Mohit Joshi Vice President and Head of Financial Services in Europe, Infosys
European banks’ return on equity (ROE), a key measure of profitability, is likely to average less than half their cost of capital again this year. This lags well behind US rivals as lenders struggle with high costs and weak economic growth, according to the latest European Banking Barometer report from EY. The pressures on ROE, combined with tighter and costly regulations, increased capital requirements, higher operating costs and reducing returns are major challenges facing European financial services organisations today.
In order to manage these challenges and remain competitive, financial services companies need new operating options. As part of their journey towards a leaner, more agile future, we are seeing the sector undergo widespread business restructuring – including selling or buying assets – as well as forming partnerships or joint ventures with like-minded groups or competitors. The idea is to reduce operating costs and improve efficiency.
Financial services operators must reduce costs and improve efficiency to improve ROE and bolster balance sheets. The “low hanging fruit” of internally-driven outsourcing and personnel costs has already been leveraged by these organisations. The next step to improve efficiency, rationalise processes and technologies will come from mutualising back office functions.
We are seeing significant interest from banks seeking to create utilities in order to service costly and administration-heavy tasks including servicing post-trade processes, know your customer (KYC), reference data and reconciliations. Size adds complexity to existing technology, operations and infrastructure environments, so unbundling from legacy systems to use an external utility model is not without challenges.
Nonetheless, established financial services providers are essential candidates for adopting utility models. However, the candidates for whom utilities are best-suited are the new challenger banks and financial services providers launching digital-only services. These challenger entrants do not carry the baggage that legacy apps and infrastructure bring, making the move to a utility model financially easier as well as physically easier.
Banking utilities come in many different shapes, from pseudo utilities that comprise a single platform to support a single customer bank to full-blown industry-wide utilities like secure financial messaging provider SWIFT. Most recently, three banks – Goldman Sachs, JP Morgan, and Morgan Stanley – created a company that will clean reams of reference data at a lower cost than they would otherwise spend individually.
With any utility in financial services, there are significant considerations and obstacles that need to be overcome:
- Regulation – Financial services utilities need to be regulated in some shape or form. There is a fundamental question about who will handle overall liability when things go wrong? A strong, collaborative working relationship with regulators is essential
- Utility Structuring and Commercial Models – The type of commercial structure the utility will adopt is very important. Does the partnership wish to restrict the utility to only a few clients or make it an industry-wide operation? What shape or form will the partnership take – joint venture/synthetic joint venture/purely royalty-based arrangement? What roles and responsibilities will each participant in the utility take?
- Business Case – Organisations need to know the true cost of ownership of their existing estate so they can compare accurately to the cost reduction the utility can deliver. Those that have highly documented infrastructure assets and processes have potentially achieved significant savings already from offshoring IT and operations. For them, the business case needs to stack up over a much longer term and take into consideration factors that can accelerate cost savings, such as financial engineering
- Utility Roadmap – The roadmap is a long and complex one and involves several phases and considerations, including forming an enterprise platform, driving towards SaaS, creating a solution on a private cloud and then finally migrating to a full-fledged utility
Additionally, there are several technical and functional challenges to consider:
- Understanding the data privacy and security requirements
- Agreeing whether to buy versus build for the core of the utility
- Architectural complexities in banks’ interconnected legacy environments
- What partner ecosystem to choose
- Determining the non-functional requirements that the utility should meet, such as performance & scalability
- How to deliver and run the utility for multiple tenants
Financial services organisations need to think about the segmentation, targeting, and positioning of the utility in a way that allows the participants to have an equal voice in the roadmap while retaining the core functionalities that will support the majority of the industry’s requirements.
With operators such as banks demanding over 50% savings on existing process spending, it is critical to focus on the innovations impacting all the elements of the utility e.g. process automation, self-service portals, creation of thin-trades, open technology platforms for regulatory reporting, and several others.
Looking ahead, the growth of industry utilities will unshackle financial services companies from the burden of performing several non-core activities. Instead, they can focus more on higher-value core differentiators. Doing so will allow them to possibly operate more like hedge funds. Their focus would then be on pure business-generating activities such as sales, marketing and relationship management. This means a focus on bank-specific pricing, risk management and value-add services.