Consolidation has been a central theme in treasury over the course of the last decade. Many large banks and multinational financial institutions have invested a dizzying amount of time and resource into deploying powerful management solutions and developing a range of seamless, vertically integrated processes in order to better manage cash, investment, FX and make smarter strategic decisions. But unfortunately for many banks, the investment required in order to centralise treasury function in this way isn’t always readily available.
According to PwC’s Global Corporate Treasury Benchmarking Survey 2017, an overwhelming majority of treasury departments continue to be overstretched despite the ever-expanding nature of their remit. That’s why 67% of professionals responsible for carrying out various treasury functions on a daily basis don’t even report directly to their company’s treasurer – and it’s also why an increasing number of financial institutions are now opting to outsource essential back office and payment factory processes to simplify and streamline their otherwise fragmented treasury departments.
The concept of outsourcing has been around for centuries. Adam Smith is widely credited with developing the idea as part of his ‘competitive advantage theory’, and over the course of the twentieth century manufacturing industries transformed outsourcing from a loose economic theory into their core growth strategy.
So, what exactly is outsourcing? Simply put, outsourcing is the process by which an organisation delegates some of its in-house operations or processes to a third party. While in contract, ownership or control of those processes generally remain with the parent company, while third parties are responsible for carrying out and reporting on the predefined tasks.
There are several types of outsourcing that have become incredibly commonplace.
First and foremost is IT outsourcing (ITO), which involves an external service provider being given responsibility for managing specific applications for a financial institution. Server management and infrastructure solutions, network administration, isolated cloud centres and software development are the most common functions to be outsourced, and ITO is typically implemented to save banks time and money while introducing flexibility in terms of data storage, product offerings and speed of service.
Another common type of outsourcing is business process outsourcing (BPO). This is an established methodology for slashing inefficient internal operation processes and instead involving a third party to manage an entire business process like accounting, finance, customer service or HR. BPO offers a compelling business value proposition in terms of gaining operational efficiency and reducing costs, and is independent of economic cycles. That being said, because BPO sees organisations handover day-to-day maintenance of fundamental business processes, it’s not a decision FIs make lightly.
Finally, an emerging trend in outsourcing amongst financial institutions is the relatively new concept of ‘full-fledged product outsourcing’. According to researchers at PwC, this third form of outsourcing in the banking sector is starting to gain traction in Europe and sees financial institutions enter into partnership agreements with BaFin-licensed and regulated fintechs to take on vast swathes of a bank’s value chain. In many cases, full-fledged product outsourcing hands product development, operations, compliance, regulatory infrastructure and IT over to a third-party – while the bank retains ownership of said tasks and instead focuses its time on customer interface and its balance sheet.
This new bank outsourcing trend enables FIs to gain a competitive edge and establish lean and flexible operations across the value chain to deliver products and services faster and cheaper than ever before. That being said, each form of outsourcing comes hand-in-hand with its own set of advantages and disadvantages across the banking sector.
At its core, outsourcing makes perfect sense for any organisation struggling to carry out processes internally with existing time, money or skillsets. Yet while cost and time used to be the primary reason for outsourcing non-strategic functions like payroll or logistics, a surge in technological innovation and a fresh crop of enterprising fintechs have given FIs a wide range of new opportunities and reasons to outsource bigger and more important treasury functions.
Generally speaking, outsourcing enables organisations to improve operational performance, vastly improve speed, reduce operational risk and increase efficiency through better consolidating and centralising functions. Banks that strive to keep everything in-house typically end up developing a series of vertically integrated silos that result in extensive duplication and redundancy across businesses and markets.
Not only do these duplicated structures and inflexible services generate needlessly high costs, but they also reduce flexibility and damage quality of service through blatant inconsistencies. That’s why banks should be avoiding these silo traps at all costs – and there are some key strategic advantages FIs can expect to gain by steering away from this model and turning to outsourcing instead.
Outsourcing often ensures institutions are getting improved delivery access to world-class skills, extraordinarily faster project start-up and benchmarking information about other FIs to enhance reporting and strategic decision-making. By leveraging that specialisation with greater economies of scale, third-party providers can subsequently offer banks lower costs that increase their competitive advantage.
Yet above all else, the key benefit of outsourcing for banks is unprecedented and affordable access to cutting-edge technology. According to a joint study by PwC and fintech company builder finleap, an increasing number of banks are now looking to outsource key treasury processes in order to prevent fast-rising fintechs from displacing them. That’s why 88% of banks now say they have concrete strategic plans to foster co-operations with fintechs, and 90% of banks with existing outsourcing partnerships say they’re satisfied with current co-operative arrangements.
The move makes perfect sense. After all, by co-operating rather than competing with innovative fintechs, FIs are effectively killing two birds with one stone.
Not only do the banks gain flexibility, cut costs and deliver better products by outsourcing to fintechs, but they’re also consolidating existing competitive advantages across key financial markets. Third-party vendors are left to make extensive investments in technology, methodology and people, while leaner banks are free to focus their resources on better meeting customers’ needs – simultaneously shedding that old-fashioned image seen by treasury as archaic institutions with too much red tape and duplication.
That being said, it’s worth pointing out the decision to outsource core treasury functions and business processes does not come without a certain degree of risk, too. Although outsourcing in the banking sector is incredibly simple in theory, it can also be difficult to execute without exercising a certain degree of caution.
Short-sighted outsourcing deals often wreak havoc on a bank’s reputation or delivery of service if the economic benefits of a deal have been overestimated or the parties have failed to establish an appropriate baseline for pricing and tracking. Likewise, banks have been known to fall flat after completing fixed-term outsourcing partnerships because they’re not still actually prepared to manage the transition and post-deal processes in-house.
As a result, banks must tread carefully indeed before entering into any sort of outsourcing agreement with a third-party provider. Organisations need to carry out extensive research and due diligence before selecting the right partner, negotiate terms and change management, consider timeframes and organise adequate exit and contingency policies in order to mitigate unforeseen risk.
Which services are outsourced in banking?
Financial institutions are constantly being pushed to re-examine their core functions in order to deliver better value for investors. This constant drive to re-evaluate and become more flexible has led to an inherent erosion between what’s considered a core and non-core function – paving the way for a range of new outsourcing opportunities along the way. Fortunately, dynamic treasury management solutions have enabled FIs to both centralise and outsource a variety of processes and services without losing ownership of those functions.
In terms of treasury functions, banks are increasingly outsourcing a range of typical transactional activities. The coordination of trade confirmations is particularly simple for FIs to outsource alongside reconciling securities and account statements, realising financial transactions and settlement. That being said, strictly speaking any aspect of corporate treasury can be outsourced – from the operation of netting systems and cash flow forecasting, to liquidity management, back office accounting and loan management.
Cash management is often one of the first processes to be outsourced, as fintechs and larger organisations normally have the ability to process more transactions quicker, enabling banks to speed up the process and optimise their cash. The processing of bank statements, scheduling and payments are also commonly being outsourced – lending way for a new dynamic of third-party bank account management that includes opening and closing accounts, document management, and administration of powers of attorney.
At the end of the day, the processes, functions and services a bank chooses to outsource aren’t limited in scope by opportunity or choice. Enterprising fintechs and major incumbent financial services providers are now capable and totally equipped to handle full-fledged outsourcing partnerships with banks. Yet in an era of increasing regulatory convergence and wariness over trust and control in the financial sector, banks must also tread carefully.
An extensive amount of due diligence and strategic decision-making must go into any shared service agreement or outsourcing partnership. That being said, and despite the apparent risk, the overwhelming benefits of outsourcing in the banking sector simply cannot be understated. By outsourcing treasury functions, FIs can become leaner, more flexible and offer better value to both shareholders and customers alike.