Co-operation key to survival in new era of cash management

The cash management world is changing fast. Beset by increased competition, a constantly evolving set of regulatory requirements and a somewhat unsteady global economy, life as a transaction banker is very different from just five or six years ago. Not least in the fast-paced cash management for financial institutions market.

The biggest single difference to the transaction banking landscape from five years ago might well be the relative importance to a bank’s overall operations these services hold. It need hardly be noted that this once overlooked segment is held in rather more regard than it was in the heady pre-crisis days. The so-called ‘masters of the universe’ of the investment banking world have faced increased scrutiny and criticism, coming under fire for excessive risk taking and monstrous profits.

Meanwhile the rather less spectacular, but steady (and far more socially acceptable) returns offered by transaction banking have boosted its profile. Even during the worst of the crisis, Treasury Strategies’ Transaction Banking Index (TBI), designed to track the size and stability of the transaction banking market, did not dip below levels established at the beginning of 2008, despite drastic falls in global market capitalisation and trade. Indeed, earlier this year, the firm announced that the index had reached a record high, increasing 3% year on year in the third quarter of 2010. It added that it expected transaction banking revenues to outpace gross domestic product growth as trade and production continue to recover.

Cautious optimism

Transaction banking’s star may be rising but that does not mean things will all go its way. The European and North American financial sectors are staging a faltering recovery, but given that the eurozone debt crisis is still far from resolved, and the US is at risk of defaulting on its obligations if Congress fails to vote in favour of lifting its $14,300bn debt ceiling, a vigorous upturn is far from certain.

Elsewhere, earthquake and tsunami-devastated Japan is facing the prospect of several more quarters without positive growth. Meanwhile, even emerging markets, many of which came through the financial crisis relatively unscathed, are at risk of overheating and are facing potentially dangerous inflationary pressures.

The overall outlook is positive, but there are certainly causes for concern, as Torsten Slok, Deutsche Bank’s chief international economist, notes in a macro-economic overview on pages elsewhere in this guide.

Customer demands

Transaction bankers are facing additional demands from their clients too. A global scope is increasingly sought; rare is the major corporation which does business exclusively in its home country. Banks able to provide consistency of service in multiple markets, or an entire region, and watch over both ends of a transaction can provide enormous advantages to their customers. But doing so is not easy.

IT demands are increasing too. The business banking sector has customarily lagged rather drastically behind the consumer sector in technology terms, but clients are now looking for more technical sophistication. Comprehensive and efficient client connectivity can allow customers to do business more effectively, for example, but the front-end functionality is important too. Gone are the days when a treasury portal built around basic functionality and a simple text-based interface was enough to keep users happy. In an evermore sophisticated online world, business users are beginning to expect the same intuitive and simple experience they enjoy when ordering books or searching the internet when authorising payments or checking net cash positions. 

Demand is even growing for transaction services via mobile device. Some 93% of 160 treasury organisations across Europe surveyed by Treasury Strategies indicated they would like to view balance information via their mobile devices.

Changing regulation

Investing in these technologies can prove monumentally expensive, however. And budgets are being assaulted from a number of different angles at once.

The regulatory environment across the banking world remains in a state of flux. And even though transaction banking has not been the subject of much public or political ire, it nonetheless risks being damaged by regulation designed to cut down on riskier banking practices and avoid another global financial crisis.

The proposed third version of the Basel Committee on Banking Supervision's Basel Accords, for example, has been the cause of much concern among transaction bankers. They fear that the stringent new capital requirements, along with planned global standards for leverage and liquidity proposed under the legislation, will increase the amount of capital that banks have to set aside for trade finance, making it a far less attractive business proposition. Larger banks may then cut back trade finance operations, and smaller institutions could be forced out of the market entirely.

For many institutions, the Single Euro Payments Area (SEPA) is an ongoing headache too. While it has met with approval from banks, businesses and regulators and there is a desire to create a single payments zone, open up cross-border competition and make payments easier for consumers, this has not translated into decisive action. So far, SEPA has been a saga of delays, frustrations and painfully slow progress.

Despite falling behind schedule, SEPA will happen eventually though, and for European financial institutions, compliance will be mandatory in order to continue to operate in the market. But that will not come cheap. Even though institutions understand the need for SEPA, it represents an outlay in an environment where future returns may be even tougher to come by than they are at present.

Increased competition

Compliance is, of course, a priority for the entire financial industry. The issue for transaction banks is that cash which might be spent on the new technology and services needed to remain competitive will instead be sapped by costs, such as compliance, associated with just staying in business. This means that margins, which were never high, are being squeezed even tighter.

Meanwhile, transaction banking’s increased popularity has led to increased competition, as banks ramp up their efforts to grab a piece of a market which, by its very nature, will not expand fast enough to accommodate them all.

Competition comes from other sources too. Non-bank payments providers, for example, have been slowly growing market share for years now, and are starting to position themselves as genuine threats in some parts of the market.

What these myriad issues amount to is that becoming a truly global transaction bank is tougher than ever. It requires enormous levels of investment and effort, and not every bank will have the resources or the stomach for it. Some current providers may even be forced out of the market.

At the same time, almost every bank provides some form of transaction banking services, and demand from corporations and businesses is unlikely to let up. Unless it does, even the smallest bank will be reluctant to give up a stable business and an annuity flow that is less vulnerable to the volatility which has damaged other banking segments.

Co-operation with rivals

So how can banks continue to meet the needs of their clients?

One possible solution to this not insignificant problem is to take advantage of another bank’s scope or expertise. That is where cash management for financial institutions comes in.

Even the largest global bank will not be able to provide the same level of service or be on the end of every transaction in every territory, but for local or regional banks the problems are far worse. In order to provide their customers with full international coverage, banks have actually begun to work with their peers in some markets, even while they compete with them in others. Given budgetary constraints and tough market conditions, playing to each others' strengths can make a lot of sense. A mid-tier regional bank with a limited budget, which focuses on client relationships, can prosper and maintain the strong relationships built with corporate clients if it picks its battles, focuses on customer relationships and extends its scope by working with a selection of partners. If the same bank tried to do everything itself, it would likely fail miserably.

Such relationships work both ways. A larger partner may take advantage of a local institution’s regional expertise while providing it with some global services.

This kind of collaboration is not just taking place on a regional level, however. Outside of the very biggest players, banks cannot afford to invest in the best of everything. Instead, they must choose where to compete wisely. Accordingly, a bank may not provide a certain type of product or service in a certain territory – something related to cash or cheque collection activity which requires a branch network, for example – so it can outsource that service to another bank (or in some cases even a non-bank provider such as a post office network).

Using another bank’s branch network will be fairly obvious to the end-user. However, banks are also working together to provide more seamless services, which, in some cases, the customer will be completely oblivious to. If, for example, a bank does not have access to a clearing house in a certain country, it might employ a third-party bank to manage its transactions. There is an increasing appetite for these services, market participants say, as corporates push for a service that will cover all of their needs without the additional complications and counterparty risk considerations of dealing with multiple banks.

Challenges and opportunities

Cash management for financial institutions shares many similarities with the broader transaction banking landscape. Many of the products and services supplied to corporates are reasonably similar to those supplied to other banks. However, the prospective customer base may be even tougher than demanding international corporations. An average mid-sized bank for example, is likely to be rather more technologically and financially sophisticated than a mid-sized corporation, and as such may prove rather more picky, holding its cash management service providers to high standards.

At the same time, for banks which have the ability to offer these services to their fellow financial institutions, there are real opportunities in the market. Western banks, for example, might find their emerging market contemporaries keen to take advantage of euro and dollar processing facilities. Similarly, small and medium-sized players are beginning to realise that success comes from playing to their strengths and local expertise. Banks with a truly global suite of cash management services will be able to meet clients’ requirements for clearing and payment services, for example, enabling them to concentrate on their core business, cut costs, increase efficiencies and expand their operations in line with their regional or sector strategy.

While there has been some consolidation in the cash management landscape, it remains fragmented. Given that barriers to entry are growing ever higher, this could play nicely into the hands of the banks able to effectively operate internationally.

As a result, while some cash management providers differentiate themselves by focusing on regions or market sectors, some will try to stand out by offering services around the entire financial supply chain.

Big effort

But this approach is not for the faint-hearted. Becoming a true transaction bank requires enormous investments of time and money to meet regulatory and technological demands.

There is no doubt that it requires sheer size too. Transaction banking has become much more scale-driven than it was in the past. To succeed, a transaction-processing bank needs a low-cost, highly efficient, infrastructure, and thanks to compressed margins, creating and maintaining that without haemorrhaging money requires massive payments volumes.

These cannot be built overnight. The steady appeal of transaction banking means that volumes cannot be amassed swiftly without winning business for the wrong reasons, such as price erosion, extensive credit exposure or taking on clients viewed as too risky by other providers.

But just because smaller institutions will not be able to compete with the very largest global transaction services providers, does not mean the future is bleak. It just requires a focused business model. Local or regional banks which play to their strengths and shop out non-core functions to a global bank may find they actually save money, even while providing their clients with a higher standard of service. On both sides of the relationship, transaction bankers will have to collaborate to survive.