasks, such as human relations and payroll, financial institutions held firm against the trend for many years. The business of banking was far too important to let any of it be handed over to a third party.
But economic reality has long since dawned and outsourcing is now a common approach, particularly for processing-intensive tasks in the back office. To sweeten the pill, a number of terms are used as alternatives to outsourcing – white labelling, private labelling, grey labelling, and joint ventures. They all, essentially, mean about the same thing – banks can hive off elements of their business that they can no longer afford to run to specialists or scale players who can achieve results at a much lower cost.
The latest drivers of outsourcing are the Single Euro Payments Area, the European banks’ initiative to harmonise payments across the euro zone, and the European Commission’s Payment Services Directive, which provides the legal foundation for the creation of an EU-wide single market for payments and must be transposed into national law across the Union by November 2009.
The two initiatives will transform the payments industry in Europe, treating cross-border payments as local ones within euro zone countries, leading to a decline in these revenues for European banks. The World Payments Report, a survey published by Capgemini, ABN Amro (now part of Royal Bank of Scotland) and the European Financial Management and Marketing Association in November last year, estimates that direct payments revenues for European banks will decline by between 38% and 62% in some parts of the market by 2012.
In the absence of this revenue, some banks may find it is not cost effective to stay in the payments processing game, particularly as they will face greater competition from new market entrants, such as the payment institutions created by the PSD. “The Payment Services Directive and some other changes in the payments business are providing a catalyst for banks to consider whether or not they want to be in the payments business,” says Alan Koenigsberg, core cash management product executive for EMEA and the Americas at JPMorgan. “I think in the euro zone, consolidation will lead to about five big banks dominating as payments service providers.
“Many banks are looking at component outsourcing, where they will hand over a component of the business, like clearing and settlement, while retaining the customer relationship. Banks are looking to outsource the parts of the business that they feel are not value-added, but they want to continue to face the market with their brand.”
The World Payments Report found that 58% of banks already outsource or plan to outsource part or all of their payments activities within five years and 68% plan to offshore the activity as well, whether back office, IT or support functions.
Said the report: “Banks are repositioning their business models (on a European scale), enhancing their service offerings (competitive model), and optimising their delivery models to sustain their strategic ambitions in the future payments marketplace. Banks are turning to delivery models that rely on open architectures to:
▪ Enhance product offerings: flexibly add white-label products to their portfolios quickly enough to satisfy clients;
▪ Outsource payments processing to third parties, or insource others’ corporate or financial institution payments; and
▪ Permanently optimise this model by offering clients the most competitive integrated services in the market.”
Successful banks, said the report, will convert their delivery models into open architectures, which will enhance their product offerings, support the needed flexibility to bring white label products quickly to market, outsource payments processing or insource processing from others, and permanently optimise this model by offering clients the most competitive integrated service products on the market.
White labelling, which has been long established in the FX world, is attractive because it enables the bank that is outsourcing its activities to retain its brand and customer relationship.
In a paper on SEPA and sourcing challenges published in December last year, UK legal firm Denton Wilde Sapte said larger SEPA players, aiming for ‘critical mass’ transaction volumes, are focused on creating an end-to-end SEPA offering, including white label and insourcing services for smaller SEPA players. These banks would also provide the additional optional services (AOS) that are a considered an integral part of SEPA, given that they will help banks to recoup their losses. AOS may include integrated treasury systems and financial supply chain tools.
“Whichever strategy is chosen, effective systems and sourcing will be a key component of a successful SEPA strategy,” said the Denton Wilde Sapte report. “SEPA will demand significant IT investment by banks and careful reviews of their organisational processes. As the SEPA schemes are independent of underlying payments infrastructures, banks can secure competitive advantage by developing leaner mid-and back office payments operations, more efficient customer fulfilment and data routing functions and greater product innovation.”
Among the banks that are aiming to be major players in the SEPA environment is Deutsche Bank, which offers financial institutions the chance to leverage its global branch network and domestic clearing memberships. Corporate clients open accounts with Deutsche Bank, which are embedded in a single customer service and relationship management interface through the financial institution. Deutsche Bank provides its full set of cash management services, including the option to white label db-direct internet, the German bank’s web-based electronic banking system and its liquidity management technology.
Colin Digby, director of wholesale solutions at Deutsche Bank, says a dozen banks are already using the whitelabel option and it is being rolled out in a “number of other banks” as well. The key advantage of a white label service, he says, is that it retains the same look and feel of the client’s bank.
The implementation of white labelling differs from bank to bank, says Digby. “In some cases, the bank will use only the front end system to receive transactions which they then execute on their own book. They will also provide reporting and data back to their clients in the same application,” he says. “Another category of user takes the front end and complements that with Deutsche Bank’s processing capabilities.”
Way back in May 2004, Deutsche Bank stole a march on its European rivals when it announced a strategic partnership with Barclays Bank that allowed the UK bank to provide its larger corporate customers with cash management services across Europe. The deal was hailed as a first in Europe, with Deutsche Bank offering its cash management franchise to another financial institution to serve its corporate clients.
The main drivers for white labelling or outsourcing, says Digby, are cost, time to market and the level of expertise required in-house. “If you intend to build or buy an electronic banking system, you need a supporting infrastructure around it, which needs to take into account IT, bug-fixing and future development plans. Regulatory requirements in the payments industry are becoming more stringent and the development piece is therefore more complex,” he says.
Digby says many more clients are happy to say “we know you are a global transaction bank and you have developed these systems yourself and we will buy that and will be able to go to market immediately and be future-proofed against further developments in the industry.”
Only stage one of SEPA – credit transfers – has been achieved to date. By November 2009 the PSD is scheduled to be in place as will be SEPA direct debits (which need the PSD to be in place). Until then, and perhaps for a couple of years afterwards, most observations about SEPA and its impact will be speculation.
In a speech at a conference organised by the Federal Reserve Bank of Kansas City in the US in May last year, Getrude Tumpel-Gugerell, member of the executive board of the European Central Bank and one of SEPA’s main cheerleaders, raised the issue of non-banks and their role in SEPA, something that has concerned Europe’s financial institution incumbents. She said: “Non-banks offer complementary services to banks, basing their success on economies of scale. It is also conceivable that a bank may establish its own ‘non-bank’ and confer upon it part of its payment functions. Thus, the questions raised are to what extent outsourcing could expand, and whether banks in the future would maintain commercial relations with their clients, as is the case in the IT business nowadays.”
JPMorgan’s Koenigsberg has a similar view. “White labelling, joint ventures and outsourcing have become plays in the SEPA environment. The Payment Services Directive creates payments institutions and there is no reason these cannot be created as subsidiaries of banks. The PSD will be a catalyst for banks in deciding whether or not to play in the payments space. Depending on the size of the institution, it could outsource its own payments to another provider, or could create a payments factory and insource, thus creating a truly private label business.”