Cash management poll results: The big two pull ahead of the field
THE CASH MANAGEMENT and payments business doesn’t have to worry about adjusting to trends that reverse every six months, although it might well wish that was the challenge it had to face. Its own key trends are daunting: increasingly demanding clients, intense competition, the unravelling of the payments process, technological innovation and regulatory pressure. And these trends always point towards the same thing: lower margins.
The need for scale in the struggle against declining margins is set to intensify as the European Union’s plans for a Single Euro Payments Area (Sepa) bear down on the sector. The Sepa project aims to create a domestic payments market across the eurozone, eliminating the difference in price between domestic and cross-border payments and enabling companies and individuals to use one bank account to make payments anywhere in the eurozone.
It has been described as the largest project the European banking industry has ever undertaken. Set to launch in January 2008, when banks are expected to offer new euro payment services to their clients, and due for completion in 2010, Sepa’s impact could reduce banks’ direct payments revenue, which typically accounts for as much as a third of most of their revenues, by 30% to 60% below expected 2010 levels. The impact, calculated by ABN Amro, Capgemini, and the European Financial Management and Marketing Association, amounts to €13 billion to €29 billion.
“We’ve been re-engineering our model for a number of years,” says Andrew England, head of product management at Deutsche Bank, which comes third globally in this year’s Euromoney cash management poll. “We’ve been collapsing operations areas into hubs, deploying a common technology platform and sourcing operators from low-cost centres. We’ve invested a lot into rationalizing our systems but Sepa takes us up another level in terms of pressure on revenues and costs.”
The huge impact of Sepa on the payments business might require banks to lower the cost base of their payments businesses by 50% or more just to maintain profitability. The substantial amount of investment required means that few banks will be able to do this. According to Boston Consulting Group, the average European bank already plans to invest $80 million to $120 million on its payments business over the next five years just to cover the basics, with up to a third of the amount solely attributable to meeting the cost of complying with laws and regulations. Bankers are unanimous that the economics of the business has now come to the point where banks will be forced to rethink their strategies. Some, they say, will be forced to almost completely abandon the business. More consolidation of some sort in the payments business, most likely through partnerships and outsourcing, is inevitable.
This September, Citigroup and Lloyds TSB, the fifth-biggest UK bank, agreed a partnership deal in payments and cash management services. Under the deal, Citigroup will use Lloyds’ branch network and domestic payments system to help serve the UK needs of its multinational corporate clients. Lloyds will use Citigroup’s international systems for its UK corporate clients.
Adding domestic flows “The Lloyds TSB deal is part of our European strategy,” says Naveed Sultan, head of EMEA cash management at Citigroup, which came first overall in the poll. “We’re repositioning our business so as to be able to participate in domestic flows to complement our strong position in cross-border flows and international cash management.
“Before the euro we positioned our business to concentrate on cross-border flows and on providing primarily overlay and international cash management services for our multinational clients. The emerging reality of a single market, however, has created a competitive imperative for us to be able to offer domestic capabilities as well as cross-border ones. Our large clients, who are looking for the next level of efficiency, now expect us to also start providing domestic services in each of the countries they operate in so they can consolidate their banking relationships with fewer providers.”
Partnerships of this type are among the strategic options that a number of banks with relatively strong domestic volumes, such as Lloyds, are considering, but many will have to go further and outsource at least parts of their businesses.
“The market is becoming more and more competitive,” says Nick Viner, a payments expert at Boston Consulting Group. “There is more and more pressure on prices and it’s a tough market for people to play in. We are seeing more active conversations about partnerships as banks are being forced to make choices.”
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“With the level of pricing pressure in the market, consolidation should accelerate” Ann Cairns, ABN Amro |
Even Deutsche Bank, one of the handful of global cash management providers, has chosen to outsource its low-value domestic payments processing to rival Postbank, to lower costs and focus on higher-margin parts of the cash management business. In cash management speak, Deutsche’s strategy is to separate its “distribution” from its “manufacturing”.
Barclays has chosen to focus on its domestic payments business but in 2004 struck alliances and reached white-labelling deals with Deutsche Bank for pan-European business and ABN Amro for trade.
“Those banks that decide they are too small to stay in the game and who are looking to outsourcing as an option will need to act fast as there are only a handful of partners,” says Michael Angus, vice-president at Capgemini.
But outsourcing deals are far from easy to implement and many smaller banks are wary of losing control over such a central part of their business. “With the level of pricing pressure in the market, consolidation should accelerate,” says Ann Cairns, senior executive vice-president of transaction banking at ABN Amro, which ranks fifth globally and second in western Europe in the poll. “We insource the trade business of over 36 banks. The key is that both institutions have to feel comfortable with how each manages risk, complies with regulations and about each other’s standards and processes. The deals themselves take a long time to go through as there are so many details to work out and implementation is fairly long as well – at least six months.”
As well as trying to lower costs and increase volume through outsourcing and extending their abilities through partnerships, banks are trying to offer higher-margin services to corporate clients. The current focus of the top banks is trying to integrate the financial supply chain more closely to the actual supply chain.
By having a cash management system that matches the physical supply chain – when goods are actually sent and received – a company is enabled to pay only when it needs to. It can also help to improve vendor financing terms and optimize working capital. This is achieved in concrete terms through such measures as electronic invoicing payment and electronic billing and payment.
Cutting in on the chain But banks are no longer the only players in the payments business. The payments chain is unravelling as clients, banks, and non-bank competitors analyze and target the revenue or savings opportunities of each link in the chain.
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“We are seeing more active conversations about partnerships as banks are being forced to make choices” Nick Viner, Boston Consulting |
In the US, technology companies such as First Data Corporation and Total System Services have established strong positions in the debit card transaction processing and issuing businesses. First Data Corporation generates about $3 billion in revenues from these services. But these companies threaten bank revenues indirectly too by helping smaller banks to compete more effectively as well.
Banks also face competition from clients of their other businesses and from other parts of their own businesses. Asset managers and custodians such as Bank of New York, Mellon, Goldman Sachs and Morgan Stanley are targeting corporates with highly efficient short-term money-market instruments for liquidity management, which compete directly with the liquidity management services provided by cash management banks.
Lucrative parts of the retail business, such as cross-border remittances, are also under attack not only from such companies as Western Union but also from credit card providers such as Visa and MasterCard, which now offer prepaid debit card services for international money transfers. Analysis released in September by Aite Group, a financial services consultancy, estimates that these services could capture 4.4% of the US outbound remittance market by 2007, compared with just 0.7% today. Indeed, the conversion of the credit card companies from bank-owned associations into for-profit companies could well come back to haunt banks in unforeseen ways.
Fees under pressure
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“The emerging reality of a single market, however, has created a competitive imperative for us to be able to offer domestic capabilities as well as cross-border ones” Naveed Sultan, Citigroup |
Sepa is not the only piece of legislation challenging the lucrative payments business. Regulators in the EU, US, Mexico, New Zealand, Switzerland and Australia are all taking a close look at credit card interchange fees. In Australia the government ordered Visa and MasterCard to slash interchange fees among member banks by almost two-thirds. This September, the UK found MasterCard and its bank owners guilty of overcharging customers. The threat of further legal action by retailers is one of the reasons why banks are keen to float MasterCard [see equity markets news, this issue].
Other regulations, such as Basle II and the USA Patriot Act, which primarily address other concerns, also increase costs for the payments business.
While banks focus on improving margins in their corporate business they seem content to let others drive innovations on the retail side, which in some markets such as France and Spain is worth more than the corporate business. With the exception of internet banking services, new payment methods such as mobile payments or stored-value cards are taking off without banks. The Octopus card, which started in Hong Kong in 1994, has gone from an integrated transport payment card to one that is also widely accepted in stores. Some 95% of Hong Kong consumers use the card for transactions worth $2.2 billion a year. In the UK, some believe that the very similar Oyster card could replicate the Octopus success story.
Consumers do not always readily embrace new payment methods but retailers are starting to force the pace of change. In September, Shell announced that it would stop accepting cheques at its UK filling stations, and Tesco, the UK’s largest supermarket chain, said that it was contemplating introducing cashless stores. Cheques and cash are expensive and time-consuming to process and usage is declining in many markets. This benefits banks but again it is not banks driving the change.
The old cash management and payments business is dead. In the new business, haunted by regulators and unfamiliar competitors, banks and other players need to have clearly defined and realistic business models. There isn’t room for everyone.
