Building tomorrow’s banks today (Part 1 of 3)
New ways of working to reduce costs and increase operational efficiency
Banks’ back office costs are out of line with today’s revenues. In tackling the issue, banks need to look at new ways of solving some of the industry's oldest problems says Angus Scott, Euroclear’s Head of Product Strategy and Innovation.
After several years of balance sheet shrinkage, banks face a moment of truth. Despite a mass withdrawal from unprofitable or capital-intensive business lines, returns remain stubbornly low.
According to Coalition, a financial analytics and consulting firm, the top investment banks achieved a return on equity of just 6.7% last year. Compare that with a cost of capital in double figures and a sense of the problem starts to emerge.
New economic reality
Waiting for these trends to reverse is not an option. As a recent paper by Morgan Stanley and Oliver Wyman predicts: ‘Many banks will fail to meet their cost of capital in the next two years, especially in Europe ... Despite removing $4trn to $5trn of balance sheet, a similar amount of risk-weighted assets and $20bn of cost since 2010, there is still too much capacity relative to the forward-looking client revenue opportunity.’
To compound this, regulation is pushing up the costs of capital and collateral.
Against this backdrop, many banks are stuck with back offices built for a pre-crisis world that relied heavily on steady product and revenue growth. Before 2008, the emphasis was on promoting and selling new products.
The idea was simple: get the revenues and the ‘factory’ could take care of itself. In today’s world, those factory costs need pruning and the industry needs an operating model in line with the economic reality.
The need to cut costs
This is spelled out in the Morgan Stanley/Oliver Wyman paper. For all the cost-cutting of recent years, it says, ‘infrastructure costs have stayed resolute ... success over the next two to three years will hinge on banks being able to overhaul their infrastructure cost base and respond to new technologies.’ Up to 20% of infrastructure costs, or around $15bn, could be released, it suggests.
At Euroclear, we believe that doing this successfully requires a new approach.
Much of the cost cutting to date has had limited impact. Consider offshoring. Savings on labour and premises have often come at the cost of increased complexity. Tasks have been broken up rather than unified.
Expertise built up over years has often been lost and turnover within the offshore operation can be high. Direct costs may fall but indirect costs often rise.
STP: A panacea for all?
Straight-Through Processing (STP) is often viewed as the panacea – and it can be. Many trading activities have been successfully automated.
But there are always breaks to deal with.
The more a firm automates and the leaner it gets, the more sensitive it becomes to exceptions. There is a magnification effect when there are too few people on tap to swallow up a problem effortlessly.
Time for a new approach
The low-hanging fruit has been picked, and much of what is left has so far been difficult to fix. People trumpet STP rates of 97% or 98% but they rarely mention the cost of dealing with the other 2% to 3%.
The breaks are often down to data protocols and too expensive to resolve. What’s more, many systems are duplicated and there are vertical silos with major differences between markets, geographies and instruments.
And on top of all this, there is a regulatory agenda that takes precedence over rationalisation and re-engineering. MiFID II, Basel III, EMIR, TARGET2-Securities – the impact is cumulative, the deadlines tight and the required investment deep.
Breaking out of this straitjacket requires fortitude and creativity in equal measure, and taking a new look at solving some of the most persistent problems back offices face.
About the author
Angus Scott has over twenty years experience in capital markets infrastructure and securities services, specialising in strategy and strategic change management.
As Head of Product Strategy and Innovation at Euroclear Group, he is responsible for creating and delivering a portfolio of new, commercially viable product opportunities that support Euroclear's strategic agenda.