DIGITAL TRANSFORMATION OF THE BANKING INDUSTRY, Part 3

  (Source: East Japan Railway Company)

Leverage Digital Technology

In the banking sector, players should strive to become trailblazing purveyors of financial services that leverage digital technology.

There are areas in the banking services value chain where firms should work independently to generate unique, in-house, high-value-added services and products; there are also areas where banks stand to benefit by collaborating with other firms to drive down costs. Also, firms should consider collaborating with other firms to leverage economies of scale and economies of scope, parlaying cost centers into new profit centers, and securing a role in the industry infrastructure.

In actual operation, after deliberating and implementing such initiatives, big-data analytics and the automation of all processes will prove the most important. Here as well, a shift to a modular supply structure will be required, and a critical factor in determining the success of financial institution management will be alliances — namely, how adroitly firms partner with other entities.

In Conclusion

Celent offers the three points below as food for thought and policy prescriptions for modernization in the banking industry.

1. Technology as a driver of growth:

  • Look for ways to pioneer new segments through the use of technology without fixating on the segments that have been your bread and butter up to this point.
  • For example, robo-advisors can be used not only for mutual fund but also for insurance products sales to retail customers. Bancassurance and alternative distribution channels should also be driven by robo-advisors.

2. Vertical disintegration:

  • Prioritize finding the sweet spot for cost and risk and revisit and rethink your processes (such as vertical integration and/or internalization, and the use of horizontal division of labor and/or outsourcing) across the board.
  • For example, enhancing the agility of new payment product research and development might be achieved by vertical disintegration of banking business into payment services discovery, development, and marketing organizations.

3. Industry-wide priorities:

  • Place top priority on initiatives to raise financial and IT literacy among customers.
  • Actively seek to leverage monetary policy and system reform as business opportunities; avoid a passive approach to system reform.
  • Rebuild the industry value chain through methods of modularization, specialization, and integration.

Legacy modernization in the banking industry is much more than simply the application of novel technology. Rather, it portends nothing less than a structural overhaul of the banking industry, an opportunity to envisage anew and redefine the industry’s future. There can be no doubt that this transcends the mere establishment of a digital channel; rather it will certainly impact products, services, IT units, and sourcing models, and, in so doing, provide the banking service providers of the future a chance to seriously consider exactly what kind of companies they would like to be and the corporate cultures they would like to foster.

Celent perceives legacy modernization in the banking industry as instigating change at a fundamental level, in both business execution and organizational structure. Moreover, this transformation promises to have legs and vast implications that will play out over the long haul. Legacy modernization is much more than just new technology and it will have sweeping implications.

 

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Related releases:

Legacy Modernization in the Japanese Banking Industry, Part 1

Legacy Modernization in the Japanese Banking Industry, Part 2

 

Back Office Outsourcing by Buy Side Firms

In the last few years buy side firms have had to make lot of changes in their mid and back offices. There are primarily two drivers that have forced firms to make these changes. Leading up to 2007, the economic climate was favorable, and profits were rising, which meant technology budgets were also on the rise. Many firms made technology investments on an ad-hoc, or as per need, basis. Since the front office trading departments are primary revenue generators in trading firms, the technology decisions were largely determined by front office staff based on their immediate needs for certain asset class or execution methods. The mid and back office activities were largely ignored and continued to be run by legacy systems. The crisis of 2008 changed firms’ priorities dramatically. Revenues dwindled and margins were hit. In tumultuous economic climate managing costs became an utmost priority. While downsizing enabled cost cutting in the short run, firms had to consider long term cost savings opportunities by improving operational efficiency and making strategic technology decisions. Against this backdrop the mid-back office was ripe for attention. Many institutions still use legacy systems. Most of them are based on simple excels, offline communication, and handled manually without much automation. There is little integration in the mid-back office of the disparate platforms used in the front office. These create huge operational inefficiencies, and if not addressed adequately, can diminish or even nullify the efficiency gains achieved in the execution of trades. In the aftermath of the financial crisis, the regulatory environment has undergone rapid changes and is still evolving. This has created additional obligations for mid-back office processes in the areas of risk management, reporting and regulatory compliance. It has become essential that firms address the complete trade cycle in a much more holistic way, and are on top of their processes almost on a real time basis to be able to adequately address regulatory and business needs. These two drivers are often conflicting with each other. In the short term, firms have to prioritize technology investments to address regulatory and compliance related issues. Large numbers of impending regulations and a finite technology budget have meant most of the spending is being made to meet regulatory issues, which leaves little room to invest in projects on efficiency and process improvement. Some firms have mentioned to us as much as 60% to 80% of their change management budget is being spent on regulatory and compliance related issues. In this backdrop, outsourcing of mid-back office processes by buy-side institutions is becoming popular. Since almost all of them have to make same, or similar, arrangements to adhere to regulators’ demands, there is good potential for the development of shared utility services whereby firms can outsource some or all of their back office functions to a third party service provider. While the trend of outsourcing in back office function is not new to the industry, this practice is gaining greater traction as buy-side firms realize the complexities of reconciling higher volumes of more complex trades – this is increasing the strain on staff and IT. At the same time, service providers have improved their capabilities and now offer a wide variety of choice for their buy-side clients. Custodian banks are seeing a surge of interest in their outsourcing services from buy-side firms. Increasingly custodians are finding that clients are asking for solutions specifically to deal with the new derivatives regulations. The concentration of flow driven by outsourcing is likely to accelerate within derivatives operations. However, we expect the trend will eventually affect cash securities operations as buy-side look to rationalize their back office functions. Through outsourcing services, investment manager will move fixed cost into variable ones and decrease the complexity of their back office operations. This evolution will be particularly acute in derivatives operations due to the complexity of dealing with the new regulatory regime, DFA and EMIR. Prime brokers will be able to leverage their back office capabilities to insource additional flow, especially around derivatives operations. While there are similarities in the mid-back office functions and processes at global institutions, large banks also need significant customization to manage firm specific needs. The challenge in developing a utility based service model is to design a common platform that will still have room for addressing custom needs. Many providers are considering of coming up with such an offering. There is a race to accomplish this at the earliest as they understand that the first one to offer it would have a big advantage over others.

Outsourcing in Wealth Management: A Growing Trend

Outsourcing has been in use in the financial services industry for quite some time, at least for a couple of decades. However, wealth management firms have lagged the financial services industry in adopting outsourcing, primarily due to issues relating to privacy, data security, and loss of control. Many of them did not invest in technology from a strategic point of view for a long time, instead taking a siloed approach depending on specific business needs. The global financial crisis has contributed to a major paradigm shift in this regard. The crisis has significantly impacted both revenue and costs. Lacklustre market conditions have prevented them from generating superior returns impacting top line; this has been exacerbated by loss of clients, who, driven by disappointing returns and loss of trust, have looked away from their advisors or looked to diversify wealth management relationships. At the same time increasing regulatory pressures and newer regulations have compelled wealth managers to grapple with newer challenges in terms of control, compliance, risk management and streamlining operations. In this evolving environment wealth managers have slowly started to wake up and embrace technology and operations outsourcing as one of the solutions to meet the challenges. Cost cutting remains the primary driver behind adoption of outsourcing, which typically can save 20% to 30% of costs over a 3 to 5 year period. Secondly, outsourcing also offers easy scalability options; this is more relevant now as firms are either cutting down or closing operations in certain markets, while looking to expand in others – all in a short period of time. Time to market has therefore become critical. Data management, especially in large organizations offering multiple services, is another aspect that firms are looking to outsource. Along with benefits, there are a number of areas for concern with outsourcing. The most important of them is loss of control and security, both of great importance to wealth managers. Data privacy and data hosting constraints continue to be key concerns; violations in this area can be harmful for wealth managers’ brand image, which somewhat limits the universe of functionalities that wealth managers are comfortable to outsource. Another concern is around fiduciary responsibility and compliance and operational risk. Since the firm is responsible for regulatory compliance for all operations, including the ones outsourced, there is an increased need for easily accessing data and information for enhanced control and client and enterprise reporting. Firms will need to demonstrate their ability to provide the information requested by both clients and the regulatory authorities on-demand and in formats for consumption tailored to the individual’s preferences. Over time the industry has evolved a set of norms to overcome the concerns related to outsourcing. Extent of outsourcing adoption varies by region, the US being far ahead of Europe, while Asia lags the other two regions by some distance. Adoption also depends on the size and nature of wealth management firms. While Tier I and Tier II retail banks, insurance companies and brokerages have outsourced significantly, adoption of outsourcing remains moderate in smaller sized firms, especially in trust companies and family offices. In terms of functionalities, the further a wealth management function is from a client “touch point,” the more likely it is to be outsourced. Therefore, mid and back office functionalities are more likely to be outsourced. Outsourcing in the areas of global custody, securities lending, client servicing, and accounting and settlement of trades in is relatively widespread. Front office functionalities have been outsourced less; while some firms are slowly outsourcing their client on boarding or financial planning functions, outsourcing in the areas of product development, marketing, and fraud management is still limited. Outsourcing in the wealth management industry is likely to see further adoption in the near future. This will be mainly driven by firms in the US and Europe. Outsourcing practices in wealth management is still not as mature as those in other parts of the financial services industry and wealth management firms are starting to realize its benefits. In addition, existing market conditions as well as external factors like regulation will drive the growth in outsourcing business. IT budgets are expected to remain flat or decline in most markets. This will restrict firms’ ability to spend on technology. However, this also means firms will now have to do more with less and channel investments efficiently. Outsourcing provides one option for increasing efficiency without needing significant investments in infrastructure. Tier II and tier III firms will embrace outsourcing following the lead of tier I firms. While IT outsourcing has been the dominant part of outsourcing practices till now, process outsourcing is likely to gain more traction in future.

Indian Banks Migrating From Self-Service Model to Outsource Model in ATM Space

There was a time when banks wanted to have control of all the activities, especially those that involved the new technology; right from identification, deployment, installation, ownership and management. As time passed by, banks realized that all this took a significant bandwidth in order to have a dedicated team that did not justify the productivity and costs so involved. During this time, Reserve Bank of India allowed banks to partner with third party vendors to outsource certain technology completely even without prior approval from the central bank. Banks in India are increasingly migrating from self-service model to outsource model to achieve cost savings, increase the convenience for customers thereby banks can focus on core banking business. From banks perspective, there is better efficiency in ATMs if outsourced to third parties. Apart from this, it also helps to standardize the systems and process across locations. Another benefit of such model for banks is that the service charges incurred from such outsourcing can go under operational expenses in banks books as opposed to the assets in self – service model. ATMs in India are now in outsourcing phase, where banks are thinking on outsourcing ATM related deployment and maintenance to third party vendors. Banks like HDFC bank, ICICI bank and AXIS bank have already outsourced their ATM management and maintenance to third party vendors. And several others want to try out in bits and pieces before outsourcing the entire process. At present, 20,000 ATMs in the country are maintained by third party vendors like AGS Transact Technologies, Financial Software & Systems, Tata Communications, Euronet, Fidelity National Information Services, Prizm Payments and First Data. Apart from this there are also ATM equipment manufacturers like NCR, Diebold and Wincor Nixdorf who also cater to end-to-end solution needs in the ATM space.

Outsourcing in Indian Life Insurance Market

India’s domestic outsourcing market is gaining momentum. Most outsourcing service providers are turning inwards both to diversify risks and partake of the growing opportunity on home ground. Focus is now shifting from telecommunications and technology outsourcing to financial services outsourcing in the country. Of these, the Insurance BPO services market is expected to grow to USD 1.5 billion in size in the next three years- a substantial increase over its current USD 720 million size.Interesting to note here is that unlike their European & North American peers, Indian carriers are not driven by cost compulsions but rather are challenged by volume and manpower constraints resulting in the built-up of a favorable disposition towards outsourcing (See Image).

Carriers see vendors as partners providing best in breed knowledge and performance to enable them to focus on their growth objectives. Indian vendors and multinational vendors have only recently started catering to the outsourcing needs of the domestic market. With the increasing incidence of outsourcing in insurance sector, critical manpower base and know how specific to the Indian geography are also evolving at the vendor end. More firms are likely to realize profitability once the market acquires sufficient breadth and depth.

Celent recently published ‘Outsourcing Trends in Indian Life Insurance’ which captures the key issues and trends in the domain.