After a decade of reform and retrenchment, the banking industry is on a more secure footing. However, it is unclear whether banks have adapted their operating infrastructures to the post-crisis landscape, writes John O’Hara, co-founder and chief executive officer at Taskize.
In June, the Federal Reserve confirmed that all 34 major US banks had passed its latest round of stress tests, enabling them to resume dividends and stock buybacks. In Europe, despite slow progress toward European banking union, the worries that prompted the initiative are receding. All major European banks achieved core equity tier 1 capital ratios of 11-16% in Q2 2017, well in excess of regulatory minimums and significantly higher than five years previously.
Financial performance, however, remains well below historical norms and other sectors. Having inched up steadily in recent quarters, the US banking sector finally achieved a return on equity (ROE) above 10% in Q2 2017, albeit with wide differences between laggards (5-6%) and outperformers (12-15%). In Europe, the picture is worse. The European Banking Federation puts European banks’ collective 2016 ROE at 3.5%, down from 2015’s 4.3%. With a 9% average cost of capital, the sector is barely breaking even.
The rising costs of meeting steeper compliance obligations and evolving customer expectations will continue to outstrip revenues, regardless of changes in interest-rate policy or the termination of quantitative easing.
The era of high leverage, low wholesale funding costs and high margins is over. Pledges on both sides of the Atlantic to review post-crisis reforms to support economic growth may ease the transition to the new normal, but will not bring back the good old days. Pressure on banks to continue cutting costs through operational efficiencies can only intensify.
But cutting operational costs is no easy matter. In times of low yields, you cannot compromise on the quality of service delivered by the back-office, yet errors, delays and breaks are tolerated less when there is less profit to go around. How then to reduce their stubbornly high cost and frequency, and the back-office’s burden on balance sheets, without further damaging customer trust and confidence?
Banks’ attempts to achieve this by shifting responsibility for the back-office have achieved mixed outcomes at best. Though not highlighted in financial statements or on balance sheets, quality and control have tended to suffer, even when costs have been reduced. A recent DTCC survey showed almost 50% of firms still experience moderate to very high costs fixing trade exceptions. Several credible service providers are attempting to build business process outsourcing (BPO) franchises, but the complexities of taking over and managing highly customised processes from a diverse range of banks remain difficult to overcome in a way that achieves both cost savings and productivity improvements for users, and revenues for providers.
Years of under-investment have left back-office processes too manual, fragmented and inefficient to be shipped offshore, migrated to a BPO provider or overhauled by enterprise-wide transformation on today’s budgets. Processes run on systems that are deeply embedded into the fabric of the bank, their origins obscured by the passage of time, causing many to fear the consequences of tinkering with the unknown. While some have succeeded in retiring platforms, back-office systems easily run into the thousands at most global banks, while back-office headcount can be more triple that level. Despite escalating regulatory pressures, the risks and costs of wholesale back-office reengineering are too large to contemplate, but the same could be said equally of continued reliance!
Banks’ individual efforts will not address the key problems like the lack of standardisation and effective data and process sharing across counterparties. As an industry, we have to recognise the obvious: we’re all in this together.
Mutualisation of back-office costs and risks is very hard to pull off, but not impossible. I have two reasons for optimism. First, whilst banking may lag other industries on collaboration, there are still many examples where sustained multilateral efforts to standardise processes and drive efficiencies have achieved results. From industry-owned cooperatives such as SWIFT, to industry association working groups, to the development initiatives of client-owned market infrastructure operators, it is clear banks can collaborate effectively to tackle common problems.
Second, advances in technology are making it easier to improve back-office productivity and efficiency without undertaking the Herculean task of ripping out existing systems. Technological innovation may not be able to reduce the number of breaks and exceptions caused by the balkanised back-office landscape, but it can accelerate, automate – and importantly, mutualise - the processes deployed to resolve them.
Leveraging utilities can help back-office staff to track and resolve errors and breaks more effectively, and exchange information on errors more efficiently and more securely. Further, using a common platform not only encourages collaboration across counterparties, but also fosters best practice in back-office processing by, for example, enabling benchmarking and peer group analysis.
Many challenges lie ahead for operations staff, but it is clear banks will have to mutualise risks and costs to really get a handle on back-office operational efficiencies. It’s time to mobilise the power of the crowd.