Moving closer: why lenders are looking to cement client relationships

Q: Since the financial crisis there has been talk of transaction banking enjoying something of a renaissance. Is that the case or has this been overplayed?

A: It is true to a certain extent – immediately after the financial crisis this area was seen as a ‘stable’ source of income for banks. Statistics reinforce this view; transaction banking continues to outperform most investment banking lines of business (in terms of revenue growth) in the post-financial crisis period. This type of business does have certain advantages – it offers low capital absorption and fairly constant financials, and it creates liquidity and funding. Yet despite being relatively low capital- or risk-weighted asset-intensive, it requires considerable technological investment, reinforcing the need for scale. There are also a number of ‘uncontrollables’ that are placing an increasing amount of pressure on the business.

Q: What do you mean by uncontrollables?

A: There are some factors that we, as transaction bankers, have little or no influence over. The most obvious of these is the macro-economic environment. There is naturally a direct correlation between shifts in world trade and global payment flows. Last year proved to be an extremely challenging year – particularly in the western hemisphere – but the forecast for the second half of 2014 and beyond looks far more promising, and the consequent growth in gross domestic product [GDP] and trade will have a strong positive impact on cross-border payments. According to Deutsche Bank’s research teams, global GDP will grow by 3.5%; broken down into 3.2% for the US, 1.1% for the eurozone and 6.8% for Asia (excluding Japan). Asia will undoubtedly remain the region that contributes most significantly to global growth.

The second key ‘uncontrollable’ is the geo-social-political environment. Obviously we have no influence on current political uncertainty of the kind present in Argentina, Thailand and Turkey. The recent Ukraine/Russia situation also affects our business – not only must we comply immediately with any imposed sanctions, but the situation brings prolonged uncertainty as to whether any agreement can be reached between the US and Russia with regard to the Foreign Account Tax Compliance Act [Fatca], which comes into effect in July 2014, and means that failure by a foreign financial institution to disclose information regarding revenue will result in a requirement to withhold 30% of tax on payments of US-sourced income.

The third ‘uncontrollable’ concerns economic and monetary policies. We are operating in a period of sustained low interest rates (for example, the US Federal Reserve has kept its target rate at 0% since 2008); a situation unlikely to change for the foreseeable future. This, too, has an underlying effect on our business as earnings resulting from net interest income on holding clients’ cash balances still account for a sizeable portion of overall revenue. We are constantly asking ourselves questions around the wider impact of such policies – for example, to what extent do alterations in Fed monetary policy have implications beyond the US?

Finally, there is the topic of regulation. Although we all know regulation is essential to ensure a safer financial system, it is repeatedly adding substantially to the cost of payment transactions. Complying with anti-money laundering (AML) requirements alone is, according to Boston Consulting Group, costing the industry more than $5bn a year, increasing at an annual rate of approximately 8%.

Furthermore, AML or Know Your Customer (KYC) is only one element. Single Euro Payments Area platform investments have also been considerable, in addition to the multi-million-euro investments to successfully build our state-of-the-art Money Transfer New Architecture (MTNA) platform for dollar and euro processing. Fatca costs have involved changes to static data systems and – depending on the country of operation – internal reporting systems, to enable reporting about financial accounts held by US tax-payers to the Internal Revenue Service.

The Basel III rules on capital and liquidity also come at a cost, with certain balances having a reduced liquidity value for banks. At the same time, they are adding to the balance sheet, which in itself is constrained by Basel III rules, i.e. the leverage ratio. The cost of the capital necessary to back up certain types of transaction banking business will increase. Although this will affect trade finance (given the risk-weighted asset requirements) more than cash management, there is a greater need than ever to take a holistic view of regulations. At the same time, regulation is one of the key drivers of change in customer demand and in shaping future business relationships.

Q: How are client relationships developing?

A: In terms of correspondent banking, we are continuing our move towards a much more client-centric model. Thirty years ago, correspondent banking was very vanilla, consisting simply of automating telex over a huge network of banks. This evolved over the next 20 years and further consolidation took place – with a focus on efficiency improvements – resulting in fewer relationships. Yet these relationships remained very bank product-centric with (inefficient) multiple agreements. In the past five to seven years, however, the world has changed quickly – change sparked mainly by regulation and technology. Our underlying clients are also looking for more integrated solutions as their businesses expand across the globe.

As the process of consolidation continues, relationships are becoming deeper and more collaborative in nature, with both parties working together to improve their understanding of end-customer behaviour, identifying new market opportunities, and, vitally, liquidity monitoring. And with volumes concentrated with fewer parties, the typical remit of the network manager has also increased, moving away from a purely administrative function to a broader and more important role. Discussions no longer revolve solely around pricing and reciprocity, but are also concerned with efficiency, strategic partnership and security.

In fact, security is now one of the defining factors in correspondent banking relationships. Over the past 18 months there have been significant developments in the transaction banking landscape. Certain providers have retreated from correspondent banking relationships with many financial institutions, and from specific countries or even entire regions. Others have pulled out of certain products deemed too risk-intensive, or as a result of regulatory pressure. Such factors reinforce consolidation – but, perhaps more significantly, we are now also witnessing a real change in mindset concerning the extent to which banks are willing to work together.

'Commitment' has been a word used too freely in the past – however, with the aforementioned developments, the recurring question from clients has always been: “Will my provider be there for me in the long-run?” In this sense, the term 'relationship' has taken on a new dimension and, as a result, banks are securing business that may have seemed inconceivable a year ago. Providers and clients are now working much more closely in order to examine the full picture and identify and mitigate any risks that it presents. As part of the selection process, network managers are now looking beyond purely operational aspects and are actively engaging in compliance and risk issues.

With regards to risk, for example, banks need to have a real-time overview of group-level risk exposure – a view that covers all of a bank’s payments flows, including those delivered by third parties. As a result, assurances are needed that third-party providers can offer liquidity for their clients’ intraday requirements, given the potential amount of exposure that banks have with third party-supported payment flows. In this respect, intra-day reporting and real-time tracking of payment flows will become crucial to more efficient funding.

Managing capital and funds efficiently is not only a necessity from a regulatory perspective, but also with regard to assuring stakeholders of ongoing financial sustainability. Consequently, a network manager will analyse their correspondent banks’ enhancements to their payments systems infrastructure – both technological changes to meet regulatory requirements, and the provision of value-added data outlining opportunities for improving straight-through processing rates. Customer service has also taken on greater importance, with dedicated service contacts, multiple channels for queries and flexible servicing hours. Finally, business continuity plans – to maintain the continuation of services in the event of disasters – are vital in any evaluation process.

In short, relationships between correspondent banks have become far more intensive and complex.

Q: Is transaction banking business becoming more competitive?

A: Transaction banking is a highly competitive business. Although the volume of cross-border payments is steadily increasing year on year, margins are typically reducing, especially in developed markets. As a result, successful providers must be able to identify, establish and execute the correct business and operating models. In recent years, we have seen a recalibration process principally around two main models – one highly flexible and customised (typically local banks), the other designed to cost (typically global banks). 

Each of these models has their respective strengths; a global bank will have a broad network, and the scale of investment needed for innovative technology and heavyweight platforms, while local banks have in-depth local market knowledge and a large base of local retail and corporate clients. However, banks at both ends of the spectrum are becoming increasingly reliant on each other in order to mutually maximise profitability. 

For example, as local banks look to support their local corporate and retail clients’ business during expansion (in line with ongoing globalisation), they typically need access to the international network of a global provider. Likewise, a global bank will be reliant on capturing flows of local banks’ underlying retail and corporate clients to realise economies of scale.

Q: What about competition from outside the traditional banking sphere in the form of non-bank service providers [NBSPs]?

A: NBSPs already exist in a number of forms. They may support financial institutions – by providing outsourced specialist services, acting as partners to financial institutions or using the services of financial institutions as part of a new payment method business proposition – or they can be competitors. Banks are likely to see further competition from tech companies (such as Google, Apple and Amazon) as they explore the possibilities of providing online banking and money-lending services. To what extent this will affect core retail and wholesale banking providers remains to be seen, however, especially as regulators have yet to decide whether such companies come under their supervision. It is highly unlikely that a Google-like entity would be happy with the same status as a regulated bank.

Payments innovation is also susceptible to hype. It is hugely debatable whether e-wallets, for example, will replace credit and debit card payments. The likelihood is that we will be in a phase for many years to come where mobile wallets, even if they were to be successful and replace the card-form, would not replace the underlying account enabling the payment.

Q: There has also been a lot of talk of renminbi emerging as one of the world’s main payment currencies. Has that also been hyped?

A: Over the past few years, China has taken a number of steps towards internationalising the renminbi. As a currency, it has moved towards full convertibility with respect to trade and can now be used in exactly the same way as the euro or dollar. According to the latest figures from Swift [the Society for Worldwide Interbank Financial Telecommunication], it has moved up to seventh place in the world’s most-used payment currencies. There is no doubting the benefits of using the renminbi as a trade settlement currency – from efficiency gains and managing foreign exchange risk to allowing companies to negotiate improved terms. We fully expect to see the growth of the renminbi continue, and in that respect we have invested significantly to ensure we can offer a full range of renminbi products and services.

In fact, renminbi clearing forms an integral part of our strategy to be the leading provider of cash management services to financial institutions globally, and supplements our existing range of euro, dollar and select local clearing services, rounded off with comprehensive multi-currency solutions.