Transaction services providers are increasingly looking to technology to give them the edge in a market dogged by regulations and rising costs. John Beck reports.

As the financial crisis took hold, transaction banking emerged as one of the best performing lines of business for many a global bank. Today, a good risk-return profile makes global transaction services (GTS) an increasingly attractive and important business in a constrained balance sheet environment. But the sector is facing fresh challenges. Margins are shrinking, costs are increasing, the spectre of increased regulation is menacing the market and corporate customers themselves are taking control of the treasury functions traditionally consigned to banks.

For banks, these combined pressures are creating a need for technology innovation to streamline operations, improve profitability and keep up with the ever-increasing demands of multinational corporate customers.

Regulation looms

The banking sector as a whole is under increasing scrutiny from regulators globally and the transaction banking sector is no different. Trade finance remains one of the lowest-risk banking product sets, but a paucity of default data has made it difficult for bankers to put the case for more lenient treatment of trade finance instruments under Basel III - particularly since these are held off balance sheet.

While few bankers would deny the necessity for new regulation to improve the transparency and robustness of the banking sector, transaction bankers are worried that new risk weights, liquidity requirements, and leverage constraints will hard-hit trade finance and corporate financing facilities - such as multi-option facilities.

Some smaller banks, for example, complain that they risk being smothered with regulatory requirements and left unable to meet the needs of their corporate clients. Moreover, bankers argue that their clients - in particular smaller and mid-sized corporates - will pay the price for new regulation: in a low-margin environment, they argue, transaction banks will have little choice but to pass on the additional costs of regulation to their end customers.

As a result, market participants stress the need to engage with regulators and ensure that any future regulation meets its objectives without constraining the industry's ability to support global trade and economic growth.

But regulation is not affecting all financial institutions equally. Smaller banks, particularly those in Europe and the US, are feeling more than their fair share of the strain, according to market participants.

Indeed, as a result of these ever-increasing demands, some transaction bankers feel that only a handful of global banks will have the scale, reach and ability to continually invest in the systems and processes required to remain profitable. Those that cannot compete on an equal footing are likely to focus on niche segments of the market, or may partner other firms where necessary. As such, transaction banks are likely to partner with other banks more and more, with larger banks supplying banking services to smaller local firms who then distribute these services and products to local clients.

For this reason, most agree that technology is key in enabling institutions across the globe to accommodate challenging market conditions. Local banks may need to collaborate with specialist providers to tailor technology to market demands, while larger firms are starting to consolidate operations to a single platform in an attempt to create a more cost-efficient system.

As our virtual round table of the industry's leading transaction bankers demonstrates, nearly all market participants stress a real need to work with partner banks and networks to offer clients a full range of cost-efficient services.

Bettering the banks

Transaction banks are not just battling with thinning margins and the threat of burdensome regulation. They are also seeing competition from the very clients they hope to woo: increasingly corporate treasury teams are taking on more and more operations themselves - not just in terms of technical operations, but funding lines too.

For example, the financial turmoil of the past two years has led to an increased focus on liquidity management, and corporate treasurers are asking banking treasury services and technology providers for tools - such as intraday cash management services - to help them to gain a single view of liquidity.

In response, some banks are eschewing traditional cash management processes in favour of providing netting facilities and cash pooling to help corporate customers avoid the high cost of borrowing by making better use of internally available cash.

However, this is no longer the exclusive preserve of the banking sphere and some corporations are bolstering their treasury platforms with systems designed and implemented in house.

As such, it is possible to identify a growing trend among corporations, say market watchers: corporates are developing proprietary treasury platforms instead of relying on bank-supplied systems. The concept of a multinational developing an in-house bank is not necessarily a new one, but an increasing number of businesses are opting to develop their own cash management platforms, believing that they will do a better job than the banks themselves. And it is becoming easier for a corporate to develop more in-house treasury systems thanks to ever more accessible technology and the advance of online services.

The appeal of this kind of approach, corporates say, is that it allows them to tailor treasury processes to perfectly suit business operations and negates the often costly and time-consuming process of modifying an existing platform. And as The Banker's cover feature this month outlines, future regulation will make this ability even more important. As regulators in both the US and Europe seek to reduce systemic risk, corporates are likely to become embroiled in major reforms sweeping the over-the-counter derivatives market. These reforms, which in some cases may see corporates subjected to the same cash and collateral requirements as financial firms, will require corporates to have more sophisticated cash and collateral management processes.

Taking control

Elsewhere, corporations are taking control of more and more of their financing operations. Some are dealing with credit ratings agencies themselves, for example - bringing the relationship in house instead of trusting it to a banking partner. Others are making their own fund-raising arrangements, in some cases as a result of the inability or reluctance of banks to provide loans to businesses.

However, this trend may not be permanent. After hitting a low of about -30% in the first quarter of 2009 with regards to which sources CFOs at major UK companies found the most attractive for funding, bank borrowing approval levels increased to about 20% as of the second quarter of 2010, according to a survey by accounting and consultancy firm Deloitte. Likewise the percentage of CFOs who report that credit is easily available is at the highest levels since the first quarter of 2008.

It remains to be seen, however, if corporates will feel the same once the much tougher capital and liquidity regime under Basel III becomes embedded into the system. As this month's cover feature outlines, liquidity lines to corporates are likely to be costlier and funding more constrained in coming years, leading to a testing time for both corporate treasurers and transaction bankers alike. Tough decisions will have to be made regarding who receives funding and who does not.

But as other transaction bankers point out, this also offers an opportunity for transaction banks to differentiate themselves and assist their clients through innovative problem solving. This may require transaction banks to operate on a more joined-up basis and collaborate with other business lines, such as custody functions, for example. It is likely to be the banks that have already begun working towards this that will be best placed to assist their clients in what will be a challenging period of permanently constrained credit.

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