The introduction of the single euro payments area (SEPA) payment instruments represents an additional cost burden for banks in Europe. In order to adopt the minimum levels of compliance with the rulebooks for the SEPA Credit Transfer and SEPA Direct Debit, banks will need to adopt new message standards based on the ISO 20022 XML format. But, simple compliance is unlikely to leave banks with a compelling proposition to offer their end-customer. To remain competitive, therefore, banks are also likely to need to bundle a series of additional product and service features, which will add further to the cost pressures and resource squeeze they already face. Couple this with the reducing margins on SEPA payments as a consequence of regulatory and competitive forces and it is easy to understand why, more than ever before, scale is an absolute imperative in the payments business. For the smaller player, therefore, the time is ripe for considering its positioning in the European payments space.
Important Factors to Consider
While SEPA is a catalyst for change, it is not the only factor. Banks need to consider other matters, such as:
- Increasing sophistication of customers who are demanding more flexible solutions.
- Globalisation of business, with customers’ demands for cross-border services perhaps outstripping the levels able to be supported by their bank.
- Increasing regulatory pressures outside of SEPA, such as increasing compliance costs for anti-terrorism/anti-money laundering and of operational, credit and market risk management.
- Additional mandatory payments developments, such as the Faster Payments initiative in the UK.
- Increased infrastructure-driven standardisation around data formats and product schemes.
- Competition from both banks and non-banks, with third party data processors looking for scale and corporates looking to work within their supply chain to disintermediate traditional banking activities.
- In certain locations, there may be a shortage of skilled staff available to support the payments business.
To meet this array of challenges, institutions would ideally like to achieve three goals, which, on the surface, appear mutually exclusive:
- Reduce cost.
- Improve product breadth and capabilities.
- Minimize investment.
In reducing cost, the institution would like to move from a cost base that is largely fixed to one that is highly variable. In addition, the driver is to reduce overall operating expense and risk.
In improving product capabilities, the drivers are to expand the product offering and market reach, perhaps introducing global solutions, and to offer a robust and sophisticated delivery capability.
In terms of the investment challenge, the institution will be looking to minimise capital outlays on platform upgrades and re-focus on the core business.
Strategic Options
The financial institution could decide that the pressures are far too great and that it should simply abandon the business altogether. Clearly, this has the advantage of reducing investment, but it does nothing to meet client needs around the product set and will lead to shrinking revenue.
It could decide to re-invest in the business, either buying new functionality or re-engineering existing platforms and capability. This will permit the customisation of solutions to meet client needs, but is likely to delay realisation of the financial benefits and will require ongoing investments to ensure the solution remains competitive going forward.
Or it could decide to outsource key activities to a partner. This should serve to reduce overall investment costs and pave the way to move onto a variable cost basis. It should also improve speed to market and increase flexibility of the end-customer proposition. But it does require the existence of a robust, trustworthy supplier or, better still, a community of such suppliers, who will readily compete to provide services on an outsourced basis.
A European Central Bank survey of EU-based banks’ motives for outsourcing (reported in the Basel Committee on Banking Supervision’s Joint Forum on Outsourcing in Financial Services, published February 2005) revealed that the following factors were the most important:
- Cost reduction.
- Accessing new technology.
- Allowing a better focus on the core business.
- Benefiting from economies of scale.
- Freeing up resources to concentrate on other activities.
- Gaining service improvements and improving quality.
- Becoming more flexible.
The added pressures arising from SEPA simply serve to reinforce these drivers and we can expect to see a growing trend for the outsourcing of payments-related activities in the coming years.
The same Basel Committee report also outlined the key risks associated with outsourcing and the major concerns which any institution planning to follow the outsourcing route should consider.
| Risk | Major concerns |
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| Strategic Risk |
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| Reputation Risk |
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| Operational Risk |
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| Compliance Risk |
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| Contractual Risk |
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| Counterparty Risk |
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| Access Risk |
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| Exit Strategy Risk |
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| Country Risk |
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| Concentration and Systemic Risk |
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And remember, where financial institutions and payment-related activities are concerned any outsourcing arrangement is likely to be considered ‘material’ by the regulator of the outsourcing institution and will be subject to regulatory scrutiny by the relevant authority.
Business Models for Outsourcing
So where does all this leave European institutions considering outsourcing some or all of their transactional business? With yet more to think about. Outsourced business services can be delivered in three different models:
1. The application service provider (ASP) model tends to be an IT-only play and allows the institution to add another dimension to its traditional ‘build versus buy’ deliberation. By effectively renting space on the provider’s platform, it is possible to develop a ‘pay as you go’ approach that provides:
- Reduced costs and complexity of technology support.
- Reduced licensing and upgrade costs.
- Potential to develop a reduced cost and more robust disaster recovery capability.
- Scalability to support volume growth.
The ASP model, however, does present challenges around:
- Integration with existing systems and processes
- Third party implementation dependencies
- Creating an effective SLA and service management process
- Security and communications infrastructure
- Implementation support and escalation processes
2. The business service provider (BSP) model brings in business processing alongside technology. This allows the institution to:
- Gain relatively low-cost access to a world-class integrated environment for business operations.
- Scalability to support volume growth.
- Transaction-based pricing on a variable cost basis.
- Focus management attention on revenue generation.
The same challenges as with the ASP model will exist, along with other factors, such as:
- Establishment of the boundary between service provider and outsourcer, especially where client contact may be involved.
- Cultural resistance (on both sides) to new organisational and control structures.
- Exit strategy.
3. The third approach is business process outsourcing (BPO), which involves the technology, the business processes and also the people to operate the service. As a ‘lift out’ of the existing business, implementation risk may be lower as there is greater continuity and the service provider’s expertise in running and changing the business over time will lead to reduced operating costs. Among the added challenges with BPO lie the creation of a contract and service level agreement (SLA), which enables (guarantees) continuous improvement and the HR issues regarding transfer of personnel.
Taking all these factors onboard, a European institution looking for an outsourcing partner could be guided to consider one who can offer:
- An absolute commitment to the transaction banking business and to offering its own clients world-leading transaction banking solutions.
- Full service capability across the transaction set.
- A track record of investment in technology and low-cost processing.
- A technology and operations base which supports multi-entity, multi-time zone, multi-currency, and real-time activity.
- Global scale and global distribution capabilities.
- An understanding of, or, preferably, the same exposure to, the regulatory demands facing the institution.
- Additional services wrapped around payment solutions which extend the offering from management of SWIFT infrastructure and operations (bureau model) through to reconciliations processing and exception management.
- A contractual arrangement supported by measurable and enforceable service levels.