Evolving a Mid-tier Payments Architecture: Part 1
The payments business is a cornerstone of most banks’ operations. But as the number of channels and the volume of transactions increases, banks are receiving a growing number of multi-channel, multi-format payment instructions and messages that they need to process efficiently and in a timely fashion.
Besides pressure from customers and volumes there are also many regulatory and other external pressures affecting banks’ payment businesses. Liquidity is an area of major concern, as the cost of providing a payment service increases when accessing Real Time Gross Settlement (RTGS) payment networks, Continuous Linked System (CLS), and compliance with the Basle 2 Capital Adequacy Framework. While these developments reduce systemic risk, they result in high costs to banks, which have to be recovered from charges or unit cost reduction.
The best way to reduce unit cost is to increase volume through winning new business or making existing customers more profitable. But while dealing with the processing, repair, reformatting, routing, translation and investigation of payment messages, it is sometimes easy for banks to lose sight of the fact that for most of them the majority of payments originate from corporate customers, and these corporate customers have particular needs.
To win and retain new corporate payments business banks need to understand the corporate trade flow that leads up to the payment request, make these steps easier for the customer through tighter integration, while also providing a range of value-added services.
The ideal payment infrastructure to achieve this goal should be a general utility that will make customised services available to both internal and external customers within a framework of defined business processes. But this doesn’t require wholesale replacement of complicated back-office systems. A mid-tier architecture can instead be developed alongside existing infrastructures and provide a layer of functionality that integrates with corporate customers, third-party services and internal systems, while processing messages according to configurable business rules.
This mid-tier layer enables banks to make the most of the existing assets in their payment infrastructure, while offering better quality service to win and retain new business.
In the past decade many companies have invested large amounts of time, money and energy in attempting to banish inefficiencies from their physical supply chains. Simultaneously, but separately, they have also undertaken projects to streamline their financial supply chains.
These two supply chains – the physical and the financial – exist in virtually all forms of commerce. Any form of trade will ultimately end with a payment being made and reflected within the trading counterparties’ respective records. But the lack of integration between these two supply chains, and between corporates and their banks, has meant that the full economic value and efficiency gains targeted by automation initiatives have not been fully realised.
Physical supply chain management has grown from tackling logistics issues such as improvements to, and better integration of, manufacturing, transportation and warehousing, through to enabling better collaboration between trading partners. This has resulted in shorter time to market for new products and reduced production and inventory costs.
Technology has often played a part in realising these benefits in the physical supply chain. Similarly, Enterprise Resource Planning (ERP) applications have helped to streamline information flow in the financial supply chain through advanced modules for accounts receivables, accounts payables and general ledger.
But the financial supply chain is broader in scope than just internal accounting practices. It also incorporates external relationships with banking providers, and products and services such as letters of credit, financing and payments. Financial institutions are increasingly offering these corporate banking services online, but there is still a very low level of integration between the banks’ services and the corporate customers’ systems. Besides ERP, these systems also include a range of others, such as accounting packages, personal finance managers or even homegrown applications that together make up the corporate back office.
For banks’ corporate customers there are multiple steps involved in generating and receiving purchase orders and invoices, and currently many of these steps have to be repeated to initiate the payment through the financial institution.
The ultimate goal is to have these payments generated directly from an invoice file, that has been output from the corporate back office. After all, the banks are supposed to be the payments experts, so why should the corporate have to manually re-key information that already exists in a standard electronic form? By not eliminating this manual step, straight-through processing is impacted and errors increase. This causes problems not only for the customer, but also for the bank’s back office support areas, which have to deal with subsequent corrections.
Part of the reason for this lack of integration is that banks often do not appreciate that the majority of corporate payments are initiated in response to a trade document. But perhaps the biggest reason is that traditionally bank management has felt that technology integration doesn’t really have a role in banking.
This view is changing, but in most cases integration with the corporate back office has been ad-hoc and on a limited scale. Only those customers that have strongly demanded integration, and threatened to change banks if not provided, have benefited. Most integration work has often been done on the banks’ terms and not the customers. But while a few years ago the technology itself was a legitimate hurdle to better integration, the process has now become a lot simpler. With component-based architecture becoming more commonplace, as well as more open APIs from package vendors i.e. ERP suppliers, it is now quite feasible for banks to implement a payments infrastructure that provides the level of automation that clients require.
B2B e-commerce represents another area where greater input and cooperation from the banks as payment providers could greatly benefit corporates. While different online exchange models have emerged – from the public and industry consortium exchanges to the single company procurement portal – all have encountered problems in accommodating the financial supply chain.
While these procurement hubs do automate the procurement process, they usually require buyers to use credit cards or go offline to make the payment. Often this part of the process is still reliant on cheques. In fact, according to research conducted by the Gartner Group and Visa in the US, 86 per cent of all B2B payments at the start of 2002 were still made using cheques, despite the fact that only 11 per cent of companies find cheques or cash to be an efficient form of payment. This just adds to the time it takes to complete a transaction, increasing costs and reconciliation activities, while delaying the receipt of payment for the seller.
Some B2B exchanges have tried to solve the problem of integrating payments into their service themselves, but have for the most part failed. B2B e-commerce represents a major opportunity for banks to integrate their payment offerings into the trade flow and become more involved in the corporate activities that lead to financial settlement. There are banks that have decided to take this opportunity and become involved with various B2B initiatives as a settlement services provider. But too often these have been viewed as stand-alone projects, separated from the rest of the bank’s traditional payment processes.
For banks that take an enterprise-wide view of their internal payments infrastructure and how it interacts with corporate customers, regardless of the channel, there are numerous benefits to be gained. Chief among them is the ability to easily provide a wide-range of value-added services that will boost customer satisfaction and profitability.
A bank’s payments infrastructure not only needs close integration with the trade flow, but internally it also needs to provide an integrated business proposition to the customer. The organisational structure should not be an inhibitor to a customer relationship. So the walls that divide lines of business such as treasury, international, domestic or trade finance, should not be evident to the customer, who just wants to make a payment, or indeed settle a trade transaction, and doesn’t care who within the bank is involved.
With an efficient payment architecture that bridges the bank’s internal systems and is tightly integrated with corporate customers – through corporate back office systems and online B2B portals – banks will have access to data that enables them to offer valuable services such as invoice discounting, payment netting, inward payment discounting, aggregated FX contracts and investment products.
The corporate world often criticises banks for the price of their payments services. And if the corporate customer is dealt with on a payment-by-payment basis, then it can be expensive.
But tighter integration with the corporate’s supply chain and back-office systems means that payment information can easily be routed into a virtual warehouse where real-time analysis of information enables banks to be proactive in their service offerings. For example, a bank looks at a particular customer’s records and sees that it has 15 payments due this month, each of US$100,000 dollars. The bank could suggest the customer make just one FX contract for the total amount because it can get a better rate as the 15 payments come to over $1 million.
Similarly, payment aggregation services could benefit a company that might make 500 separate payments in a day to five of its trading partners. By aggregating that down to five payments, the corporate has to pay fewer fees and reconciliation also suddenly becomes a lot easier.
While this might at first seem counterproductive – the banks will obviously lose out on FX and payments commissions – it is a much better way for the banks to maintain their own treasury positions. Even though they can make more commission income on multiple transactions, this approach costs in terms of efficiency and the bank’s ability to manage its own books and liquidity. Larger, fewer deals also make it easier to analyse trends at the customer level and offer practical services and deals that make them more loyal.
When a corporate has a range of banking relationships, and no one bank can offer all the services it needs, it will cherry pick and use different banks for different services, or even different connectivity to clearing houses and payment networks. If a bank can offer tight integration, as well as value-added services such as sweeping, pooling, aggregation and netting it is likely to get a much larger share of its customers’ business.
The following diagram illustrates the areas in the corporate trade cycle and back office where banks can provide value added services that can be delivered by developing a mid-tier architecture:
To achieve these benefits of tighter integration, banks will need to undertake some re-engineering of their payment systems. But without a strategic review of the complete payment offering and infrastructure, across all lines of business, any re-engineering effort is unlikely to succeed. Spending money on introducing new payment functionality just to the corporate banking department, or just to treasury, is not always in the best interest of the organisation.
While many banks are currently averse to investing in new systems at all, a review of the complete payment infrastructure need not end in a proposal for a wholesale replacement of existing back-office systems. Often these processing systems are perfectly capable of meeting current and near-term business needs, and wholesale replacement is likely to be very disruptive, expensive and risky. Instead, it is better to develop a mid-tier layer that can provide the revenue generating functionality that corporate clients are looking for, as well as enabling straight-through processing by providing clean transactions to the back office.
Any proposal to introduce a new element to a payments infrastructure should be based on more than just potential cost savings. Banks might be under pressure from harsh economic conditions, but now is the time to offer proactive services to the market and develop projects that will contribute revenue to the business.
Of course, cost savings are an important element to look for in any new technology investment, but a more long-term view needs to be taken. Where will the payments business be in three years’ time? A cheap infrastructure is no good if no one is using it because a competitor has developed a new value-added service offering that actually attracts new clients.