Evolution in Corporate Transaction Banking
The globalisation of the economy has had an immense impact on the way large corporations are managing their cash and liquidity. Many corporations have reacted by taking steps to standardise and harmonise their finance processes across entities and regions by establishing regional shared service centres and implementing centralised back office systems.
What were once payment factories simply offering a hub for processing payments, are now evolving into holistic corporate transaction banking systems that can offer corporates a holistic means of managing all transactions that flow to and from their banks. What has precipitated this change, and what are the wider trends in the corporate transaction banking area?
The credit crisis has sparked a major rethink within corporates of how and where they put credit facilities in place. Corporates are looking to use internal cash more efficiently and get more visibility over their cash. One area that treasuries can find challenging is when it comes to gaining access to their cash once it has been identified. The situation is exacerbated in ‘difficult countries’ that have prohibitive tax regimes preventing the easy movement of liquidity outside of the country. An opportunity exists here for the large cash management banks with presence across countries such as this to advise their clients and leverage their network to provide value-added services in this regard.
In addition, with the global economy in a fragile state post-crisis, corporate treasurers are placing a greater emphasis on having an overall visibility over their cash position. Achieving this visibility, together with the ability to access this cash, directly affects an organisation’s bottom line. Investing in this process can allow corporates to reduce their short-term borrowings by up to 30% – a figure that is bound to be attractive in the current climate.
“Access to external capital still cannot be taken for granted,” explains Mario Tombazzi, senior vice president, regional liquidity product management, HSBC Asia-Pacific. “The importance of a company’s working capital is especially important: liquidity risk can force large corporations into bankruptcy, and counterparty risk is also increasingly on the agenda. As a result, the opportunity cost of the internal sources of funds has increased. It’s not only important to have enough funds, but also to manage them in a way that keeps them accessible and visible.”
While there is this good interest among corporates for setting up payment factories, shared service centres and the like, the attitude seems to be that if they’re going to go down this route, they will also split their business between a number of banks in an effort to reduce exposure and hedge counterparty risk.
Corporate treasurers that embark on discovering how many banks and accounts their organisation uses can find themselves facing quite a painfully slow task, especially if this includes many overseas entities. Some business units may appear to be unwilling or unable to supply the information in the first place. This could be because these units either do not keep an up-to-date list of their various banking relationships or they see the exercise of listing them as one of group treasury interfering on their patch. Once the most accurate list has been compiled, treasury then needs to understand the reason for the amount of bank relationships and accounts and then see if there is a chance to reduce them.
The first step in this process is to establish what an account costs to set up and manage. This can be a difficult exercise to complete due to the number of variables involved in the cost structure. These include:
Once the cost has been established, it is then possible for the treasurer to set a realistic saving goal for bank charges.
The question can arise as to whether group treasury should be responsible for managing cash management bank relationships within an organisation. This is usually the norm, but can find disagreement from other areas of the organisation. Treasury can make considerable savings through bank consolidation and the continuous review of accounts, but it also needs to be aware of the effect this can have on other business units within the organisation in terms of the change in relationships that these units have with their existing banks. Any change driven by treasury has to be handled sensitively.
Figure 1: Changes in the Transaction Banking Landscape
While corporates are reassessing their bank relationships, banks are also looking at how they leverage their corporate contacts. From a bank perspective, they want to ensure they are getting a slice of the profitable transactional business. One way to achieve this is by including part of the corporate cash management business in the terms of any credit agreement offered. Corporates understand this ‘linkage’ that banks are focussing on, but any forcefulness in the bank’s approach, particularly with the linking of the credit relationship to the cash management business, is another driving factor in making treasurers question how they share their business across their credit banks. Amol Gupte, head of treasury and trade, North America at Citi, says:
“The market practice of rewarding credit with transaction business is not a new concept. However, in the wake of the recent financial crisis, banks are under immense pressure to optimise their credit extension with cross-sell business – to generate fee income and attract liquidity. As a result, non-bank providers are experiencing higher attrition rates, driven predominantly by clients moving transaction business to their primary credit bank(s).”
Despite this, Gupte points out that the banks have to be innovative and offer competitive advantage in order to attract and retain corporate clients. “With that said, it is important to note that the key drivers for decisioning for our corporate clients continue to be product quality, pricing, etc. As such, there is no significant “free lunch” business that is simply gifted to banks due their extensions of credit. To be successful, banks must continue to invest in innovation and technology,” Gupte advises.
New regulations, particularly in Europe, are forcing banks to review their payment offerings and decide if they still want to, or can afford to, remain in the business. For banks, cash – their most liquid asset – is now more valuable. Regulatory requirements now require banks to not only prove that they have enough cash and liquidity to continue trading, but they must also be able to prove that they have enough to meet their ongoing obligations. While regulators around the world are still putting the finishing touches to the new areas of compliance, it seems clear that at least some financial institutions will need to provide the regulators with sufficient data to allow for various stress and scenario tests. On top of this, the credit crisis has led to a return to ‘back to basics’ transaction banking as a main source of profit for banks. This, in turn, is likely to continue to drive increases in transaction volumes. This means that banks need to ensure that they are putting their cash to good use, leading to a greater focus on counterparty and nostro account management.
Large banks can have millions of transactions from myriad sources moving through their nostro accounts. The balances of these can change hundreds of times a second at peak times. Cash flow volumes have also risen, a trend set to continue with greater increases in electronic and algorithmic trading. These increases add pressure to the process of hitting target balances and regulatory demands, and squeezes nostro balance netting, reconciliation and forecasting processes. However, if financial institutions can successfully manage these processes, they can increase their opportunity to maximise the efficient use of cash in the money markets and foreign exchange (FX) markets, both regionally and globally.
While this opportunity exists in nostro account management, this is also an area where banks can lose money. If an institution does not have sufficient funds in its nostro account at the time of closing, it will incur penalty interest and charges. As this is short-term and unexpected, the interest rates – which are based on the current Libor rate – are high. It is a common occurrence that nostro account balances fall so short that banks are severely penalised, possibly losing them hundreds of thousands of dollars on individual trades. This can also impact their liquidity buffers, which will soon be specified by the regulators. For example, if banks in the UK fall below their threshold, they will have to submit daily liquidity reports to the Financial Services Authority (FSA) and may also be issued heavy fines.
The methods that financial institutions use to manage their nostro accounts look compromised when you compare them to the planned new regulatory requirements. For example, many banks hold complex hierarchies and nostro accounts structures, while using a multitude of manual processes and systems to maintain target balances, sweep funds, make cash flow projections, execute trades and manage risk. For global banks, these challenges are multiplied by trading a broad mix of asset classes across different time zones. Liquidity risk and operational risk increase exponentially, which leads to huge challenges in determining what the institution’s cash requirements are for its day-to-day counterparty obligations. However, with the impending liquidity regime and the return to transaction banking, banks are now recognising that this is a challenge they need to overcome.
It’s estimated that the single euro payments area (SEPA) alone which will eliminate cross-border fees and float income will result in direct revenue loss of €20bn for banks. So does it only spell bad news for financial institutions? Not according to Citi’s Gupte, who told gtnews that, “While SEPA should reasonably precipitate the exit of thin-margin players who are not able to absorb the overall revenue decrease, it will also increase trade flows within the eurozone. Well-positioned banks will intermediate in these higher flows to offset the loss of float and cross-border fees.”
One criticism of SEPA implementation is that it is happening far too slowly, as it is a regulatory-driven, not market-driven, change. Most payments within the SEPA framework are domestic with existing systems that are inexpensive and already proven – so why would an institution want to alter this process and spend money on a new infrastructure when the volumes of cross-border payments are so low? Currently most banks and corporates, and even agencies of the governments that ratified the PSD, are doing the bare minimum to meet SEPA requirements for cross-border transactions. In addition, domestic transactions are left largely unchanged. There are a number of reasons given for this – countries say that their systems are already SEPA compliant and therefore no action is required, banks say the SEPA Direct Debit (SDD) or SEPA Credit Transfer (SCT) volumes will be so small that they can process them without actually implementing any major changes, just the minimum to comply. Does a bank with six million mandates in one country want to modify each and every one of these for domestic SDDs? The answer, and common sense, would suggest not. As SEPA is a regulatory-driven change, the only way to make this happen is to increase the regulatory pressure to force financial institutions to comply.
The prevalence of bank legacy systems is another issue that needs to be addressed before SEPA can be properly implemented. Most banks aren’t keen at building a new model as again this is not a cheap proposition. SEPA was dreamt up long before the credit crisis, and banks now have different priorities. Post-crisis, many have slashed their investment budgets in order to conserve funds for their operational budget. The received wisdom is that a bank can stop investment in infrastructure and systems for a period of six months to one year and won’t lose anything in the meantime. In reality this is negative short-termism – at some point the bank will need to start investing again, and will find itself at a disadvantage to its competitors at this time. The ‘wait and see’ approach is another reason for the slow implementation of SEPA, as too many banks are waiting to see what the viable market model is before they invest in the process themselves.
With few banks providing SEPA payment methods or cash management activities due to the large investments required to keep up with regulations – and some banks will not bother at all – there will be an increase in banks ‘white labelling’ their products to smaller banks. Deutsche Bank are a good example of a provider in this situation.
As part of a major research project of SEPA and the Payments Services Directive (PSD) carried out by the Financial Services Club last year, Werner Steinmuller, head of global transaction services of Deutsche Bank, provided the following assessment of his bank’s position:
“Deutsche Bank is in a comfortable situation. We spent quite a sizable amount on SEPA infrastructure and have a brand new system that is extremely capable of doing this that is also highly scalable. Others have not made this investment so this gives us a price advantage. We have built some conversion solutions for handling old volumes and now can run both old instruments and the new SEPA instruments so, if SEPA is coming, we are extremely well positioned. If SEPA fails, I can write off the investments and still win.”
SEPA has required banks to build new infrastructure and systems, as well as new efficiencies in transaction processing. These systems and efficiencies can be leveraged across the bank’s network – just because SEPA, or even the euro currency, could possibly disappear, it doesn’t mean that these advances in transaction processing will. There is still an issue for corporates to consider here though – with white-labelling on the increase, corporates need to know who is providing their services.
Turning to the US, and Citi’s Gupte shared some thoughts with gtnews about the regulatory impact there: “The major US regulations that will have an impact on the cash management business are the American Recovery and Reinvestment Act (ARRA) and the emerging financial services industry regulation focused on increased transparency, accountability, and government oversight.” The ARRA, in particular, provides an opportunity for the financial services industry in the US to move towards greater automation.
And when it comes to white labelling, Gupte is quick to point out that it is not just regulatory pressure that is a key driver here. “Intense price competition for plug and play, plain vanilla services automatically grants advantages to the larger banks with sufficient scale to recover the substantial fixed costs. If this size-based advantage were not sufficient by itself to justify market entrance, white labeling also allows banks to expand their distribution network via indirect channels to areas where their local relationships may not be as strong,” explains Gupte.
European corporates are reducing their use of paper from within cash management and payments processes – cheques being a good example of this. SEPA is leading to a natural reduction of the use of paper, and feeds into the general movement to standardise, centralise and automate. All three of these are very difficult for corporates to achieve with paper, as processing paper is comparatively expensive.
Cheques have traditionally been more popular in the US, but even here the use of cheques is going through an unprecedented period of change. Figures from a recent Aite Group report forecast that cheque payments in the US will comprise merely 68% of all non-cash payments in 2010, compared to 80% in 2006. With stagnating top lines in light of current economic conditions, cost reductions and quests for absolute efficiency are pervasive in corporate goals. As Citi’s Gupte explained to gtnews, organisations are re-evaluating their operational processes and implementing previously disregarded tools – including electronic integration with suppliers – to enable more judicious use of internal resources, reduce cycle times, monitor vendors, capture early payment discounts, enjoy increased transparency and control, and enhance bottom line performance.
“One of the industries most aversely affected by the inefficiencies and drawbacks of paper based payments is healthcare,” explained Gupte. “The claim submission, processing (including reconciliation and verification), and ensuing payment processes dramatically extend the time between the service being rendered and the provider being able to completely reconcile its receivables. While paper cheques are still the preferred payment method of choice, more secure electronic channels will emerge on the back of new regulations.”
Asia is also experiencing a growth in the use of electronic payment systems, according to Nolan Adarve, senior vice president, regional payments and receivables product management at HSBC, Asia Pacific. Adarve pointed out to gtnews that the alternatives, such as writing cheques, are not only more expensive to process, but also more time consuming. “However, this doesn’t mean that cheques are on their way out. In Asia, thousands of cheques will still be issued and cleared every single day, Adarve explained. “For example, in Vietnam, cheques are still the preferred method of payments given the country’s culture and infrastructure. HSBC will continue to invest in the most advanced payments solutions for our customers, be it paper or electronic as cheques will continue to be a significant form of payment for the foreseeable future.”
A trend triggered by the liquidity crunch has been a greater interest from corporates across the world in working capital. The goal is to improve visibility and usage of internal funds. One example of this is that corporates are working on getting their payments as quickly as possible, while finding ways to delay making payments themselves. To improve the organisation’s working capital, treasurers must increase their cash visibility through processes such as cash forecasting, sweeping and netting. By using these standard cash management processes, corporates can gain an understanding of how much cash they have, where it is, what denomination it is held in, etc. With a full view of cash across the organisation, the treasury can effectively act as an in-house bank, providing funding to business units where necessary.
Amol Gupte says that, over the last year, Citi has seen a fundamental paradigm shift in the priorities of our corporate clients. “Prior to the crisis, corporate strategies were focused on yield. Now, liquidity and risk are paramount, although yield is still an extremely high priority. Organisations are increasingly focused on opportunities to optimise working capital and extract liquidity otherwise trapped internally within the cash conversion cycle.”
Pooling, either notional or actual, and interest optimisation across one or many currencies are seen as the ‘low hanging fruit’ in this area, given the speed with which improvements can be implemented. Pursuant to local regulations, some enterprise resource planning (ERP) systems are now available with pooling functionality. Previously, this service was predominantly provided by banks.
“In looking at higher-complexity working capital management practices, corporates are now less draconian in their payment terms for suppliers,” explains Gupte. “At the height of the crisis, the general practice was to impose lengthy terms to generate liquidity. Today, corporates are keenly focused on injecting liquidity into their supply chains through supplier or receivables finance without diluting (or potentially even improving) their days payable outstanding (DPO) or days sales outstanding (DSO). In the present environment of early economic recovery, corporates are again viewing suppliers more as strategic partners with which win-win payment scenarios such as the previously mentioned can be developed.”
This development within the financial supply chain of large corporates trying to protect their suppliers from the credit squeeze by paying early is particularly interesting, as the corporates are stepping into the role that bank’s usually have. To all intents and purposes, they are becoming the credit manager for SMEs, taking this power from banks. Is this a permanent change, or just a temporary one? Most likely it is not a permanent position for these large corporates to be in, although it is certainly sustainable until the banks get their act together and make credit available at more favourable terms.
Another credit-related issue to watch over the next 18 months is a rather sensitive topic to some. After the various government bank bail-outs around the world, many banks are now state-owned. Is subtle pressure being applied by governments for these banks to only supply credit to indigenous companies, or at least give them more favourable rates of credit? While this doesn’t appear to be an official policy of any government, it is something that some corporates suspect or are at least wary of. If governments were to lean on banks in this way, there’s a real danger of isolationism in credit management.
The fall-out from the credit crisis has caused a fundamental shift in how corporates interact with banks and manage their cash. As bank credit has become scarcer and more costly, treasurers have had to look to their own working capital management as a way of providing liquidity throughout the organisation.
In order to successfully operate a payments factory, treasury needs to have full visibility of cash throughout the business units of the organisation. This starts with accurate and timely cash forecasting, which then informs the treasury of the optimal time to implement cash management strategies such as netting and pooling. To gain this visibility, treasury technology offers many options, but it is also relies on the treasury department educating the business units that they deal with as to the benefits of providing accurate information in good time.
While corporates are hard at work trying to gain greater visibility over their cash, banks are facing equally complicated challenges. Regulatory changes from even before the credit crisis are removing access to banks from some areas that were previously profitable. Banks are now finding that they have to re-invest in their payment infrastructure in order to stand out in an increasingly competitive market for corporate business. Meanwhile, additional regulations that are being drawn up as a result of the credit crisis look set to have an even greater effect on the way that banks interact with their corporate clients. Transaction banking is evolving, and it hasn’t reached the end of this process yet.