Cross-Border Payments

Conference briefing

End of a
Banking Tradition?
By Nigel Robertson
Globa l Cash Management Ltd.
Banks may no longer be able to profitably continue their traditional role in
the transmission of money. This will
have a tremendous effect on the world's
banking systems.

Signs of signifi cant changes in the banking landscape are beginn ing to appea r,
few of which are in the banks' favor.
One of the more signifi ca nt c han ges
concern s the costs of a tradition al banking service where banks still have a virtu a l monopoly : cas h hand lin g and
money tran smi ss ion, includin g the execution of domesti c and internat io nal
payments and operatin g the check clearin g system. Declining profitabi li ty i n
eac h of these areas are digging hard into
shareholder valu e.
Cor-porate treasurers shou lei be awa re
of this issue, as it impacts the cos t/benefit of using banks ve rsu s non-b ank
ve ndors to tr ansn1it and process payments and co ll ections. More important,
however, are t he lon g-run effec ts that
w ill be chang in g the ve ry nat ure of
future bankin g systems.
A j anu ary 23 -25 bankin g co nference
in London d evo ted to " Dev e lopin g
Cost-Eiiecti ve Strategies for Lon g-Term
Profitab ility of Mon ey Transmission,"
indicated quite cl ea rJy how signifi ca nt
th is issue is and how urgent (and diffic ult) it w ill be to f i nd solutions.
A rr a nged by the In stitute fo r
Intern ational Resea rch, th e confere nce
prese ntecl expert contribution s from UJ<
"c lea rin g banks," and no n-b ank payment serv ice providers like Pay ment
Systems Europe Ltd., AT&T, Digital, and
Unysis .

Bank competitiveness: a catch-22

While current trends do not bode well
for most banks globa ll y, the timing and
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imp ac t o n Eur opea n, espec iall y UJ<

" cl ea rin g banks" is particul arl y unfortu nate. Hi stori ca ll y low in flatio n, intense
co mpetition , changin g custo mer payment habits, and the growth of non-bank
elec troni c payments mecl ia have co mpounded th e effec ts of mi sta ken past
lendin g poli c ies. And loo min g on th e
ho ri zo n are th e hu ge f uture costs of
introdu cing a sing le currency in Eumpe,
w hi c h w ill fall mainl y on th e bank in g
sector.
Th e mo st b as i c back off i ce
o perat io n-cas h ha nell i ng- acc urately
revea ls th ese banks' tough " Catc h-22 "
probl em. Some at the co nference argued
th at thi s acti vity shou ld be run as a bus iness for profit, w ith the fu ll costs of operation s being chargecl to other custo mer
areas. Few banks currently charge o ut
full y all ocated cos ts, yet they alrea dy
enco un te r stiff custom er res ista nce to
pr ice. If they move to generate for pmfit
payment operation s, overhead cos ts w ill
have to fa ll signifi ca ntl y.
Cutt in g over hea ds w ill be tou gh. O n
average, acco rdin g to industry statisti cs,
ce ntral izecl cas h process in g ce nters in
th e Ul< handle th e eq ui va lent of $380
billion annu all y at a cos t of $127 million
o r 3 ce nt s pe r $100 of volume .
Transportat ion costs acid a furth er 2.7
cents pe r $100. Cash for sa me clay va lue
is so ld in th e market fm mu ch less than
this minimum breakeven of 5.7 ce nts
per $100 and most retail ers are charged
co nsiderably less.
Other individual customers must then
bear the incremental costs. If banks pass
on the full costs, this will accelerate the
transition to other payment means (i.e,
electronic payment methods such as
debit cards and electronic purses). It
also will reduce volume and the banking
system's scope for overhead recovery.

Check proc ess in g faces a similar

dilemm a. Check vo lumes in the UJ< are
forecast to dec rease by 32% over a period of 15 yea rs to 2005. Meanwhile,
d ebit ca rd tra nsac ti o n vo lum es wi ll
exceed checks by the yea r 2002 or ea rl ier. Here too, th e banks are un avo idab ly
stuck with hi gh cost legacy systems, all

w ith an in creas ing cost base and declinin g vo lumes.

Banks cannot simply decommisison
computer centers, close bank branches,
redeploy staff, or change processing
methodologi es overnight. They need
volume to keep unit costs under control.

Non-bank competition
H owever, as m o ney tran smis sion is
ident i fied as a loss- leade r for banks ,
non-banks see plenty of opportunity for
pro fit. Thi s is a rea l threat to w hi ch
banks have not come up with a clea r
response.
Meanwhi le, the pace of changes being
di ctated by both reta il and co rp orate
customers is qui cke ning. Customers are
rapidl y becom in g co mfo rt ab l e w ith
technol ogy and awa re of how much better servi ce and aclclecl va lue it ca n deliver. Thi s is also an indicati o n of banks'
fa ilure to deli ver va lue-add ing payments
services apace w ith customer demands.
The sa me tec hnology that ca n deli ver
hi gh- va lu e se rv i ces has red uced the
cos t-of-entry and created synergies with
other forms of (information) technology.
M any te lep hone compa nies, for exam ple, are effective ly positioned in thi s
market already. O ther providers also are
attracted by the high revenues avai lab le
from transacti on process in g, espec iall y
w hen ex ist in g se rv ice quality can be
improved at the sa me time.
The outsta ndin g question for bankers,
for which onl y time ca n give an answer,
is w hether this process of disintermediat ion ha s already go ne too far to be
stopped by reregu lation of th e banking
indu stry. Or are th ere now too m any
potentia l competito rs and too many
ways to enter the market for regul at ion
to have affect?

In the long run technology wins

Fro m a strateg ic perspective, w het her
regul at ion w i II prove to be effective or
not, is irre levant. Over the next 25 yea rs,
and soon er rather th an later, the bankin g
land scape is li ke ly to change out of all
In ternat iona l Treasurer/February 20, 1995

Financial Risk Management

recogn ition. Not onl y w ill ba nking be

commoditized, b ut many banks w ill
fina ll y be allowed to fai l by their regul ating govern ments.
Th e reason : Soo n eno ugh, in dustr ial
grade inform atio n tech no logy w ill be
widely available at the PC leve l to create
a globa l, rea l-t im e com m un ic at io ns
environ ment. Cross-bo rder transactio ns
w il l have to be (and w ill be) executed
faster, better, and cheaper. M oney w ill
remain a means of exc hange, but wi ll be
entirely electron ic. Currencies may even
disappear, beca use adjustments to pulchasing power pa ri ties ca n be made in
rea l-time.
Bankin g perfo rm ance w ill beco me
in creasingly important to all bank custo mers, governments, and mark ets as
they w ill cont inu all y de m and m o re
va lue from thei r ban ki ng systems.
Security is the major area of co ncern .
Indeed, the risk of fraud may poss ibl y
favo r ba nks , if th ey ca n de li ve r more
secure systems th an non-bank pmvide1s.
But here too, time is not on their side.
No q u ick f ixe s to these lo ng te rm
trends were proposed by the conference
speakers-nothin g sho rt of a recast of
the structure of the bank ing system at the
in te rba n k, nat i o na l, and Europea n
Union leve l wi ll do.
The opportuni ties for new solutions,
improving serv ice quality in accounting,
and ri sk management and the ch anging
ownershi p m co ntm l of the services are
all fundamental issues, w hi ch corpm ate
treasurers wou ld do well to follow close- - - -l'""y,...
. '"'
111e-stakes are very hi gh and w inners
w ill be few.
So among th e many others, count a
greater need to monitor credit/counterparty risk -declining among banks and
uncertain among non-banks- as a final
spillover effect of the changing money
transmission landscape.

M r. Robertson is a principa l with Globa l

Cash Management Ltd. in London +44 (0)
749l -638060.

Inte rnational Treasurer/ Febru ary 20, 1995

Book rev iew

AWhy Guide
By Hal Dav is
" The JP Mor gan/ Arthur Andersen
Guid e to Corporate Ex posure
Man a ge m e nt," publi s h e d by Risk
Magazine (August 1994).

" T h e JP Mo rga n/ A rthu1 A nd e r se n

G ui de to Co r po r ate Ex p os ur e
Ma nageme nt" is o ne of a number of
pub li cations being offered by banks
and acco untin g f irm s to he lp intro du ce f in anc i al ri sk m anage m ent to
se ni o r m a nageme nt and d irecto rs.
Most int w du ce fa m il i ar G-3 0-t ype
rec om mend atio ns w ith va 1io us adaptat io ns. This part icul ar 88-page booklet is no exce pti on. Wh at se ts it apart,
howeve r, is th at it also prov id es so me
o f th e better "w hy do it" argum ents,
puttin g ex pos ure m anagem ent and
p rud ent deri va ti ves use in to the co ntext of co mpetiti ve adva ntage .

are traded fin ancial contracts.

Th e uniqu e thin g about the cube is its
third dim ension: exp o sures v is-a-vis
co mp e t i to 1 s. With thi s dim e nsion ,
co mpa ni es are as ked to view ex posure
and tailor so luti o ns co nsistent w ith th e
fin anc ial pos iti o ns of co mpetito rs' as
we ll as th e ir o wn f in anc i al m ark et
ri sks . Thus, it hi ghli ghts a very tangibl e
benefit of acti ve man agem ent: generatin g/protectin g co mpetitive adva ntage.
The consequences of focusing on managing a company's own exposures,
"without worrying about what the
competition is doin g," are as far-reaching as if the company chose to ignore
competitors' pricing policies (p. 27) .

As an exa mpl e, th e authors ask readers to con sid er th e con sequ ences of
co mpetitors th at are exposed to floating
interest rates wh en they are fi xed-and
interest rates are falling. They should go
further to as k what the cost to competito rs w ould be to swap out of these positi o ns. Not o nl y should a co mpa ny identi fy w hat its competitors' exposures are,
but how th ey are manag ing th em.

Why do it?
Th e aut hors argue ex pli c itly fo r active
management of ri sk, som ething, as th ey
note, that is not uni versa ll y accepted by
no n-financ ial corporat ions. In Ch apter
2, th ey ri ghtl y po int out th at no n-f inanc i al co m pa ni es are al so ex po sed to
many financial risks in their und erlyin g
operations. Ch oosing to manage them
add s stab ility to cas h f lows and valu e
to th e firm .
Th o ug h , unl ess co mp a ni e s have
id entified th e nature of th eir ex pos ures,
they have no idea wh eth er (a nd by
how mu c h) th ey would benefit from
acti ve ly m anag in g th em o r not-a nd
w hi c h o nes . Chapter 3 p rese nts th e
se rv ice-m ark ed JP M o rga n " Expos ure
M a n age m ent Cub e" fra m ew ork. It
as ks co mp ani es to identify ex posures
b y m atc hin g " va lu e dri ve rs" -e .g .,
fac to rs affec tin g th e bottom line-with
t h e effec t s of " t ra d ed m a rk e t
fac tors"- ex posures (e .g., to FX rates)
th at have bee n stand ardi zed and th at

Why do it with derivatives?

With a dea ler bank as co-author, 1t IS
not surpri sin g th at deriv ative so luti on s
are emph as ized. Chapter 5 ex plains
how deri vati ves are both more flexible
and more targe ted (they " unbund le"
ri sk) than operation al alternatives such
as plant siting described in Chapter 4.
Recentl y, the authors note, derivative
so lution s have moved from manag ing
transa ction a l ex po sures to strateg i c
ex posures. Corporate offi ce rs, thu s, are
becoming awa re that derivatives are a
strategic plannin g, and not ju st a treasury, too l : th ey " help a company move
fro m its current ex posure to its des ired
ex posur e." Puttin g d e riv at iv es and
ex po sure manage ment in th e context
of strategi c pl annin g and comp etitor
analysis sho u ld help bui ld derivative
vo lumes lost to deriva tives angst.
For a copy, contact M ark Brickell at }P
Motga n (2 72) 648-6605.
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