Cash management and transaction banking in general are feeling the squeeze – required to work harder due to increasing pressure from both a tough economic climate and a range of new regulations. Deutsche Bank’s global head of trust and securities services and cash management for financial institutions, Satvinder Singh, explores the impact of the current economic and regulatory factors on areas of transaction banking.

As the increasingly volatile eurozone once again creates huge market uncertainty, the need for optimisation and consolidation is apparent across all financial sectors. This is particularly true of transaction banking – an area affected not just by wider changes in the economic environment (a market shift towards Asia as well as the escalating debt crisis in Europe) but also by the cost and implications of myriad new regulations. As these elements ramp up the pressure on both transaction bankers and their clients, it is imperative to understand both the changes taking place and their implications for the industry.

First and foremost is the increasing turbulence in Europe and the impact this has on the availability and flow of liquidity. As sovereign debt crises within the eurozone have rumbled on, liquidity levels have been prevented from making a full recovery from the 2008 global financial crisis. Now that the eurozone crisis is escalating to August 2011 levels, this constriction on liquidity is, at the very least, set to continue for the foreseeable future. Combine this with the sluggish growth hindering key economies elsewhere, such as the US, and the spotlight is firmly placed on cash management.

Eurozone volatility and the constriction on liquidity are not the only macroeconomic factors at play. A long-term trend, irrespective of the current easing of China’s rapid economic growth, is the trajectory of the renminbi towards becoming an international reserve currency. Previously restricted to mainland China, the currency made its initial advance in 2009 with the launch of a cross-border trade settlement proposal. Since then, its progression has been dramatic – by May 2011 the renminbi constituted 10% of China’s global trade flows, and internationally available renminbi-denominated bonds have become an accessible and growing area of investment.

This has its own impact on cash management. For example, foreign corporates exporting into China will gain a considerable competitive advantage if they can accept payments in renminbi – with the further potential of expanding their customer base as well as gaining an advantage in negotiating trade terms. Therefore, corporates will seek the services of banks able to provide this capability. For banks, however, such an offering will require both substantial and continual investment if they are to keep pace with ongoing developments. In fact, upgrading capabilities to this extent may be out of reach for many smaller banks or those that lack a global footprint. 

SEPA deadline

Alongside such macroeconomic considerations, which also affect the wider financial community, there is an area of change that is having an unprecedented impact on cash management and transaction banking: the implementation of a multitude of new regulations. Certainly, the number and complexity of current and upcoming regulations (from the Payment Services Directive and Single Euro Payments Area [SEPA] to Dodd-Frank and Basel III) are weighing heavily on a sector already facing financial pressures and evolving client demands. 

Of these regulations, it is SEPA that presents the most immediate challenge, following the recent announcement of its February 2014 deadline. Prior to the 2008 financial crisis, the EU initiative to simplify intra-European payments by standardising the European markets to form a single payments area was designed to increase efficiency. Of course, the long-term benefits of the scheme have not changed. The introduction of an end date for implementation means the initiative has made the jump from voluntary to compulsory – and compliance comes at a cost.

All corporates and banks within the EU and European Economic Area (EEA) will need to adopt the SEPA Credit Transfer (SCT) and SEPA Direct Debit (SDD) before the February 2014 deadline. Particularly for those with more complex payments systems, migration to the new standards will require significant investment, both in terms of time and money. Undoubtedly, many banks will find this a large and complicated task and require the help of a knowledgeable and capable service provider.

Compliance is not the only issue. The standardisation of cross-border payments within the EU and EEA will have an impact on an important business line for many banks: euro clearing. The removal of the distinction between domestic and cross-border payments in the euro cuts out a previously reliable source of revenue for many banks. Add to this the possibility that corporates, anticipating the new regulation, may deal directly with SEPA-approved clearing systems in the meantime, and it is clear that bankers as well as their clients will feel the pressure from this initiative.

Basel looms

The same can be said of Basel III – the third of the Basel accords. Designed to increase bank capital requirements, improve liquidity and discourage excessive risk-taking, the directive’s main component is the capital ratio – a minimum required ratio of tier-one capital to risk-weighted assets.

Although the legislation has yet to be finalised, and could be subject to interpretation, an element of great concern to the entire transaction banking sector is the danger of trade finance being placed under the same category as much riskier financial tools – and subsequently becoming liable to the same high levels of capital requirements.

So not only do banks have to undertake the necessary preparations to meet the latest incarnation of the Basel Accords, but they are also faced with the challenge of demonstrating to regulators the lower default rate of the trade finance business line, in order to avoid such an overlap with more speculative types of business. The possible inclusion of trade finance in a higher-risk category is a particular concern for small and local banks. If the cost of capital of a relatively low-risk, low-margin business such as trade finance is no different to that of a higher-risk, higher-margin business, then banks may naturally gravitate towards the higher margin activity – and away from the transaction banking service they provide to their smaller partners.

Counting the cost

Independently, the macroeconomic and regulatory pressures affecting the market each represent a challenge – be it complying with new legislation or developing new currency capabilities. Together they represent the largest problem of all: the rapidly rising cost of transaction banking solutions, to the detriment of clients who can no longer afford such services and banks that cannot keep up with the spiralling costs of maintaining their cash and trade offerings.

Although the wider economy has also suffered first from the financial crisis and now from continuing European volatility and a lack of liquidity, it is the combination of a tough economic environment with the complexity and cost of a raft of new regulations that is squeezing the profit from cash management and transaction banking in general. Previously seen as a slow but steady source of revenue, the sector is now faced with both spiralling costs and diminishing margins.

As cash management and payment processing services become more expensive, they are also becoming increasingly unprofitable, especially for small or localised banks. These banks in particular will be less able to maintain their current services, let alone meet the evolving and growing needs of clients seeking renminbi capabilities or expansion into emerging markets. Certainly, there is likely to see consolidation in the sector, with a diminishing number of banks able to offer a full range of cash management and transaction banking solutions.

Partnership solutions

One solution is to partner with a global service provider – one that can boast robust international capabilities as well as offer expertise and guidance through the dramatic changes in the regulatory landscape. By partnering with such a solutions provider, local and regional banks can leverage the heavyweight technology, global outreach and expert knowledge of a larger counterpart, allowing them to maintain their transaction processing and cash management services without having to divert valuable investment from other business lines. 

A partnership arrangement is also important to global service providers. As part of the two-way exchange, larger banks can leverage the local knowledge and existing relationships of their smaller partners, creating a mutually beneficial relationship that not only meets the more immediate needs of both parties but also, through co-operation, supports long-term stability. Such partnerships are already strengthening the foundations of the cash management and transaction banking sector.

At Deutsche Bank we certainly recognise the importance of commitment to, and investment in, an area of finance that lies at the heart of the economy and is essential to banks and corporates alike. Although the demand for greater capabilities in an environment of restricted liquidity and increasing regulatory pressures forms a tough combination, we are confident that if the banking community works together then these challenges will be overcome. 

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