Are you being served?

The past few years have been a turbulent time for banking, the financial markets and the broader global economy. Of course, the financial crisis of 2008-09 brought unprecedented difficulties for many financial institutions. Alongside some high-profile failures - Bear Stearns and Lehman Brothers being the most notable - many other banks were forced to take government support in the form of taxpayer money and some only just avoided meeting the same fate.

However, despite the travails of these institutions, others emerged from the crisis well placed. Indeed, some institutions that managed to avoid government support - such as Deutsche Bank - preserved their reputations for stability and maintained their programmes of investment throughout the crisis. Such organisations will have seen enquiries from potential clients rise in response to flights to quality and stability during the crisis.

It is inevitable that in this situation there will have been some consolidation among providers, particularly in scale and volume-driven areas such as transaction banking. Certainly, many local and regional banks know their clients very well and maintain close relations with them, yet they often do not have the resources to invest sufficiently in transaction banking products and services or the scale to justify investment. They therefore need to partner with larger, specialist institutions in order to maintain or build a market-leading product offering.

And while this is a trend that was developing before the events of the past few years, it is something that has certainly accelerated as budgets for internal investment have come under pressure as they are directly correlated to profit.

The story so far

Looking at more contemporary developments, it is clear that we are not yet out of the woods in terms of an unambiguous return to growth and economic stability. EU governments are currently making unprecedented efforts to tackle their large deficits and meet their obligations in terms of servicing debt. And while it appears that another all-out crisis has been averted - for now - a close eye will need to be kept on several EU economies if the integrity of the European financial harmonisation ambition is to be maintained.

However, despite rising concern regarding sovereign risk in Europe, there is a recognition that things have moved on since the height of the financial crisis a little more a year ago. Financial institutions are certainly more wary of liquidity and counterparty risk, yet focus has returned towards profit generation - through revenue growth and cost reduction - rather than pure risk mitigation and, in some cases, survival.

In this respect, there are differences in outlook within many banks. Some believe the recession is now over and expect transaction banking to begin performing strongly again. Yet others recognise this will take time. While global economic activity may have ceased contracting, profits remain under pressure. Profitability in cash and transaction management is essentially driven by two things: fee-based and interest-based income. Volumes are certainly recovering but fee-based income has taken a hit in some regions as a result of regulatory changes, and interest rates remain at all-time lows while operations are carried out on fixed-cost base.

Differences in outlook among various sectors of the industry are unsurprising and gaps between expectation and reality have been a feature of the events of the past few months, both during the crisis and the subsequent recovery. For example, according to much of the pessimistic rhetoric of 2009, many banks - including transaction banks - were going to struggle. And while we have certainly seen failures and several institutions requiring assistance, the reality has been that some players have emerged from the crisis relatively unscathed.

Indeed, although world trade and payment volumes contracted in 2008 for the first time since 1982 - followed by low interest rates depressing profitability - the value of many transaction banking products only became fully appreciated during this difficult period as both financial institutions and their corporate clients struggled to unlock trapped liquidity. So while the transaction banking industry certainly had to deal with these factors, it was much less significant than that experienced by other, more volatile areas of banking.

In terms of transaction banking's fortunes, this positive gap between expectation and reality has been somewhat reversed in 2010. For example, earlier in the year there was a great deal of talk regarding the return of growth and expectation that interest rates would begin to rise once again. And while a number of economies have certainly emerged from recession, there is now a greater recognition that the early stages of recovery may be sluggish and that interest rates will take some time to return to the levels that would suit many transaction banking practitioners.

In this respect, expectations that transaction banking should over-deliver this year in terms of revenue generation and profit contribution have been tempered with the realisation that clients are now demanding more at lower prices, regulatory pressures remain intense and that substantive revenue growth will need to be prefigured by considerable investments in platforms, expertise and product development.

Cause and effect

Aside from the continuing fallout from the financial crisis and downturn, the other big issue for the transaction banking industry, especially in Europe, is the changing regulatory landscape, and in particular the Payment Services Directive (PSD). The new pricing schemes introduced by this initiative have impacted the business models of all financial institutions, so the PSD could certainly be considered an additional burden.

Yet, in the medium to long term, the initiative will have a very different effect on different institutions. For smaller financial organisations, the impact will be resolutely negative. These banks will struggle to continue operating profitably as they have to sustain an unchanged fixed-cost base and do not have the necessary economies of scale to cope with reduced margins.

For larger institutions the consequences will be different as they begin to benefit from consolidation and the awarding of business from non-specialist players. Indeed, Deutsche Bank's market share in euro clearing has increased from 18% to 21% in the past 18 months. However, consolidation of this type is a subtle process and will be ongoing for some time. We are not seeing providers publicly exiting any particular market but we are certainly seeing a shift in business away from smaller providers towards larger, more specialist institutions.

The PSD is also altering the way many financial institutions view the relationship with their peers. While reciprocity between providers was once the order of the day, this no longer works with the PSD, as bartering volume become pointless when there is almost no margin to be made on the business in question.

Different strokes

A combination of recent difficulties in the global economy and a changing regulatory landscape - particularly in terms of harmonisation projects such as the Single Euro Payments Area (SEPA) and the PSD - are therefore leading to new approaches of collaboration and partnering in many financial institutions. Indeed, some are now questioning aspects of their business models, defining core and ancillary services and are seeking to work with committed providers to develop new and innovative solutions.

Another key aspect of change within transaction banking providers has come in the form of attitudes towards budget allocation. In many instances, more than 80% of any budget is spent on running legacy systems and maintaining business as usual - what we might call the 'run the bank' budget. This leaves a relatively small amount for the 'change the bank' budget - looking at, for example, how processes can be made more efficient and, more importantly, how innovative change can be built. The danger here is that in a demanding environment such as the one we currently face, allocating the lion's share of a budget to the day-to-day running of the bank may ultimately mean losing momentum in terms of driving innovation and facilitating growth.

As a consequence, it is imperative that providers question every aspect of their 'run the bank' budget in an attempt to increase the relative importance of making processes more efficient, building new products and developing fresh product features in order to maintain a competitive edge. Ensuring compliance with changing regulatory requirements - such as the PSD - is also an issue here as these costs will inevitably come out of the 'change the bank' part of the budget, leaving less for innovation.

Deutsche Bank's approach in this area has seen budgets for innovation and change increase significantly in recent years, ensuring it is able to deliver market-leading solutions and continue expanding into new markets in line with the ambitions and expectations of clients - always with the proviso of making our clients successful. Another aspect of allocating budgets has been to leverage cost synergies by investing in global systems, while at the same time harmonising products on a global level.

Innovation crucial

New investment strategies need to recognise that many aspects of the relationship between banks and clients have changed over the past few years. Where it was once banks that assessed clients for creditworthiness and other fundamentals, this has become a two-way process, with potential clients increasingly looking at the sustainability of banks' business models and asking for commitment in terms of their long-term stability.

As a result, investment strategies need to be sustainable and geared towards making this case to existing and potential clients. For instance, for smaller providers, continuing to build solutions in house may no longer be viable in the long term if they have the option to partner with a committed provider.

In this respect, one aspect of Deutsche Bank's recent focus has been developing solutions with an eye to bringing them to a wider audience through partnering with other financial institutions. For example, FX4Cash has leveraged Deutsche Bank's cash management expertise with its leading position in the global foreign exchange market to offer a one-stop solution for cross-currency payments for both corporate and financial institution clients. Indeed, financial institutions that adopt this solution are able to offer increased transparency and functionality to their own clients with little to nothing in terms of up-front investment, as well as opening up new revenue streams from foreign exchange spreads and widening the product portfolio.

Another related aspect of recent innovation is the area of remittance payments. While this was once considered too small to warrant significant bank involvement, banks have now realised the huge financial opportunities in this space. To grow in this sector Deutsche Bank has recently strengthened its ties with Eurogiro, the world's second largest network for cross-border payments with a focus on connecting postal agencies around the world.

By taking an 8% share in the company and integrating this with the existing offering in cash management, the bank is offering its financial institution clients a unique retail distribution power. As this is based on the existing messaging infrastructure and account relationships, a financial institution partnering with Deutsche Bank will obtain access to a multi-country reach via a single relationship with minimal investment.

As a result, financial institutions are able to offer remittances services to many countries, such as India, Vietnam, Brazil, China and Russia. As Deutsche Bank is committed to increasing feature functionality as well as its global footprint by establishing new corridors, our partners can focus on their customer relationships and benefit from our investments at the same time.

Partnering up

Banks are being challenged to support customers with increasingly global ambitions. Local and regional institutions typically have excellent and long-standing relationships with their commercial customer base. These relationships have often grown over years and a unique level of trust and collaboration has been established.

However, as companies become more successful they have an increasing demand for international banking services. While in the past, pure export- or import-related transactions have been demanded, globalisation postulates that a number of corporate clients now require local banking services in overseas countries to support their international ambitions - for example, making salary payments in China, arranging for tax payments in Hong Kong or initiating and receiving collections in Singapore.

Local and regional banks are confronted with questions as to how they can successfully support such services as they would otherwise risk losing their customers to a competitor - not only with regards to the international aspect of the business but possibly the entire relationship. Usually, the scale for maintaining or building a comprehensive international network does not exist for many local or regional banks. As Deutsche Bank is committed to enabling the success of our financial institution clients it has invested in a partner banking offering that goes beyond a pure referral programme and offers access to the bank's global network.

With this offering our partners are able to provide their customer base with international ambitions and a range of local services and cash management products in many countries, including options to offer a white-label electronic banking front-end that can be embedded in established channels. As a result, financial institutions do not run the risk of losing their long-standing relationships with their customers but are enabled to even strengthen ties with their most successful customer base.

Tough choices

For all transaction banking service providers, the coming years are likely to throw up some difficult choices. And what is crucial here is clarity regarding business models and which approach to client servicing should be adopted. This will mean careful assessments of cost drivers, realism regarding investments budgets and an identification of where strategic partnerships should be made.

Of course, the key focus remains the client - the operating environment for transaction banks has become tougher, with corporates increasingly able to pick and choose between providers to meet their needs. Indeed, a client-focused approach will be critical to remaining successful in an evolving business and Deutsche Bank sees it as a key part of ensuring it remains at the cutting edge of transaction banking provision, whatever the global economy and regulatory bodies may throw at the market in the coming years.

Meeting obligations

Since the end of the financial crisis, banks have been under pressure to reduce costs and mitigate risks. And the increasing burden of regulatory compliance has made this situation even more difficult for many. Given this difficult environment, and faced with these changing priorities, meeting clients' cash management needs so that relationships can be maintained and built upon is crucial. Whatever the market conditions, financial institutions will continue to need cash management products in order to meet their retail and corporate client obligations, such as paying staff and suppliers, as well as conducting their normal day-to-day business.

When looking at the changed economic landscape and growing pressures placed on pricing by regulatory developments and harmonisation projects such as SEPA, many local and regional institutions will find that partnering with a global provider such as Deutsche Bank offers them an effective way of minimising investment costs while still delivering a best-in-class service to their own clients. Indeed, Deutsche Bank is committed to being the partner of choice for cash management services for financial institutions, providing market-leading solutions and enabling clients to benefit from its scale.

This is something Deutsche Bank has achieved through an extensive programme of focused investment, continued innovation and ensuring clients are provided with first-class customer service and guidance, allowing them to reduce costs and increase revenues while mitigating risks and the effects of changing regulation. In this respect, Deutsche Bank's goal is to enable our client success, whatever their location or underlying currency, providing best-in-class services to their own corporate client base.