The credit crisis has brought an end to easily available liquidity, and the resulting pressure is sending many banks and financial institutions (FIs) back to basics – taking stock of what constitutes core revenue-producing business and what does not. This process will lead many to realise that cash management (including multi-currency payments) and trade finance activities – that require a costly and continuously monitored infrastructure – are the outcome, rather than the function, of core business activities. As a result, they are a drain on human, technological and financial resources at a time when banks are facing unprecedented and conflicting financial demands from regulators, governments and investors.
Therefore, cash management and trade finance become economically viable activities for outsourcing to a specialist global provider – especially when considering that existing margins are likely to be sub-optimal.
Expense and Risk
Indeed, such returns cannot justify the steep – and escalating – costs of proprietary cash management infrastructure. System start-up costs are in the region of US$200m – encompassing the infrastructure costs, personnel, SWIFT membership and, for disaster-recovery purposes, the duplication of the entire system (which, for example, will require the back-up system having independent energy and telecommunications providers and power feeds).
Monthly running and maintenance costs need to be added to this initial amount, and they can run to US$300,000 – a sizeable enough amount to make a significant difference to any banking business line. Furthermore, these expenditures will increase if the infrastructure needs to be adapted or updated – a likely scenario in a market in which commerce is becoming ever more global and technological developments ever more fast-paced, allied with the ever-growing need to comply with multi-national regulatory guidelines.
In light of this, costs are not the only hurdle to overcome. Proprietary systems have a high benchmark for risk management and come with a great deal of responsibility. The strong likelihood of system upgrade and adaptation, as well as system interoperability concerns that may arise from merger activity, means that ‘future risk’ is an unavoidable issue.
Counterparty risk is also a crucial point of consideration – particularly for banks and FIs that self-issue multi-currency payments – as they will often have to utilise cash reserves in support of their payments. Such risk requires its own credit and risk-mitigation system and related overheads – a further drain on revenue-producing lines of business.
Additionally, banks and FIs that self-issue such payments must maintain correspondent banking relationships with banks that operate in their key currencies. And this could be a sizeable number of banks. They are also obliged, on a yearly basis, to carry out know your customer (KYC) and anti-money laundering (AML) checks with their network of correspondent banks, as well as keep track of the Financial Action Task Force (FATF) security blacklist.
It is clear that such expense and heightened risk counteracts banks’ current aims to enhance their risk position oversight in order to generate better asset management returns. So, the question is, given where we are, what can domestic and regional banks and FIs do to meet their goals and remain competitive while ensuring that their cash management and trade finance needs are met? One answer is to outsource these operations to a specialist global transaction banking provider.
In terms of time and focus, outsourcing cash management and trade finance processes would transfer the accompanying risks and responsibilities to the insourcing bank, which also means that all future expenses that may result from continuing security checks and infrastructure maintenance, upgrades or adaptations are the sole responsibility of the insourcing provider. However, the chief benefit to outsourcing these activities for the smaller bank is that it can turn a high fixed cost into a much lower variable cost – around which the business can then be budgeted. In short, outsourcing can decrease cost and remove risk.
Implementation and Contractual Obligations
The practicalities of outsourcing must be considered alongside the benefits, and it can be, perhaps surprisingly, a straightforward arrangement. Procedurally, the implementation process depends entirely on the scale of the outsourcing organisation’s transaction volumes. For banks and FIs with low volumes in non-domestic currencies, a beneficial option is to open a local currency account with a specialist provider, which can then undertake foreign exchange (FX) at pre-notified rates against this account, as instructed. For organisations with a high volume of transactions, the more effective alternative is to open individual accounts in their operational currencies, which the provider can then debit as instructed. This is more economical for the outsourcing entity as it provides greater control over the FX rates. Turnaround times for implementation reflect the scale of the outsourcing institution’s needs. For example, the maximum time frame is four to six months for the outsourcing of an entire trade operation.
Outsourcing banks and FIs also have more options with regard to the payment of fees. In some cases, the remuneration contract can even be open-ended with a pre-agreed monthly fee. This is because the payments provider can calculate a fee based on the outsourcing organisation’s previous two years’ transaction volumes. And, this charge can be re-negotiated at a later date should the transaction volumes and needs of the outsourcing bank change.
In order for this approach to work, the contractual obligations of outsourcing can be relatively flexible, although payments, receipts, liquidity, information management and customer support must be incorporated. Cut-off times, what to do with surplus liquidity, and the provision of 24-hour client services available in local languages, must also be addressed. However, these contractual issues are relatively straightforward to arrange.
The establishment and upkeep of an in-house payments infrastructure is, at the best of times, no mean feat, but help is at hand from specialist global transaction providers. However, outsourcing banks need to be sure that the help offered comes without a catch, and that there is no risk of losing business to the larger provider. For this reason, there are some specialist providers that can help by offering non-competing outsourcing partnerships, which eliminate this risk while providing domestic and regional banks and FIs with the economies of scale that larger providers enjoy.