Full results Methodology
The largest cash management banks seem surprisingly unconcerned by new competitors encroaching on their territory and by trends that threaten the revenues of one of their most important businesses. Even the fact that they are all pursuing the same strategy does not seem to worry them. Ask any of the global cash management banks to describe their strategy and they will give the same answer. They are all targeting the wallets of the top-tier multinationals.
The theory is that these multinationals are most likely to require complementary services such as foreign exchange and investment banking that banks hope to be able to cross-sell and also send and receive the most cross-border payments.
But these multinationals are also the most demanding of customers, have the most sophisticated in-house treasuries, and are the least likely to be willing to tie themselves to their banks. The falling cost and decreasing complexity of switching cash management banks now makes it possible and worthwhile for the largest corporates to review and re-tender their cash management needs more often and repeatedly to drive down the price and demand more. Moreover, according to Boston Consulting Group, revenue from cross-border payments is expected to fall at a compound rate of 1.3% a year until 2009.
With sophisticated corporate treasuries now able to do so much more to manage their cash by themselves, what do banks do to add value? John Hazelwood, EMEA head of product management at JPMorgan, concedes: "Revenues from traditional cash management services are under threat." But he says the banks can bundle services. "The ability to bundle services, particularly liquidity management such as cross-border sweeping, is a key differentiator," he says. "Our revenue base has historically been fairly evenly split between payments and liquidity products."
All banks put a heavy emphasis on cross-selling opportunities in their decisions on which customer segments to target and the pricing of their bids for mandates. But they will be dismayed by the words of one treasurer of a top-tier multinational with an extremely sophisticated in-house treasury. "We're not interested in being cross-sold products, we evaluate all things on a completely stand-alone basis," he says. The cost of switching cash management banks for top-tier corporates has fallen and the intense competition for their business has given them more bargaining power than ever before.
Banks should not underestimate customers' increased propensity to switch providers now that the costs of doing so have fallen. The Boston Consulting Group highlights three reasons why customers are now more likely to do this.
First, customers are demanding far more from their payments providers. Corporates that can now handle for themselves some of the functions they used to rely on banks to undertake expect cash-management providers to do more to add value.
Second, price transparency is much clearer. Corporates have a better appreciation of how important efficient cash management is to their overall costs and are far more likely to use competitive bidding processes to pressure banks. This has substantial implications for the cost-to-income ratio of the business to the bank.Easier switching
The increased sophistication of corporate treasury management systems has given corporate treasurers much greater control over the multitude of accounts they handle and made them less reliant on banks to organize their account information for them. Sophisticated corporate treasuries using standard formats and processes are in a position where they can simply demand that their cash management banks provide interfaces with their own systems, with a minimum of customization, instead of relying on a bank to do all the coordination for them.
Greater control over their own accounts means that corporates can better manage their own funds. With a better picture of their obligations and balances corporates can manage their liquidity more effectively, moving surplus funds out of current accounts to others that would earn them better returns.
The greater ease with which customers can switch cash management banks poses obvious threats to banks in this business because they are over-reliant on certain customer segments for revenues that they use to cross-subsidize other customer segments. If banks can identify which customer segments generate disproportionate revenues they can tailor products to attract these groups from other banks. "A cash management relationship gives banks a lot of information about their customers which they can use to communicate with them about their needs. But banks' ability to use this information has been weak," says Geoff Nicholson, leader of the UK financial services practice of Mercer Management Consulting.
An increased awareness of the significant cost savings to be reached through more efficient cash management has also driven large multinationals to reorganize their global treasury operations and rationalize the number of cash management banks they deal with (see graph).
Banks are well placed to soak up the lion's share of the revenue that could be generated from the expected 6.2% compound annual growth rate in transaction volumes, but they are no longer the only players. They will also have to think more smartly if they are to maximize the value they can get out of this growth in transaction volumes.
The amount of money to be made in the payments business has attracted a host of new entrants who see opportunities to break in to various stages of the value chain that have traditionally been the exclusive domain of banks. Treasury management software can help corporates to reclaim some of the value across the chain. Secure transport companies have competed with banks for collection mandates and have won them. IBM is working on an internet venture that would create a portal to which corporates and banks could send their information for direct matching or routing. This would remove direct connectivity between banks and corporates and make switching providers or unbundling products even easier.
The decision of Swift, the bank-owned inter-bank communications network, to allow non-financial institutions access to its infrastructure via closed user groups will also help corporate treasuries to simplify communication with cash management providers. Corporates are now able to enter into a closed user group with any bank that will permit it. "There are now 19 banks in the process of setting up closed user groups and a number of corporates," says Patrick de Courcy, head of banking markets and solutions at Swift.
This means that through a standard format a corporate can exchange information with any bank, loosening the ties to any one cash management provider.
Not everyone is comfortable with Swift's decision to allow non-financial institutions to connect to the network. "Swift appears to be moving towards becoming a corporate venture instead of a society for banks," says the head of cash management at a top-tier cash management bank. "Swift is the most prominent financial-institution communications system available but is by no means the only one possible." Indeed, though the move gives banks and corporates a cost-effective and reliable communications channel, Swift's move is also a sign that it might be developing independent interests.
Banks are also facing growing competition from non-banks in particular payments products. The revenue per transaction of different products varies substantially. In the US, for example, the cheapest retail payment method generates only 0.4% of the most expensive. New entrants have targeted the payments products that generate the highest margins for banks and undercut them significantly.
ProPay, an internet-based payment services company, makes it cheaper for a merchant to accept credit card payments than through a bank. PayPal, an alternative payments company that enables consumers and businesses to send payments via email, has also achieved remarkable success where similar bank-led ventures have had a tough time. PayPal, recently purchased by online auction house e-Bay, claims 20 million registered users and says that its account base is growing by 28,000 users a day.
Cash management revenues are concentrated in particular customer and product segments. Though total transaction volumes are expected to grow 6.2% a year between now and 2009, revenue per transaction is predicted to fall 1.9% a year as more and more switch to lower revenue generating electronic channels and clearing cycles shorten. Revenue from cross-border transactions, a good earner for banks, is expected to be hit particularly hard as the EU directive on cross-border payments comes into effect.
From June 2003 the European Commission has decreed that the cost of a cross-border payments within the EU below e12,500 should be no more than a domestic transaction. This threshold will increase to e50,000 in 2006. But domestic transaction fees vary considerably within the EU - in France, for example, they are free - which could have implications for domestic fees in the EU as well.
The 212 billion domestic transactions in 1999 generated revenues of $224 billion while the 2.3 billion cross-border transactions generated revenues of $32 billion globally. The EU directive however will cause cross-border revenues per transaction to fall at a compound rate of 5.8% a year so that by 2009 revenues from cross-border transactions globally will fall to $28.1 billion. Revenues from cross-border transactions in Europe are the largest segment of cross-border transaction revenues globally, accounting for 64%. According to Boston Consulting Group this will shrink to 42% by 2009. Globally, total revenues from cross-border payments are also expected to fall at a rate of 1.3% a year until 2009.Compensatory volume growth
Deutsche Bank, voted the best cash management bank in western Europe in this year's Euromoney poll, believes that growing volumes will be the key to combating the threat to revenues posed by the EU directive. "The new European regulation regarding cross-border payments will force prices down, limiting the scope for niche players that will not be able to gain the necessary compensating volume growth," says Andrew England, head of product management at Deutsche Bank's global cash management division.
Banks could also raise fees for repairs and non-STP transactions to help make up for the loss.
Corporate treasurers' perceptions of what banks should be doing vary widely. For the treasurer of one European multinational, price is the key issue because she does not see a big difference in standards among the top-tier players. The treasurer of a US multinational, however, thinks that banks should be concentrating on providing better services instead of merely competing on price. And while banks are increasingly trying to provide a kind of consultancy service to their customers, more than one corporate treasurer feels that banks simply do not understand their businesses well enough to play a consultancy role.
By concentrating so intensely on the small pool of top-tier corporates, where competition is most intense, the global cash management banks may be missing out on other opportunities. The trends in transaction and revenue growth in payments show that the most promising opportunities are in Asia where revenues from domestic transactions are expected to rise by 8.4% and cross-border revenues by 5.8% a year until 2009. Revenues from domestic retail transactions in the Americas are another bright spot expected to grow at 7.4% a year until 2009.
Smaller and medium-size clients are the ones who lack the resources and expertise for in-house treasuries and who could therefore reap a large proportional benefit from improved cash management services. They are also less likely to be worried about tying themselves closely to their banks and so are more likely to consider outsourcing their treasury functions.
Smaller customers also have less bargaining power than sophisticated multinationals and are more likely to be easy targets for cross-selling, although the products they would need are not likely to be such big money-spinners as the ones that can be cross-sold to multinationals. "There is a growing desire amongst small and medium-size companies to improve their cash management and the market is under-served compared with the multinationals," says Bob Mackman, corporate banking business executive at IBM. "Some of the smaller cash management banks are targeting these with cheaper and easier-to-use versions of the top-end products with which they serve their bigger clients." The danger to the lower-tier cash management banks that compete for this customer segment would be substantial if the top-tier players really set their sights on it.
Of course banks as a whole have not been oblivious to the different power dynamic at the lower end of the market. A survey by the Association for Financial Professionals and the Capital Markets Research Center at Georgetown University showed that half the respondents in companies with less than $250 million in annual revenues were required or "strongly encouraged" to purchase cash management services in order to receive short-term credit products.
The advantage of the big six is their global reach and ability to outspend the competition on technology. But technology is also a leveller and advances made by independent technology firms can help catapult smaller players into providing top-of-the-range services. Pan-Nordic bank Nordea is a good example of a second-tier cash management bank that has used technology to enable it to provide a top-tier service. It is working with IBM and Misys to introduce an innovative web-based system that will allow it to merge and mirror a client's positions with other banks through its own system.
Despite Nordea's being much smaller than the big six global cash management banks, its web-based solutions are ranked fourth in Euromoney's 2002 cash management poll after those of Deutsche, Citigroup and JPMorgan.
Payments also make up a substantial proportion of a bank's cost base - up to 40% at some institutions. Managing costs is therefore crucial to minimizing the cost-to-income ratio of a bank's cash management business. Cost structures vary considerably across institutions. The cost of a branch deposit transaction is anywhere between $1.10 and $2.30.
Financial institutions have succeeded in cutting their unit costs per transaction for several years but most of the reductions have been concentrated in the transmission and processing links in the value chain. At some institutions costs in these areas are already so low that the potential for additional cuts in these stages is minimal.
Further reductions, however, could be achieved if banks were to cut costs to best-practice levels in every stage of the value chain.
Direct revenues from non-cash payments alone are expected to be worth an estimated $290 billion in 2002, a figure that Boston Consulting Group estimates will grow to $387 billion by 2009. These revenues are estimated at between 10% and 19% of banks' revenues in the developed world, a proportion that rises substantially to between 13% and 33% when all payments-related revenues are included. The impressive value of this business to banks would be even more stunning were it possible to include the revenue from all the products cross-sold on the back of the payments relationship.
Mark Rodrigues, a managing director at Oliver, Wyman and Co points out: "As banks' other businesses suffer, they should think about putting more effort into making more from this business."
Revenues from cash management will grow as the growth in transaction volumes continues to outstrip falling revenues per transaction. But banks' centrality to the payments process and their revenues from the business are under threat.
The global cash management players are all universal banks whose cash management strategies are in danger of being blinded by the bright light of cross-selling opportunities. Cash management is about payments first, then cross-selling - at least it is to clients. Banks looking to grow cash management revenues should consider how they are going to grow payments revenues. They should think about keeping an eye on new entrants and about how they can position themselves to capitalize on the regions, customer segments, and products with the highest growth in transaction volumes, not just those with the best cross-selling opportunities.