Under the auspices of national and international supervisors, financial institutions have benefited from a distinctive status for years. Banks and payment services, in particular, were considered as the ‘lubricating oil’ of economic life: financing businesses and providing reliable payment services to settle economic transactions, etc. In the Netherlands, the Dutch Ministry of Internal Affairs decided to define payment services as one of the 12 ‘vital infrastructures’ that need to be protected. Financial activities couldn’t be left to free market forces alone.
The History of Outsourcing
One of the consequences of this distinctive status was that the sector, especially in an international context, was not really familiar with the phenomenon of competition. Arrangements between parties about, for example, raising efficiency and security, were condoned to a certain extent. The motivation was that a payment is a two-sided transaction: a payment and a receipt, with a paying and a receiving customer/bank. In order to make and keep the chain efficient and safe for all parties involved, certain arrangements are simply unavoidable. By means of a licensing system, supervisors withheld interested (foreign) newcomers from entering the domestic market. Banks didn’t experience incentives to raise their efficiency or to innovate in order to distinguish themselves from others. Also, because of this, financial institutions have become, and still are, large vertically integrated companies. This means that banks have all activities for end-to-end service delivery within the boundaries of their organisation. Being effective and efficient or not.
Within other industries it is already a common practice to reflect on internal activities and processes in a more businesslike and economic manner. For activities that are not strategic, alternative solutions can be considered. The business itself can concentrate on the processes that are of strategic importance or focus on the processes in which the business considers itself as relatively strong and therefore form the basis for competitive advantage. This development is supported by the entry of newcomers that focus on one business activity or process step exclusively: catering, logistic services, the postal department, etc. By now, outsourcing certain activities to specialised service providers has become a common practice.
In the 1990s, under the influence of a new vision on competition and the ‘virtues’ of the free market, the walls surrounding the finance sector gradually crumbled. As a result of the so-called ‘liberalization of the finance sector’, possibilities for making mutual arrangements were restricted further. Supervisors relaxed restrictive license systems. New financial services providers emerged: independent mortgage advisors identifying the cheapest proposal for customers, providers of high-rated Internet savings accounts, foreign banks offering mortgages in the domestic market via the Internet and intermediaries offering private banking services advice to the wealthy on a fee basis, etc.
In the Dutch market, we can see the previously unassailable market shares of the big ones attacked by newcomers, with the ‘mortgage war’ in 2006, for the time being, a prime example. They also attack each other more and more in their known home markets; the agricultural sector and the SME segment for Rabobank. The margins in the mortgage and savings markets face severe pressure from time to time. These are credible incentives to put the internal efficiency under the magnifying glass and to look at internal processes in a more businesslike and economic manner.
Rabobank’s Experience
Rabobank has taken its first step into the field of outsourcing – not only in the area of support processes, such as catering, logistical services and the postal department, but also regarding banking activities, such as processing of securities and international payments transactions. And while many consider ICT a core activity, Rabobank is about to outsource software design, development and testing. All in all we can state that the finance sector has become a common industry. Banks are becoming ‘ordinary’ businesses and therefore outsourcing decisions will become more and more common as a regular business activity.
Strategic choice: Rabobank payment and savings services
In the context of this more businesslike approach towards outsourcing, Rabobank Payment & Savings Services (PSS) made the following conclusion on the basis of payments market developments. Market leadership regarding payment services is based on operational excellence across the board and product innovation in selected areas.
- As is the case regarding other utilities, execution of everything related to payments must be operationally excellent: correct, quick and cheap. That’s all that customers what in doing payments.
- Banks can distinguish themselves from competitors in the field of electronic channels. Rabobank has to maintain a reputation in this area.
These factors are considered the most appropriate way a product unit can contribute to the generation of customer value in Rabobank’s markets. Achieving operational excellence is of major importance for PSS. PSS’ products and services have an important function for customers, as well as for Rabobank. For customers, PSS performs a utility function in their economic life: they can’t do without it and any malfunction is significant. For utilities such as payment services cost (per unit) is of crucial importance. Operational excellence is built on the following business drivers:
- Improvement of quality and reliability.
- Improvement of efficiency.
European banks use the single euro payments area (SEPA) as an inducement for reconsidering their position and strategy. PSS is looking for new ways of cooperation in order to reduce cost and to stay competitive in Rabobank’s markets. PSS can and does not want to keep on doing everything by itself. In certain business activities, including cross-border payments, we are too small to be able to continue efficient operations; therefore selective outsourcing is a consideration. PSS remains the unique focal point for internal customers for all payments and savings related affairs. PSS puts the emphasis on directing and managing the payments process, which is executed together with partners and other service providers. In certain areas, PSS becomes more of an ‘organizer’ (manager and knowledge centre) then a ‘provider’ (performer). The rest of this article reveals the considerations that led Rabobank in 2005 to outsource the processing of cross-border payments to Fin-Force, a subsidiary of the Belgian KBC. Subsequently, motives from the outside (market, legislation) and inner (internal processes) worlds are addressed.
Developments in the Payments Market
What developments in the field of payment services were driving factors in Rabobank’s outsourcing decision? In the payments market, particularly internationally, the following trends were observed (and are still relevant today):
- The payments market is an international market with worldwide trends.
- Increasing demands by retail and wholesale customers.
- New legislation leads to higher investments, increasing operational costs and shrinking margins.
- Increasing competition by non-banks assails the intermediary role and margins of banks.
- Increasing standardisation requires higher investments and reduces possibilities to differentiate.
The pressure exercised by the European Union (EU) to bring international service levels and costs in line with domestic levels had increased substantially. The European Commission’s (EC) attitude was in favour of self-regulation, therefore only if the sector didn’t succeed would the EC undertake legal action to define and enforce measures. This wasn’t a hollow threat as was proved by the following directives:
- It was legally enforced that certain EU payments couldn’t cost more then comparable domestic types.
- Charging for ATM transactions in EU countries is not allowed anymore.
We were, therefore, confronted with the prospect of legal action against the finance sector if the sector didn’t succeed in streamlining cross-border payment services. As a response, the sector founded the European Payments Council (EPC) and formulated the ambition to create SEPA. In 2004, the EPC launched an ambitious roadmap and timetable: from 1 January 2008, European Credit Transfer, Direct Debit and card schemes should be available. In the opinion of the EC, this is the only way European monetary unification could be finalized.
The development of the new European products, processing processes and ICT systems will require substantial investments by the banks. In addition, national and international legislation and settlement systems have to be changed radically. Also, adjustment to all this demands sizeable investments. The magnitude and complexity of the matter was so enormous that the implications for the banks could only be assessed by approximation. In 2005, the best estimate seemed to be from the Boston Consulting Group (BGC) in its Global Payments 2004 report, ‘Preparing for the Endgame’. Their investigation, in which European banks themselves provided their investment forecasts, revealed that until and including 2010 between US$80-$120m would be required per individual bank.
Only a few banks will be able to bear investments of this magnitude on their own. Most financial institutions will, in time, have to seek co-operation with other banks and service providers in order to share the investments.
Internal Processes
The process of cross-border payment transaction processing can be illustrated, in a simplified manner, in the flow chart below, which shows the process of outgoing payments. The incoming payments process is, by and large, similar, but in that case the delivery comes from SWIFT.
Delivery – paper-based, teller supported or electronic – of accounting (internal and external) for customer transactions, will always remain within Rabobank. The remaining part of the process, from controls to investigations processing, are located, from a customer’s viewpoint ‘under the bonnet’. In this field, no single bank can differentiate itself from other parties. This part of the process must be executed correctly, quickly and cheap. In other words: operationally excellent. Scale is the most important business driver. In a European market, Rabobank is too small and therefore, in the internal document ‘Sourcing Policy Rabobank Group’, operational processing of payment transactions falls in the category of ‘to be considered for outsourcing’.
Outsourcing as a Contribution to Business Goals
For Rabobank, as a whole, the most important business goal is to be number one in the markets it operates in. For PSS, this translates into offering the best value payment services, i.e. the best price/quality ratio. In the payments world, this requires large transaction volumes. In the field of cross-border payments, Rabobank’s volume was too small to be able to continue to achieve a competitive price/quality ratio. High investments would further assail the price/quality ratio of Rabobank’s payment services. Therefore, in 2005 the decision was taken to outsource the ‘under the bonnet’ part of the process. Shown in the illustration of the outgoing payments process before, this concerned the process steps controls, core processing and investigations processing. SWIFT and Nostro reconciliation were too interwoven with other processes and ICT systems, that outsourcing these steps was considered too complex at that time.
Through outsourcing the processing of cross-border payment transactions, Rabobank benefits from the larger volume of a specialized service provider and the investment can be shared with others. Only in this way, could Rabobank achieve and improve the competitive price/quality ratio. Therein lies the contribution of outsourcing to the business goals of Rabobank and PSS: market leadership and value.
Conclusion
Considered logically and strategically, it was a necessity to outsource the processing of cross-border payment transactions. Rabobank was too small in this segment to be able to bear the required investments. Co-operating with Fin-Force resulted in scale of economy, which enabled the bank to maintain a low unit price even after the implementation of SEPA. Rabobank can now focus more on customer contact and through outsourcing the processing of cross-border payment transactions, prove its innovative character in the field of process organization.