With many European banks facing a profitability squeeze in their payments franchise, the decisions they make now will affect the future of their own payments business, relationships with clients and the future of the market.

The payments business within Europe is at a crossroads. Banks are undergoing a major overhaul of business models to meet the completely new payments environment in which they find themselves. They are forced to handle a challenging regulatory environment, big technological and infrastructure changes and a client base that wants more while paying less.

But navigating this profitability crisis can be quite difficult. Let’s take the fictional example of “Charles” – a managing director responsible for payments and cash management at medium-sized Bank XYZ in Western Europe.

Restoration of returns

By understanding how changes in the market are affecting Charles’ business and the demands he faces internally, we can help to make the choices easier for those payments franchise managers in a similar situation.

Charles faces a tough job. He has met with senior management to discuss decreasing revenues, increasing costs, and the resulting effect on client profitability in all sectors. EU SEPA regulations have forced significant price reductions, customers continue to demand lower prices, and competition is heating up.

New regulatory and infrastructure developments – such as the imminent arrival of TARGET 2, pan-European direct debits, SWIFT upgrades, new formats, increasing know-your-customer and anti money laundering infrastructure needs, and of course Basel II – force Charles to consider his IT group’s request for a multi-million euro, multi-year-investment in infrastructure upgrades.

To make things worse, corporate sales complains that the front-end product suite and domestic cash management capabilities outside their home market are not competitive and they are losing customers to more product-focused rivals. His correspondent banking team complains that, given the myriad of new charges, revenue opportunities are down and much time is spent doing verification and approval for invoices.

Charles recognises they must take action and the sooner the better.

Delineating options

At a basic level, Bank XYZ could buy, build, partner for a solution, or could do nothing. Buying services from, or partnering with, another provider raises a number of questions: what services, how to choose the right provider, what is needed and what is the cost?

Building new systems in-house may be difficult to justify – as a mid-sized bank they don’t have the scale to warrant such an investment and in light of existing revenue pressures affecting the bank there is no strong business case to sell to senior management.

Finally, there is the option to do nothing, but this does not resolve the looming problems. As building and doing nothing are not valid options for Charles, he now must focus on buying or partnering, or some combination of the two.

Charles decides on buying or partnering for internal processes, transaction settlement and front-end systems. He now starts to sift through options to find what is best for his bank. Each option requires different levels of commitment to partners and clients, a difference in the complexity of the solution, different effects on revenue and cost, and ultimately on profitability.

Search for a solution

First, he looks into his options for the clearing and transaction settlement side, with a clear focus on optimising his cost base and significantly improving the service quality he is receiving from his counterparties:

  1. Clearing relationship He could maintain his current ties to the clearing systems with the ability to leverage his already made investments in connectivity, and combine this with a proven payment provider to use as a hub for receiving his flows and then re-distribution. While this is extremely easy to implement (all he needs to do is point his payment traffic to one recipient, for example, Deutsche Bank, via clearing), it is at best a partial solution as he will need to continue to invest in clearing and payment infrastructure indefinitely. This is not the solution he is looking for.
  2. Account relationships with multiple providers Next, he identifies a classic correspondent banking solution, leveraging multiple counterparties from whom to buy the services he needs. With the advent of the euro a few years back, all of his accounts in the legacy currencies were converted to euro accounts, leaving him with more than 40 euro accounts scattered throughout the eurozone. This plethora of accounts has caused him more difficulties than it has been worth, such as varying fee structures, different STP requirements, and poor liquidity management due to his scattered pools of euro liquidity. At a minimum, he needs to close most of these accounts and streamline his relationships. Maintaining multiple accounts is not a viable option for him to pursue.
  3. Single currency (ie, euro) consolidation with one provider This is an extremely compelling option. If he pursues this path, he can actively shift from a scattered landscape of providers with varying quality and fee structures to one provider with high quality services and a superior fee structure. Also, once the provider is identified, he can move quickly to implementation and start to see financial rewards immediately. This also leaves the door open to a more complex and committed relationship with the chosen provider going forward.
  4. Multi-currency consolidation with one or two providers An even greater degree of consolidation is to select one or possibly two providers globally to leverage for payment needs in all currencies. The financial impact of this decision could be huge as he could both scale back his investments and significantly reduce his banking fees paid around the world. As with single-currency consolidation, this could be implemented rather quickly, which is a real plus. To move to this solution, he would be relatively dependent upon one or two providers, so making the right choice is imperative. He needs to have faith in his chosen provider’s commitment to the business and commitment to a customer-focused product development process. Focus on the customer While the above provides him with a clear strategy for optimising the framework for the payment execution, it still doesn’t address Charles’ need for upgrading his processing infrastructure or providing customers with better front-end technology or domestic clearing access. He therefore looks simultaneously into the following:
  5. Partner banking With a lot of customers complaining about the lack of ability of their house bank to support their activities outside of their home countries and the fact that the development of a proprietary international franchise is equally expensive and time consuming, the option to partner with a single provider of domestic cash management services across the region looks compelling. Key advantages of this approach – compared to partner banking arrangements with a multitude of providers – include streamlined account opening procedures, pre-agreed wholesale pricing and billing, sophisticated liquidity management and competitive service levels.
  6. Front-end white-labelling On the front-end side, Charles recognises that white-labelling tried and tested technology of other banks provides him with the required time to market and cost base expected by his senior managers and the functionality expected by customers. Examples of successfully white-labelled products include electronic banking, netting, lockbox and trade management products. Together with partner banking services, Charles soon recognises that this will help him to position his bank as a fully fledged cash management provider to his customers. While options 5 and 6 would go a long way in addressing his customers’ requirements, help to retain his most important client relationships and improve profitability through the generation of additional revenues, they may not solve any of Charles’ technology and cost challenges. He therefore also reviews the following:
  7. Infrastructure solutions Building and maintaining sophisticated transaction processing technology calls for significant ongoing investments that may only be justified for providers with significant critical mass – which many smaller banks may not have. On the other hand, committed transaction processing banks are looking for ways to maximise the return on investments in the respective infrastructure by making it available to third-party banks. Especially high value payment processing systems, being among the most expensive and complicated systems required in the cash management and transaction processing arena which are most affected by some of the changes in the business environment, tend to be interesting for this kind of approach. Other areas where banks are looking into sharing cash management and payments infrastructure include liquidity management and cheque processing. Even accounting/DDA systems are no longer out of scope.
  8. Outsourcing solutions Finally, even putting new infrastructure in place may not solve all of the identified costs and profitability problems. Major providers go a step further to outsource the payments operations to cost-effective offshore locations – again an approach that may not make sense for Charles’ organisation due to a general lack of critical mass. Partnering with another provider to utilise existing offshoring vehicles may, however, provide him with a similar cost basis and much better time to market, ie, he will be able to reap the cost benefits in the short term. In combination with a streamlined payments and cash management infrastructure, Charles soon recognises that he may be looking at a winning combination.

 

Making decisions

With a clear focus on his initial objectives, Charles decides to start with two working teams assessing different courses and evaluate the best decision from there.

The first team will achieve cost reduction, avoidance of investment demands and improved service quality, and will enact a single currency consolidation of euro payment flows to get immediate pay-off with minimal investment. Over time, that team will progress to multiple currency consolidation – assuming they are satisfied with the euro service. They will then evaluate longer-term infrastructure solutions, with an eye to adding infrastructure and outsourcing solutions.

The second team will support the need for new corporate products and services, achieve revenue growth objectives while limiting investment needed, and pursue front-end white-labelling and partner banking, with some infrastructure offerings embedded as well.

After an evaluation period, Charles and his teams decide that it would not be prudent to implement all of the above options simultaneously, ie, the most pressing needs will be dealt with immediately and others are taken care of as the partnership develops. He can finally rest easy knowing his payments business is well set up for now and in the future.

Strong presence

As a global bank with an ongoing commitment to investing in the payments business and with a strong base in the European market, Deutsche Bank has the right combination of scale, market penetration and presence in European and global markets to support all the options outlined above and partner successfully with financial institutions worldwide.

Paul Camp, Head of Financial Institutions Strategy; and Michael Mueller, Head of Wholesale Solutions, both at Deutsche Bank’s Global Transaction Banking – Cash Management Financial Institutions.

For more information on Deutsche Bank’s Global Cash Management capabilities, visit http://www.db.com/gcm or e-mail gcm.marketing@db.com

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