Received wisdom in the payments world is that complying with the EU’s Single Euro Payments Area (Sepa) will cost banks dear and deliver reduced revenues. As a result, banks are asking some serious questions about whether they stay in the payments processing game or get out.
But for some banks, payments are their business. The decision to outsource payments processing by handing it over to a larger bank or setting up a shared service centre (SSC) with other banks requires a fundamental change in attitude.
“Many banks face a substantial bill for Sepa and it is not clear to them how they can justify this spend,” says Simon Bailey, director, marketing, global financial services at LogicaCMG in London. “It is difficult for banks to value their payments business in terms of revenue. A light is being shone on the dark alleyways of payments and some banks are not happy with what they see.”
The World Payments Report 2005, a joint publication issued by CapGemini, ABN AMRO and the European Financial Management and Marketing Association (EFMA) last September, estimated that while payments volume in the eurozone will rise between 2003 and 2010, the impact of Sepa could reduce banks’ direct payments revenues by €13bn-€29bn, which would be 30%-60% below expected 2010 levels. For this reason, the report stated: “Banks must simultaneously drive significant cost from their payments infrastructure and identify plus implement new payments volume/revenue growth actions.”
In its fourth progress report on Sepa, published in February this year, the European Central Bank (ECB) took issue with the Sepa doomsayers.
“Today, banking communities follow business models that were established in the past to fit the needs of individual countries,” it said. “For banks that intend to maintain these business models at any cost, Sepa will appear to be a project that increases costs and reduces revenues. For those banks that adjust their business models to the requirements stemming from European integration and technological progress, Sepa will be an opportunity to take a competitive advantage.”
The ECB argues that the benefits of Sepa will come not only from reduced banking fees, but also from improvements in costs. It says: “Several studies have shown that, currently, the revenues that banks generate from their payment business vary considerably from country to country. As Sepa will eliminate national barriers, it will foster greater competition and, as a result, exert downward pressure not only on banks’ revenues, but also on processing costs.”
Reducing costs
For the banking system as a whole, the ECB says, the effect of Sepa will depend on banks’ ability to reduce infrastructure costs, eliminate the maintenance of different procedures for domestic and euro area payments and reduce manual handling in some parts of the payment processing chain.
The business case for rationalisation and greater automation exists in the euro payments area just as it has in other market infrastructure areas. Looked at this way, the ECB says the investment costs for Sepa instruments and procedures should be regarded as a “business development that previously occurred in a purely national context”.
Many of the larger banks are hoping that smaller and medium-sized banks will beat a path to their doors, handing over payments processing activities or entering into shared service relationships. Indeed, one of the Sepa opportunities identified in the World Payments Report is the ability of banks to attract processing volume from other banks.
Jerry Norton, director of global financial services strategy at LogicaCMG in London, says economic modelling undertaken by the company suggests that the very largest banks in Europe have a business case to create an internal SSC for payments without having to insource payments from other institutions.
“The larger banks will inevitably do this, putting payments through one factory in one country in the eurozone,” he says. “The icing on the cake will be that they can go to another bank and say ‘I have this payment factory, can I bring your payments into that and charge per transaction?’ I think this will happen and the initial target will be the middle-tier banks.”
Mr Norton says that smaller banks do not have large payments volumes and are not doing a great deal of cross-border payments at present. “We think there is a strong case for middle-tier banks to outsource payments processing to the larger banks and we know a number are thinking about it.”
However, the decision to outsource payments processing is a battle of hearts and minds, he says. “The trouble with payments is that some of the banks are worried about a type of identity theft – what are they about if not payments, and what will they do without them?”
While LogicaCMG believes middle-tier banks have the most to worry about, Mike Hampson, head of financial institutions solutions at ABN AMRO, says smaller players will not be unaffected. “While smaller players will have smaller payments processing volumes, they will still have to make an investment in the infrastructure to adapt to the new regulatory environment. For this reason, they will revisit where they best add value and where they should participate,” he says.
Global networks
Banks that outsource payments processing are not just getting access to the mechanical clearing and payment services, says Mr Hampson, but also to global networks that will give them a broader range of services that they cannot currently offer their clients.
Smaller banks will also benefit from the larger banks’ access to European clearing systems, he says. “As clearing systems in Europe consolidate over time, the larger banks will be able to place more bets in parallel as to which of the clearing systems will survive, as we are usually members of most of them. This is not an opportunity open to the smaller banks, who will have to decide whether their current clearing relationship will survive.”
The World Payments Report says that to compete in the commodity payments processing business, banks will have to continue cutting payments costs and form new processing partnerships. All banks will have to make choices, which will include lowering the processing cost base, selectively insourcing, outsourcing or offshoring specific payment processes and building processing scale by winning new volume or consolidating existing infrastructure (insourcing, outsourcing or merging).
Regulatory pressure
ABN AMRO’s Mr Hampson says Sepa is just one of many regulatory changes that the financial industry faces. “There is a significant amount of regulatory pressure on all of us, and as a result, everyone will be more focused on choosing the areas in which they will participate,” he says. “Many financial institutions are focused on the upfront investment that is needed to become Sepa-compliant by 2008, but I think the biggest issue these institutions face is the pressure on pricing. This will influence their choices as to where they will invest.”
Banks need to ask themselves whether they add value to their customers by doing all of the back-end payments processing themselves or whether they can add more value by using someone else’s capabilities and focus on developing products for clients, he adds.
Attitudes to payments are changing, but more gradually than many people would believe, says Mr Hampson.
“It’s often helpful to look at other industries. In the car industry, activities that were once deemed core have been outsourced. For example, companies may choose to be either designers or manufacturers of cars, and we are beginning to see a similar process in banking.”
