This article is based on a roundtable discussion on the payments infrastructure held at SIBOS.
The payments infrastructures employed by banks today are a reflection of the past. They have served the industry well over the years but are becoming less suitable for the future. These infrastructures were designed to support the payments business as it was, primarily focused on supporting internal needs of the bank, but they do not provide easily for the continuing changing regulations and due diligence needed for today.
The new infrastructures need to be very versatile. They must provide for multiple and changing channels providing existing and new services. They must accommodate industry changes and new market infrastructures such as Target 2 and EBA Step 2. They have to provide a platform for cost reduction in an environment of increasing and changing customer demands. Most important they also have to cater for the needs of external bodies, in particular the due diligence required by regulators and government. As Ray Mulhern of Wachovia commented: “It’s not dead, but it’s certainly very inefficient in many areas.”
This is a fundamental change and means that a new environment needs to evolve. The move towards this has to be considered in the context of a risk management framework that balances risk, cost, capability and future requirements.
Regulation
New regulations create serious issues for banks. There is no choice to supporting new regulations – it is a price of being in the payments business. New regulations create great pressure on banks – they are the biggest challenge and can prove very costly to deal with.
Regulation change, such as those created by SEPA, OFAC, Basel II, IAS, Sarbanes-Oxley and other authorities, need to be implemented across multiple payment types and affect multiple bank products. SEPA alone has resulted in over 40 legislative directives. With the current silo based payment infrastructures this can result in one regulatory directive being implemented numerous times, this is a costly and risky exercise. The focus is now on managing the changes needed for due diligence and regulation.
Pressures
Besides regulation, there are other pressures on the payments industry that are considerable. New market infrastructures, such as EBA, ISO20022, create the need for further changes that cannot be avoided. Cost pressures are relentless, for example, the advent of the EU rules for SEPA has created pressures that will increase further as the industry is forced to implement more competitive structures. Eight per cent of revenue is now spent on compliance according to Wachovia’s Mulhern.
Customers themselves create further pressures. They are looking for better services at lower cost and for shorter payments cycles. In some instances they are driving the industry with groups such as TWIST. Commercial customers are looking to integrate their back office systems with the banking systems, to create automatic payments from ERP systems and this introduces additional requirements for the payments systems – for example, the preservation and transmission of reference data. The issue these create is again the need to be able to respond in a timely way, minimising risk and cost. Again the current infrastructures do not easily facilitate this.
Existing Systems
The existing systems have served banks well for years and there is an understandable reluctance to change them. These payments systems have worked well and can continue to work well within the limits of what they do. But their decentralised and siloed nature makes change difficult and time consuming. “The challenge is in the legacy siloes, how do you retool the infrastructure?” said John Mesberg at IBM.
Modern payments systems are no longer just about processing payments, they have to support both internal and external due diligence. The range of regulations is going to increase, not decrease. Sarbanes-Oxley, Know Your Customer, liquidity management, new EU directives and new EU terrorist legislation are all adding to the problem.
The structures for the future will need to process the payment itself, but they also need to be flexible and allow changes, such as those forced by legislation and governance, to be accommodated quickly and easily. The current infrastructures do not make this easy – they are rigid, expensive and risky to change. “The banks have been good at adapting, but we are about to go through revolutionary change,” commented Edward Glassman at ABN AMRO.
Exploitation of Current Strengths
Some aspects of the current systems have great strengths:
- Volumes are catered for.
- Proven reliability.
- Well understood by business operations and IT department.
For example, a bank may have a very good system for foreign exchange systems, liquidity management, or limit management that they have depended on for years. These quality systems should be retained and exploited, but they should be treated as components and utilised as service points. They can then be combined with other services within a more flexible infrastructure that orchestrates the services to achieve the processing needed.
Often a bank will have several systems fulfilling similar or identical roles, in this case then the best should be chosen and the others retired. This way banks will be able to change only that which has to be changed, to solve weaknesses, or to add new function, such as new regulatory requirements, while retaining the strong parts of their existing systems. “We must utilise the best of what we have, but make it available to many users”, says ABN AMRO’s Glassman.
Positioning for the Future
The aim is to increase cost effectiveness, improve flexibility and the ability to be dynamic – enabling response to market and environmental pressures. The approach has to be one of rationalisation through incremental change within a managed risk framework. “Banks cannot sustain the current cost structure,” says IBM’s Mesberg. The aim being the ability to utilise the best of what exists today, while adding and supplementing that with new capabilities that can be utilised in a common framework across the many products and channels. “We need tools to help us link the silos, so, for example, we can share an OFAC filter,” says Wachovia’s Mulhern.
The exploitation of reusable components as service points within a common framework and the underlying infrastructure to support this are the key elements needed.
Risk of Change
How to organise change without risk or more importantly minimising risk is a key concern. Management of risk is critical, but the risk profile is changing, it comes from many areas: customers, industry, internally and regulatory.
Different banks will have different profiles and will put emphasis in different places. But it is moving to the point where making a series of small (and sometimes not so small) forced changes to accommodate new regulation across the range of systems is becoming increasingly risky. It is reaching the point where it may be less risky to evolve to a new environment which can orchestrate the payments flow, utilise the best parts of the current systems and enable new functions to be easily embedded. The impending changes need to be managed very carefully.
A Way Forward
“Banks have invested too much in their infrastructures to simply enter into an era of wholesale replacement,” claimed ABN AMRO’s Glassman. According to Wachovia’s Mulhern, “We will see better connectivity (via message brokers and the like); consolidation of redundant applications into a best of breed at enterprise level; and selective replacement where technology is clearly outdated and replacement is more economical and faster to market”.
The challenge is to identify where and what to change. Identify the most critical areas that need to be replaced and do this using a new platform that is component based and can be reused in other areas. By identifying the most critical areas that need to be replaced, banks can plan their approach to gain the most benefit, with the least risk.
This could be single areas such as directory services, routing or validation, or a set of areas making up a major part of the processing. This needs to be established within a cost/benefit framework as well as a risk and capability analysis. Banks need to consider if they can make these changes themselves or get help from outside and, for example, utilise external components rather than create their own.
There is sometimes an understandable reluctance to do this, since they have been dealing with these issues internally for many years. But this in itself can be a risk, the market is moving so quickly that an internal focus can create difficulties. It is easy to lose sight of the market and miss key opportunities.
There is also the question of capability, with so many changes being required at the same time, many banks will not have the resources or skills to do all that is required. There is therefore a strong argument for considering outside assistance, especially for the ‘industry’ low value-add aspects.