The historically stable and secure transaction banking business is undergoing great change. Joy Macknight reports on industry initiatives and innovative technologies now coming to the fore. 

Wim Raymaekers

Global transaction banks are coming under pressure on many sides, from a challenging regulatory environment to changing customer demands. New entrants are eyeing this space and could gain an edge from the move towards open banking in many jurisdictions. Incumbents, on the other hand, remain weighed down by legacy infrastructure, viewed as the biggest internal challenge in transaction banking, according the 2016 World Payments Report.

Worryingly for many banks, the transaction business is facing falling margins and reduced revenues, after many years of being a profitable and steady source of income that could support other businesses. Research by data analytics firm Coalition shows that the margin in payments, for example, has compressed by more than one-third – from 6.8 basis points (bps) to 3.9bps – between 2010 and 2016.

“The margins are lower for most transaction banking products,” says Coalition research director Eric Li, who adds that the overall margin for financial institution (FI) clients is characteristically lower than that of corporate clients.

Nevertheless, institutional banking remains ‘stickier’ than corporate banking, with higher volume flows and a more concentrated market due to the small number of banks with the large-scale global infrastructure to build a broad product suite.

Rethinking their offering

However, the dip in profitability has led many to rethink their transaction banking offering, both in the FI and corporate space. The ongoing retrenchment is unlikely to turn around soon, as incoming regulations will most likely dampen margins even further.

For example, the Markets in Financial Instruments Directive II (MiFID II), which comes into effect in January 2018, is predicted to have a negative impact on asset managers’ profit margins, which will have a knock-on effect on the banks that serve the buy-side, according to Mr Li.

“Profit margins for most asset managers are predicted to fall. Fundamentally, if a client’s profitability is deteriorating, then they won’t be inclined to pay higher fees for cash management and securities services,” he says.

“As a result, the smaller providers will be squeezed out and this will lead to more industry consolidation. If a bank isn’t big enough to absorb industry macro shocks, then it is more likely to get acquired by a bigger provider.”

A matter of compliance

MiFID II is just one of many regulations that are impacting the transaction banking business. Others include the Payment Services Directive 2 (PSD2), Basel III, Dodd-Frank, and know your customer (KYC) and anti-money laundering rules – all of which incur a considerable cost for banks.

Unsurprisingly, the rising cost of compliance is seen as a major external challenge to transaction banking in the 2016 World Payments Report, ranking third after fintech competition and evolving customer expectations.

“Compliance has become a significant challenge for banks, especially the speed and intensity at which new regulation is currently being mandated in the US, Europe and other jurisdictions,” says Francesco Burelli, managing director, at Accenture Payments Services.

Didier Vandenhaute, PwC partner and head of the consultancy’s global banking and cash management treasury network, testifies to the frustration voiced by banks in regards to the amount of time, resources and energy that needs to be invested just to stay abreast of changing regulations.

“Banks are throwing people and money at compliance, but all this activity doesn’t help improve their business nor the customer relationship,” he says. In PwC’s 2015 European transaction banking survey, 88% of respondents thought regulation was the number one threat to their business.

Know your KYC rules

Both Mr Burelli and Mr Vandenhaute single out KYC due diligence as a major pain point for transaction banks, magnified by the large fines being meted out by regulators. The Bank for International Settlements has voiced concerns about the time-consuming and complex nature of KYC rules leading to a reduction in correspondent banking relationships. “Many banks are trying to make the customer on-boarding journey more efficient and less onerous, but they must ensure that they don’t fall foul of the regulators,” says Mr Vandenhaute.

Payment margins

To date, the trend has been towards an industry utility to solve the KYC issue. For example, Swift launched its KYC Registry in December 2014 and, as of November 2016, has more than 3000 members. Others includes Bankers Almanac, Depository Trust & Clearing Cooperation’s Clarient Entity Hub, Markit/Genpact’s KYC.com and Thomson Reuters’ Accelus. In February, the Monetary Authority of Singapore announced it was developing a national KYC utility for financial services.

None have seen a groundswell in adoption, however. In its correspondent banking report published in July 2016, the Committee on Payments and Market Infrastructures identified two main issues holding back greater use of KYC utilities: the need for data type and format standards across the different utilities, as well as the backing of relevant authorities.

The emergence of regulatory technology (regtech) start-ups focused specifically on compliance in financial services will help ease the KYC burden, according to Mr Burelli.

“There is an increased investment in regtech looking at compliance challenges through the smart application of technology,” he says. “For example, artificial intelligence [AI] and robotics are two significant enablers for smart process automation and machine learning that can help FIs address the fast-changing regulatory environment.”

Changing expectations

The new, easy-to-use interfaces and business models being brought to market in e-commerce and retail banking have revolutionised the customer experience, and are beginning to have an impact in the transaction banking arena. Both corporates and FIs want a more seamless experience, especially in cross-border payments.

Swift has leveraged its network to create the global payment innovation (gpi) initiative, aimed at making international payments faster, transparent and traceable. In just 12 months, more than 20 global transaction banks have implemented the Swift gpi, with another 50 in the implementation pipeline. In May, Swift released a real-time cross-border payments tracker, available via an open application programming interface (API).

Wim Raymaekers, programme manager at Swift gpi, says several banks have already integrated the gpi’s open API into their front-end channels. “Now corporates can self-serve," he says. "They can see the status of their payment in real time from their bank’s portal through an API call that goes to the database.” Swift is currently exploring multi-bank access to the tracker.

It is also planning an industry challenge with its fintech ecosystem, Innotribe, to develop overlay services for the gpi. Mr Raymaekers says: “We wrote this collaborative innovation approach into our strategy last year and are now delivering that through APIs and our cloud database. It is an exciting journey to open banking and open APIs.”

Although currently offered to corporate clients, many banks have indicated they will also offer the tracking ability to their FI clients, so the latter can pass on gpi payments through their domestic corridors.

Blockchain: the missing link?

In addition to industry initiatives such as Swift gpi, to help improve transparency and standardisation in transaction banking, Mr Burelli mentions emerging technologies, such as blockchain, or distributed ledger technology (DLT). He highlights the many proof-of-concept (PoC) pilots currently under way at different banks. “In five years’ time, some of these blockchain initiatives will emerge as proven platforms for specific use cases, for example cross-border payments, clearing and settlement,” he says.

For example, in April Swift launched a PoC application, in collaboration with several global transaction banks, to test whether banks can use DLT to improve the reconciliation of their nostro accounts in real time, optimising their global liquidity. The results will be presented at the Sibos conference in Toronto in October.

According to Mr Burelli, AI, robotics and data analytic tools will fundamentally change the transaction banking business. However, Mr Vandenhaute is disappointed there has not been more investment in data analytics to date, particularly on the corporate banking side.

“These banks have huge amounts of transaction data, but it sits in many different systems and often isn’t harmonised. Banks also seem more hesitant than large online players or fintechs to use customer data, but they could truly benefit from the masses of data they control, as well as leverage PSD2 and the move to open banking,” he says.

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