The fall in interest rates in the UK is another setback for the transaction banking business, already hit by rising regulatory costs and falling commodity prices. After long being considered a reliable division of banking with stable returns on equity, transaction services will now find it even more difficult to make a profit.
While the decision of the Bank of England to reduce rates to 0.25% was intended to help the UK economy, the drop in revenues for banks already struggling to make adequate returns could provoke an unintended response.
Although low rates are not new in some geographies, for banks with UK exposure it is an additional pain point.
Steve Everett, managing director, head of product and propositions at Lloyds, says: “European banks have been at zero interest rates for the last few years, but if they have a strong UK presence they are now being hit on both sides.”
In response to low rates internationally, many have been exploring options to prop up returns, including raising margins to borrowers and charging businesses for maintaining short-term balances on deposit.
Rajesh Mehta, Citi
Rajesh Mehta, regional head of treasury and trade solutions, EMEA, at Citi, says: “The global banks will have already been thinking about how to deal with reduced rates, and will have started to introduce new protocols to deal with this. They have been exploring fees but, more importantly, what can be offered as a value-add service to clients, such as innovative products and FX.”
This expansion of services has been taking place for some time, with some banks choosing to include products such as card services under the transaction banking business. They might find now they need to speed up plans.
Lloyds' Everett says: “The solution is to offer a broader portfolio. This can help to meet more of the client needs, and can levy charges for the services.”
There have already been moves to begin charging for some services. Germany’s small co-operative Skatbank and Raiffeisen bank have started to charge customers for holding deposits. RBS and NatWest have informed small business customers that the bank will be changing its fees structure to a flat fee, with additional costs for further services.
|Suzanne Janse |
van Rensburg, BAML
Suzanne Janse van Rensburg, regional head of liquidity for GTS EMEA, Bank of America Merrill Lynch (BAML), says some banks are taking the step to make up for losses, adding: “We have seen some banks charging for deposits where rates are negative. It can become very costly to do business and they may need to charge in order to compensate.”
However, the question of what exactly counts as a chargeable service is creating discrepancies between banks.
Enrico Camerinelli, senior analyst at Aite Group, says this is not clear cut, explaining: “Banks are having to change the business model, asking clients to pay for services. It is difficult for them to ask to pay for transactions, so instead they look towards service fees. But what counts as a service is creating problems.”
BAML's Janse van Rensburg says the bank is looking to address this by working within the corporates’ expectations. “A client recently asked what they would be charged for, and we returned the question, asking what they would be willing to pay for?" she says. "What we usually find is that it is advisory services and data which add the most value.”
Services that are now coming at a cost price need to be desirable enough to validate higher fees.
Citi's Mehta says: “Innovation is important if it is to be used to justify additional cost. If it is believed that a bank can offer the same services but now charge for it, that will be hard for clients to understand. Our clients want to be sure that they are being offered a best-in-class service, not just a vanilla banking service at a higher cost.”
Banks have also been reassessing the corporates they want to work with, broadening the client base to work with companies they can provide further fee-based services for.
Janse van Rensburg says: “Banks are looking more broadly at how they can help their clients with the working capital cycle, and add value to the process. In the past it has been possible to cherry pick who to work with – now banks also want companies they can support more across the whole working capital piece.”
Another solution to reduce costs is operating more digitally, says Omar Al-Bakri, director of wholesale financial services at Alderbrooke, as heavily paper-based areas of the business such as trade finance are keeping costs high. However, moving to digital requires increased investment at first.
Camerinelli adds there is also the matter of how much banks can charge for a predominantly automated service, adding: “A more electronic way of running the business needs to come in. This reduces costs, but the banks can’t charge the same amount in fees as they did before. It is a catch-22 position to be in.”
The move towards digitization will potentially mean fewer members of staff.
Alderbrooke's Al-Bakri says:“Whilst front office staff remain key to driving the business and keeping it profitable there is increasingly less requirement for people working in the back and some middle office functions. Banks are exploring opportunities to reduce costs with new systems and through digitising their transaction banking platforms. Banks are also beginning to work with third party providers in the fintech and payments industry that are able to provide solutions at a significant cost reduction."
Senior transaction bankers are reluctant to discuss the possibility of cutting jobs. One banker said there will be no direct correlation between the bank's staffing and the fall in interest rates.
Mehta adds that the amount of work being done will continue at the same level. “Staffing levels should not be greatly affected across the industry," he says. "The amount of work that needs to be done doesn’t alter with the rates falling. What’s happening is that banks are being paid less for the same amount of work.”
Instead there is a push towards focusing on the quality of staff.
Al-Bakri says: “Pre-crisis transaction banking was viewed as the unsexy part of banking. But post-crisis the emphasis has been on it as a significant contributor to the banks P&L.
"It is a relationship driven business that provides long term sticky revenue streams at a fraction of the capital outlay by comparison to capital markets focused business lines. Despite the obvious slowdown in revenues across the transaction banking industry it remains at the forefront of banks strategy. Because of this the quality of the individuals who work in the sector also has to improve.”
Everett says that the focus will be on hiring and retaining the best people for the job, adding: “Banks now are looking for people who can add value to the business and help it to grow. In difficult times you need to be able to push back as hard as you can.”
However, analysts say that declining revenues make job losses inevitable.
|Patricia Hines, Celent|
Patricia Hines, senior analyst, corporate banking at Celent, says: “As compliance costs increase, interest rates remain low and projected GDP growth under pressure, most recently because of the uncertainty caused by Brexit, banks will continue to reduce staffing levels.”
Al-Bakri adds that some of the workforce will be willing to move on as they see new opportunities to use their talents opening up elsewhere.
“We are seeing an increase in the number of senior people deciding to leave banking, forced or otherwise to move into boutiques, advisory firms and fintechs," he says. "The banks simply don’t need as many senior people running fundamentally smaller and tighter shops.