While transaction banking may be the last preserve of healthy fee income, a shake-out is coming that will redraw the map
Those banks that had debated whether to invest in transaction banking services over the past five years are now probably glad that they did—the business has been the last preserve of profitability for many banks, such as hard-hit Citi, which saw its cash and trade net income grow 25% in Asia in 2008 over 2007, and 38% globally. But with investment dollars dwindling fast with cost-cutting measures, the challenges for transaction banking players will only be magnified in 2009, which is sure to see major change as a shake-out hits industry players and separates dabblers from those that have dug their heels in and have committed the resources to stay in business.
Business has suffered: SWIFT traffic has been down ever since—no surprise—October 2008, and year-to-date figures for March show a 4.19% slide in message traffic globally with a decrease of 8.1% in the Asia Pacific region, although a very weak January and February have been followed by very strong March volumes that exceeded those of March 2008. In terms of business lines, only the large securities business saw an increase in traffic, while payments, treasury and trade dipped.
In a global survey of FI bank relationships by FImetrix, findings showed that not everything in the FI space is gloomy: 54% of respondents said that their network of correspondent banks had not changed as a result of the crisis. But, of the 46% who reported change, 87% said that they had consolidated their number of bank relationships and only 13% said that the number of their bank relationships was increasing. Meanwhile, 68% are planning to continue to consolidate their number of bank relationships.
To build a strong transaction business, banks will need a broad regional footprint and local expertise, as well as key local bank partnerships. They will also need to invest to maintain and expand their global platforms in order to keep their products integrated. To expand their distribution, building relationships with local SMEs will also be key to developing deep supply chain financing capabilities, and banks need to think strategically about how they structure their sales teams, as well as how they restructure their various products to adapt to rapidly changing situations.
Going forward, banks are expected to become more focused, competing in products and geographies where they have great chances of winning mandates, and emphasising old-fashioned products and practices. Some feel that there will be no room for global titans that do everything, everywhere. To advance in the business, much will fall back on a new paradigm of capital allocation: this applies not only to investments in maintaining and expanding the IT needed to stay cutting edge, but it will also show which businesses had been able to survive only when funding was cheap and plentiful. But given uncertainty, banks will need to act quickly to find out which strategies work in the various economic and regulatory environments that are taking shape right now. The will also need to determine how the shake-out is affecting capacity and competitor business models, and how much more retrenching will be necessary.
Cash management: cool for cash
Although global SWIFT volumes for cash management were only down 7% in the first three months of 2009, this represents a huge chunk of SWIFT volume as payments represent the largest part of the collective’s messaging volume. But even in good times, considering the need that the business has to balance performance, product innovation, client mandates, capabilities and a regional footprint, cash management can be a logistics nightmare for any bank hoping to gain a winning edge. The business is also going through an identity crisis, with a wide swing from a consolidating trend in good times—moving cash management mandates to a single provider—to a diversifying one in times of uncertainty and crisis. Banks now want to mitigate counterparty risk despite the added expense of maintaining multiple relationships and attachment to multiple systems.
The need to stay on top of technology is probably also more acute here than it is in other businesses. “Technology is the most important thing to ensure efficiency of cash and payments,” says Songpol Chevapanyaroj, first senior vice president of corporate business at Kasikornbank in Thailand. “Banks will have difficulties in deciding how to invest and how to strategise their business priorities for payments, but those that do will find themselves in an advantageous position.” In terms of investment, banks are in two camps: some feel the need to acquire new technologies to be more relevant to their clients, while others are willing to streamline their offerings and to strip away the “bells and whistles” that were favoured in the past. Accordingly, banks in the former camp tend to favour tying up with or acquiring smart IT companies that provide cutting edge services, often customised for sophisticated clients, while those in the latter are big on speed and security.
For those in the specialisation camp, competition is pushing them into mobile technologies to enable payments via new channels such as mobile phones. Remittance technologies and commercial cards are all high cost and high maintenance businesses that can earn good fees with significant volumes. To add new revenue in tough times, players with large infrastructures are getting very serious about farming out bandwidth to smaller players in the form of white-labelled solutions for additional fee income—if the proper level of trust between both parties can be attained. The jury is still out whether banks want to become outsourcers to other banks, just as banks are not sure whether they care to outsource to other banks—the word “Chinese walls” tends to be an over-used one in transaction banking. But as banks buckle under the strain of maintaining expensive infrastructures it may become a more lively discussion, even more than it has in the past.
Treasury: running blind
With SWIFT reporting that global volumes for treasury are down 14.5% in the first three months of 2009, treasury activities have been highly impacted by money supplies that are facing slower growth or shrinking. Banks tied to the market are finding thta the challenge is to grow deposits, or at least keep their levels flat in declining markets such as Hong Kong, which saw its M3 money supply shrink 1.1% month-on-month in February, 2009, the latest month that records are available.
The treasury business has also been heavily affected by volatility in the financial markets. The crisis has put tremendous pressure on treasurers and CFOs to manage cash efficiently and cost-effectively. With the cost of liquidity soaring and the availability of liquidity plummeting, many companies are in tremendous difficulties, and the banks are in the same positions. Pricing has also been a major challenge; for 20 years, Libor had been relied upon to be a benchmark, but as markets dried up, Libor also became dislocated. While the three-month Libor gap had been 10-20 basis points in boom times, it has fluctuated up to 57 basis points, and then on to 149 basis points, ballooning sickeningly with each cut of the prime rate. On top of the rate’s gyrations, there is also the concern that Libor does not factor in the credit risk of each individual institution, and treasurers are looking for a new benchmark that will allow for a new standard in transparent pricing.
While there is some debate about using the price of credit default swaps, there are many mismatches, not the least of which is using a long-term indicator as a basis for short-term one. As one banker notes: “What is going on right now is a major dislocation of the traditional pricing benchmarks like Libor, and we just have not found what the new level is and so we have just crazy pricing going on occasionally. You have herd mentality that makes no sense at all, so sometimes I’m just as puzzled as anyone else.”
Financial supervisors also offer a modicum of uncertainty, as they exercise their powers to call up banks and ask them about their liquidity at any moment of time; it is a call the banks have to answer, and it challenges not only their own infrastructure but that of the various markets that they operate in. And in the coming months, the burden is expected to grow as new regulations come into place seeking to correct the imbalances that have existed in the past. “We are also likely to see new regulatory challenges coming for banks over the next 6-12 months, and the cost to comply with them will further drive consolidation and innovative wholesale solution structures,” says Daniel Marovitz, head of product management for global transaction banking and chief operating officer for technology for global banking at Deutsche Bank.
Trade finance: sleepy shipyards
Perhaps the happiest transaction banking business is trade finance, and those in the industry are relieved that there has finally been a move away from the risky, cutthroat underpricing of risk that came with the over-abundance of funding in the pre-crisis era. But the business is crashing at a sickening rate, as data gathered by Haver Analytics shows that from a 2007 peak of 20% growth, the total exports from 15 major exports around the world has fallen by a rate of shrinkage of over 30%, and set to fall still. SWIFT volumes for trade finance, meanwhile, are down 15.1% in the first three months of 2009, and trade finance experts enjoying the return of margins to the business may not have long before the expected onset of corporate bankruptcies brings reality crashing back.
With exporters hoping to be paid as soon as possible and importers seeking to delay payment as long as possible, the business is clearly a difficult one to manage as it is expensive, IT heavy, capital intensive and risky. The return of margins is the only happy point for those still in the business. Funding is starting to become available, with export-import banks and multilateral financial institutions such as the International Finance Corp. and the Asia Development Bank and many others providing funds and guarantees. The World Bank Group has also launched a global trade liquidity program for developing companies that aims ultimately to support $50 billion in trade volumes. In times of slowing trade flows, banks with strong ties to export development agencies will be leveraging these relationships to build up their share of the market.
But this doesn’t mean that they will be able to shirk the infrastructure needed to support the business. The feeling in the industry is that trade finance, if done correctly, can be a low risk service. There is concern that, as corporate bankruptcies increase, there will be more insights into which institutions were not doing trade finance correctly: skimping on the IT needed to manage the processes, or dangerously underpricing risk and diluting checks and balances needed to run a safe business. When trade volumes return—and some analysts believe that this will happen sooner than later—there may be fewer players in the market.
Given the challenges facing the transaction banking industry, it does seem that those who want to survive the shakeout will need not just plentiful resources and good relationships, but also nerves of steel. With such adverse conditions, it is a real return of the risk reward condition, where bankers that take the risks stand to gain the rewards; probably more a maxim of investment banking than transaction banking, but these are unusual times. – by Peter Hoflich
