Utilities: Rethinking operations in financial services

European banks’ return on equity (ROE), a key measure of profitability, is likely to average less than half their cost of capital again this year. This lags well behind their US rivals as lenders struggle with high costs and weak economic growth, according to the latest European Banking Barometer report from EY.

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Date published
October 12, 2015 Categories

The pressures on ROE – combined with tighter and costly regulations, increased capital requirements, higher operating costs and reducing returns – are the major challenges facing European financial services organisations.

In order to manage these challenges and remain competitive, financial services companies need new operating options. As part of their journey towards a leaner, more agile future, we are seeing the sector undergo widespread business restructuring. This includes the selling or buying of assets, as well as forming partnerships or joint ventures with like-minded groups or even competitors. The idea is to reduce operating costs and improve efficiency.

Financial services operators must reduce costs and improve efficiency to improve ROE and bolster balance sheets. The ‘low-hanging fruit’ of internally-driven outsourcing and personnel costs has already been leveraged by these organisations. The next step towards improving efficiency, rationalising processes and technologies will come from mutualising back office functions.

We are seeing significant interest from banks seeking to create utilities in order to service costly and administration-heavy tasks, including servicing post-trade processes, know your customer (KYC), reference data and reconciliations. Size adds complexity to existing technology, operations and infrastructure environments, so unbundling from legacy systems to use an external utility model is not without its challenges.

Nonetheless, established financial services providers are essential candidates for adopting utility models. However, the candidates for whom utilities are best-suited are the new challenger banks and financial services providers launching digital-only services. These challenger entrants do not carry the baggage that legacy apps and infrastructure bring, making the move to a utility model financially easier as well as physically easier.

Back to basics

Banking utilities come in many different shapes, ranging from pseudo utilities that comprise a single platform to support a single customer bank to full-blown industry-wide utilities such as secure financial messaging provider SWIFT. Most recently, three banks – Goldman Sachs, JP Morgan and Morgan Stanley – created a company that will clean reams of reference data at a lower cost than they would otherwise spend individually.

With any utility in financial services, there are significant considerations and obstacles that need to be overcome:

Additionally, there are several technical and functional challenges to consider:

Financial services organisations need to think about the segmentation, targeting and positioning of the utility. Each should allow the participants to have an equal voice in the roadmap, while retaining the core functionalities that will support the majority of the industry’s requirements.

With operators such as banks demanding over 50% savings on existing process spending, it is critical to focus on the innovations impacting
all the elements of the utility such as process automation, self-service portals, creation of thin-trades, open technology platforms for regulatory reporting, and several others.

Looking ahead, the growth of industry utilities will unshackle financial services companies from the burden of performing several non-core activities. Instead, they can focus more on higher-value core differentiators. Doing so will allow them to possibly operate more like hedge funds. Their focus would then be on pure business-generating activities such as sales, marketing and relationship management. This means a focus on bank-specific pricing, risk management and value-add services.

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