Outsourcing of payments processing now extends far beyond payments to include infrastructure outsourcing and even branch outsourcing.Joerg Pinkernell shows this is no longer just about cost reduction – it is also an opportunity to seize other competitive advantages.
Payments processing is often entwined with other areas of a bank that superficially appear unrelated. As a result, payments outsourcing has always been something much discussed, but little done.
However, environmental factors are driving a change in this situation. For example, the EU regulation on cross-border charging for euro payments has created a cost/revenue gap that the Single Euro Payment Area (SEPA) will further widen. Figures from the Boston Consulting Group (BCG) show bank payment costs expected to increase 4% per annum versus a 2% increase in payment revenues. Nevertheless, BCG estimates that the top 75 banks in Europe will need to invest $6-9 billion in their payment systems over the next five years.
A significant part of this investment is both compulsory and profitless, eg, the anti money laundering (AML) and know your customer (KYC) drive. In addition, the regulatory environment will undoubtedly continue to change, thus requiring ongoing investment.
Changes in corporate client behaviour are also bearing down on margins. Smaller corporates are now demanding functionality previously reserved for large multinationals. These demands often require the bank to invest in automation that generates minimal return.
More opportunity
These pressures have rapidly pushed outsourcing of payment processing from theoretical discussion to urgent reality. At the same time, the range of outsourced payment services has expanded, which has done much to overcome payment processing’s interconnected nature.
Outsourcing of payment processing now covers many areas, including:
- business process outsourcing
- cross-border payments
- domestic payments
- handling of paper-based transactions
- internet services
- general ledger and account admin
- reconciliation and Nostro management
- liquidity management
- SWIFT service bureau
- branch outsourcing
- infrastructure outsourcing (e.g. netting and settlement platforms)
- IT-hosting
‘Bank in a box’
One area that can encompass many of the others listed above is outsourcing of foreign branches. There are three broad possibilities here:
Business infrastructure outsourcing (BIO) – the client financial institution (FI) uses the outsourcing provider’s IT infrastructure for activities such as payments, image processing, FX, money market, reconciliation, investigations, accounting, general ledger, SWIFT connectivity, and possibly also netting/pooling. In addition, the provider can handle manual activities in areas such as repairs, investigations and paper-basedtransactions.
Business process outsourcing (BPO) – employees of the outsourcing provider work on behalf of the client FI to fulfil the same tasks listed above, but use the client FI’s existing systems.
BIO + BPO – the outsourcing provider performs the various tasks using a mixture of its own and the client FI’s systems/infrastructure.
Whichever approach is used, the client FI still retains complete visibility.
Specific drivers
In addition to the general arguments in favour of outsourcing, branch outsourcing is also driven by more specific factors:
Previous network expansion – foreign network expansion was often intended to take advantage of cross-border revenue opportunities. The EU cross-border charging regulation degraded these, leaving foreign branches exposed to high fixed costs and falling revenue.
Client expectations – growing client functionality expectations mean that new products must be made available via foreign branches to remain competitive, but the branches’ high fixed costs make the business case hard to justify.
Cutting back – closing the branches may save fixed costs, but incurs other risks. If the bank can no longer support clients non-domestically, competitors may step in. If any resulting business is competently executed, then the bank also becomes vulnerable to these competitors approaching the same clients in its domestic space.
Beyond cost saving
Historically, branch outsourcing has focused on cost saving, but other longer-term strategic advantages are now apparent. An outsourcing arrangement substitutes variable costs for fixed costs, while leaving value-added front-office activities and strategy with the client FI. A presence can be maintained from less expensive premises, so clients will still enjoy the same quality of relationship. At the same time, outsourced systems and personnel should still appear as if directly owned/employed by the client FI.
Removing fixed costs radically improves strategic flexibility. For example, the client FI can quickly support geographical expansion by its key clients. Branch outsourcing also means that the client FI’s product line is no longer curtailed by its resources, as it has access to its outsourcing provider’s full product functionality. Such providers are typically major banks that have the broadest possible product line for most markets.
Branch outsourcing also allows for volume and functional extensibility. The client FI’s transaction volumes are no longer constrained by their branch network capacity. The client FI is also insulated from the costs of upgrades required to accommodate AML/KYC regulation changes, as these will be included in the outsourcing package. Finally, the client FI should benefit from access to best of breed technology and processes backed by a quality assurance methodology, such as Six Sigma.
But what if?
Although the arguments in favour of branch outsourcing are compelling, some push-back from within client FIs is perhaps inevitable. However, the objections commonly raised are readily addressed:
What if the outsourcing provider competes for our clients? The client demographics of the client FI and provider will by definition have minimal overlap. Any reputable provider should be happy to sign a non-competition clause to guarantee this.
What if we need new non-standard functionality and the outsourcing provider refuses to supply it? A provider of any scale should be able to deliver broad functionality as standard. However, if bespoke functionality is still required, the provider should be prepared to commit to a response and unit cost for this.
What happens if the provider quits the outsourcing business? Any committed provider will be prepared to offer at least a five-year contract. Also, a major outsourcing provider’s own network costs benefit substantially from the scale economies derived from outsourcing, so it has the strongest incentive not to quit.
Are we giving up control of our business? No. The FI client still holds the banking licence for the branches outsourced, and therefore by definition must retain business control. The client also retains overall control of the processes it outsources. In fact, the FI client gains better control of its business, as it will have a tighter grasp of costs and will enjoy standardisation of best practice processes.
No longer hypothetical
All the advantages of branch outsourcing are equally applicable to an FI’s domestic operations. As a result, some FIs may choose to use foreign branch outsourcing as a valuable test bed for determining the extent and nature of further outsourcing activity. This is obviously relevant in a banking environment that is increasingly hostile regarding cost/revenue ratios. As a result, payment outsourcing in general, and branch outsourcing in particular, are no longer hypothetical discussions focused on costs.
Instead, they are an urgent call to action that also encompasses strategic flexibility, revenue enhancement and better end-client relationships – and perhaps even business survival.
Joerg Pinkernell, Head of Payments, Settlement and Outsourcing Solutions, ABN AMRO. joerg.pinkernell@nl.abnamro.com
