Outsourcing SEPA - A Viable Business Proposition?
With the start date for the single euro payments area (SEPA) confirmed, banks are intensifying their discussions and focusing on their strategic positioning. Most recognise that SEPA will deliver many long-term benefits to both banks and their customers. Yet there remains a degree of anxiety with respect to the short and medium term implications of the initiative.
In the short term the implications are expected to be limited. For customers, the necessary changes need only amount to the introduction of two new payment instruments and related standards, which in most cases will work alongside the existing ones. The further development of existing technology to implement these standards, while incurring some financial expense, will also require a degree of change to the payments infrastructure.
Further consideration of the long-term payments climate in Europe reveals an environment of comprehensive change. The whole landscape of payment systems in Europe will change. Clearing systems that have been around for many years are unlikely to survive in a more uniform transaction-processing environment. New competitors may enter domestic transaction processing markets, and traditional cross-border payments and domestic payments will inevitably converge over time – eroding fee structures and putting a lot of pressure on processing systems.
During these early stages, it is still fairly uncertain for how long, and in what ways, the old clearing instruments and the new systems will co-exist, with clients providing domestic and cross-border payments in both the legacy and SEPA formats.
The difficulty for banks is justifying a business case for further investment in their payment infrastructure in such a changing market. Other important issues arise, such as the need to create a competitive advantage that will keep them ahead of their competitors and new market entrants, or the reluctance to spend their budget on complying with mandatory changes only, rather than improving their competitive positioning in different or related areas.
SEPA has certainly been an important catalyst of change with the resulting reviews of payment processing infrastructures. The implications of changes in non-SEPA related traffic will also need to be evaluated, along with possibly increasing financial demands.
Given the scope of SEPA and its related instruments, it is surprising that we have not seen a frenzy of business process re-engineering, offshoring or outsourcing projects on the market – perhaps suggesting that the connection between the macro-economic concept of SEPA, and the reality being faced by banks on implementation, is still rather tenuous.
Transaction processing is considered a core competency for many banks, so transferring such a core activity to a third party requires clear strategic direction, as well as a good handle on the existing processing, technology and, most importantly, cost structures. The most likely scenario is that most banks do not yet have reliable management information systems (MIS) in place to enable them to assess the true profitability of their payments business, particularly as in many instances it is subsidised with other revenue sources, such as FX or interest income. As most banks are still in their evaluation phase, best practice has not yet been established across all markets, especially in the SEPA space, and this has thus far resulted in limited collaboration between banks.
However, more recently, the market has been seeing an increasing number of SEPA-related requests for information (RFIs) and requests for proposals (RFPs) from financial institutions focusing on cost reduction/avoidance and product enhancement. Banks are realising that one way to remain competitive is to make use of superior products, and the associated low cost structures, developed by others. The kind of solutions that have been requested range from relatively light partner banking services to front-end white labelling to more comprehensive application service providers (ASP) and wholesale outsourcing solutions.
Setting up the respective arrangements appears to require a high degree of technical integration, which may become a significant obstacle to partnering with another financial institution in this area. But banks are actually already quite familiar with outsourcing vital parts of their operations in other strategic areas, e.g. HR and procurement, and appropriate organisational, technical, regulatory and legal structures are already in place for these types of transactions.
Choosing a provider who has a market leading system that will maintain the flexibility to cope with all future developments is another key concern. The solution to this is to conduct a thorough due diligence of the products on offer and the track record of previous transactions. The scalability of the available solutions and the degree to which they need to be customised are good indicators of their future competitiveness.
The third potential concern is the project risk itself – an appropriate assessment of the ability of the combined project team to implement the solution within the agreed timelines and budgets. Again, track record and tried and tested, end-to-end solutions, as well as resource availability and commitment, are of vital importance in this area.
Then the commercial dynamics and risks need to be fully understood, as the transaction should make good economic sense for both the insourcer and the outsourcer. One should consider the degree to which existing systems and infrastructure can be utilised for the solution, without significant customisation. Also amortisation timelines for the implementation costs need to be reviewed carefully, as does the pay back period of outsourcing versus building solutions in-house. One of the key strategic considerations is the dynamics between fixed and variable costs, as outsourcing typically results in a shift of fixed costs to variable costs, enabling banks to incur expense as the associate revenues also increase, which is ideal when entering new markets or developing new products.
A growing number of groups are waking up to the fact that there may be a new market development, with associated business opportunities. While technology firms are mainly focusing on the creation of the systems, specialised outsourced service providers are more interested in running customer’s proprietary systems in more streamlined, offshore locations to derive the related operational benefits and to leverage the labour-cost arbitrage. Banks are a natural candidate in this space – they combine technical and operational expertise with solid banking know-how. At the same time though, offering the respective products and services to other financial institutions requires a clear strategic direction and product and operational excellence, as well as the credibility that arises from the maturity of the internal structures – and currently only a handful of banks have really entered this space.
With this variety of new models evolving in the payments arena, the market for the provision of these solutions is set to expand significantly approaching 1 January 2008. The current uncertainty relating to the expertise of the providers may create concerns for the outsourcers, but in this area, the opportunities clearly outweigh the threats. The more efficient use of investment money will lead to more robust and better products, while consolidation will result in increased competition and better prices. In combination with a solid regulatory framework, the developments should further help to realise the full potential of the SEPA initiative.