Market change is being thrust upon transaction banks at a pace so rapid that many struggle to adapt. Competition has spiked. Profitability has tanked. Compliance with regulation is suffocating investment. The era of open banking is here, threatening traditional business models. Many institutions find themselves struggling to meet the imperative to innovate, reinvent and survive.
Digital banking represents one path forward where a multitude of possibilities exist for generating new sources of value creation. But any actions to renew the business model without also overhauling the operating model will likely fall short.
Traditional bank operating model: part of the problem
Today’s operating infrastructure – comprising people, process and systems – is driven by a service model reliant upon burgeoning “middle office” operations teams who struggle with disjointed legacy infrastructure to on-board and support clients. This cumbersome and expensive operating model siphons increasingly scarce profits, and erodes market share in favour of more nimble and less burdened challenger banks, global behemoths (e.g. FANG) and fintechs.
The arduous account opening process best exemplifies the flawed model. For many banks setting up new operating accounts, including cash concentration account structures, is a time-consuming manual process that requires weeks to months to complete. The process is often accompanied with new requests of existing clients for the same (but now stale) KYC and UBO documentation thereby promoting deep client dissatisfaction. The inefficiency of the account opening process is costing banks clients. According to a recent Thomson Reuters KYC compliance survey of 1,000 non-financial corporations, 12% reported changing banks in the past year because of KYC issues, a number that even rises to 20% in Singapore.
In today’s market banks are in no position to lose even a single client. Competition is fierce for the final frontier in high-margin revenue: Transactional FX business. Traditional sources of revenue in what has long been known as the “payments business” have been utterly decimated by globalisation and liberalisation of markets. The disappearance of float revenue on balances and the increasingly loss-leading cross-border payments products (those without an FX component like Sepa) are the new norm.
Exacerbating profitability challenges and threatening existing business models are initiatives like open banking (e.g. PSD2). As non-banks accelerate their account information provision services (e.g. AISP), yet another source of revenue is threatened as commercial and corporate clients will have new alternatives to bank channel services. At the same time, the ever-increasing costs of market infrastructure participation (i.e. compliance and instant payments) continues unabated. Total comparative and competitive disadvantage awaits many banks. A wholesale change in thinking and action by financial institutions is needed.
Virtual account management (VAM) offers transaction banks a means to reinvent the operating model that for many has become unsustainable from a competitive and cost perspective. Global Tier-1 banks have recognised this and adopted VAM technology. But the benefits are available to institutions of all sises, including those without the same infrastructure, resources and network. VAM represents a fundamental transformation in the operating and service model to support commercial and corporate banking business.
VAM: An example of first-principles design thinking
In 2011 the authors of this article invented the product strategy behind virtual account management. Using a first-principles design approach, instead of viewing the servicing of corporate cash management from the perspective of a bank’s traditional operating infrastructure, VAM would offer an entire set of global corporate cash and liquidity management solutions on the basis of self-service. This approach took a very different view of “virtual accounts,” which for decades had been more commonly known as reference accounts in core banking platforms. Instead of using virtual accounts to merely enhance reconciliation reporting, they are being used to usher in a wholesale shift in digital banking.
In a transaction banking context, traditional channel or Internet banking services have been largely limited to customer data management, payment order capture and account information provision. VAM completely expands the nature and scope of digital banking by providing clients with the platform and functionalities to manage their multi-bank global cash and liquidity on a self-service basis.
All VAM propositions are empowered by a client’s ability to create and structure virtual accounts to support their business requirements – with or without bank treasury consulting services. Prior to VAM many corporates – except those with the resources to invest in best-in-class TMS or ERP in-house (IHB) bank solutions – had no option but to open physical accounts to manage working capital (e.g. business unit funding, cash concentration) and financial control (e.g. segregation of duty, payroll confidentiality, reporting). To clients this resulted in greater account and transaction fees as the finance director (FD) moved cash across operating accounts as well as the account administration headaches of signatory management (e.g. FATCA) and multiple KYC submissions.
A look at the account model of a typical legal entity before and after rationalisation using virtual accounts under VAM illustrates how VAM works:
Figure 1: Single entity account structure before and after VAM rationlisation
Figure 1 illustrates how VAM rationalises the operating account landscape of a typical legal entity to one per functional currency. At the same time, this is achieved without any functional loss to business operations since the VAM platform supports every functionality associated with a physical current account (i.e. payment and collection processing, balance and transaction reporting and overdraft control). In fact, the VAM platform provides even greater financial control through user access, transaction authorisation and limit management controls defined by the client itself. Moreover, because there is only one account which holds balances that were previously dispersed (i.e. trapped) across multiple accounts, FDs can make working capital available across BUs without book transfers (for accounts at the same bank) or ACH transactions. In addition, any redundant overdraft facilities are eliminated.
The multi-entity group corporate face the same and greater challenges due to its fractured bank and account landscape. This includes difficulty or inability to obtain real-time cash visibility across group accounts, inefficient working capital management due to trapped cash and the need for layers of concentration accounts and physical cash movements to consolidate control of the corporate asset. All of which results in misallocation of capital due to operating inefficiencies and elevated banking fees associated with maintaining excess bank relationships at the local subsidiary level.
Figure 2: Group treasury simplified account structure before and after VAM rationalisation
Figure 2 illustrates how the account rationalisation under VAM advances the drive towards optimisation available under in-house banking. Within the VAM virtual account framework a group treasury can maintain one physical account per functional currency but self-manage its IHB operating accounts for each participating legal entity, who in turn create and structure IHB virtual accounts to support their business units. Under VAM a group treasury achieves real-time consolidated cash visibility in one physical account while at the same time delivering related-party (i.e. intercompany) balance segregation and reporting, financial control and transaction operations (factories), multi-lateral netting, group-wide limit management and intercompany lending. And all managed with minimal involvement of bank operations team.
Success factors in a VAM initiative
The ultimate scope of treasury propositions that a VAM host bank might offer will depend upon three critical factors:
- The functional breadth of the VAM market solution a bank purchases;
- The VAM host bank’s level of expertise in global cash and liquidity management;
- The degree to which the VAM host bank truly understands the business of its client base.
It is the last of these where the greatest challenge exists for many institutions. Transaction bank products are typically trapped in silo-based systems that are often not integrated, which coincidentally is a key value driver of VAM as an aggregator of information. And bank’s sales forces tend to be specialised by product. But in today’s market, clients want solutions, not products. Successful enterprises – banks or otherwise – are those who understand the pains associated with their buyer’s business and have a relevant, cost-effective and sustainable solution (i.e. set of integrated products) to ameliorate it.
In conclusion, VAM introduces to the transaction bank the means by which to expand its digital offering. VAM is a supporting channel platform that offers a broad set solutions in a manner that slashes the costs to support a global cash management business. By vastly reducing the resource-intensive operating infrastructure required under today’s traditional operating and service model VAM introduces new sources of revenue from business propositions that were previously available only to global tier-1 banks and multi-national corporations with great resources. It achieves this at a vastly lower cost thanks to the self-service underpinned by account rationalisation.
More reading: How to chose the ideal cash management software solution