There has been a notable consolidation of large corporate business into the hands of the global banks, with displaced banks moving into new segments and new geographies in the search for revenue replacement.
Many banks outside the global premier league face a dilemma. To retain corporate customers they must invest to modernize the key cash management product. Product gaps typically include lack of a credible international cash management capability and inflexibility in the electronic banking platform.
At the same time they face margin pressure and income volatility in the corporate business, which makes new investment difficult to justify.
Some banks are giving up the struggle, re-allocating capital away from corporate banking altogether and into retail and asset management businesses. Yet the corporate and mid-corporate segments still generate 20-30% of a typical bank's business. This does not look like a business from which a bank should simply walk away, especially as retail business will itself come under increasing pressure in future.
Is there some sort of inevitability at work, dictating that all but the premier league of global banks should lose their corporate business?
Our view is that mid-sized banks should fight hard to defend and extend their corporate business and that a reinvigorated cash management offering is a key weapon in this struggle. Banks can develop and implement an affordable strategy to protect and grow the corporate banking franchise by doing three things:
- Sounding the alert – quantifying the revenue at risk from failure to defend the business and building a consensus for change across various internal constituencies
- Choosing the battleground – defining defensible customer segments and the product offerings that will attract and keep them
- Fighting back – building a delivery platform which takes advantage of the new economics offered by both 'white-labeling' and web-based 'thin client' systems.
Sounding the alert
Deriving the necessary information to decide whether the corporate banking franchise is truly worth defending may not be simple. Many banks may not fully understand the drivers of relationship profitability well enough to be able to assess the real contribution of relationship products such as cash management. They need to recognize not just the direct fee revenue but also the indirect revenue to which cash management contributes.
Cash management is fundamental to retention of the core transaction accounts. It also generates business across other business lines such as treasury, trade or custody. While their relative weight will vary between banks, the elements to be considered in assessing the hidden value include:
- Margin on free/low interest balances
- Float
- Foreign Exchange margin
- Trading income derived from throughput insight
- Volatile element of margin
- Commission
- Cost of real time collateral
- Economic capital (re credit, liquidity and operational risk).
The threat is often not a 'big bang' loss of a whole relationship so much as an insidious loss of revenue streams as a relationship gradually unravels.
This unraveling usually starts at the point furthest away from the core transaction account – letters of credit, perhaps, or foreign exchange – and works its way in. The pivotal product in this process is cash management.
When the revenue from corporate customers has been identified the risk of its loss needs to be assessed. This is not easy but can be achieved in various ways including:
- Modeling sensitivity to customer defection for individual services, individual customers and whole customer segments
- Comparing the 'wallet shares' of customers with cash management to those without
- Comparing the revenues of customers for whom the bank is prime banker with revenues of those who consider the bank secondary or tertiary, and correlating this with cash management usage.
Choosing the battleground
Banks will be defensive in some accounts and segments while offensive in others. A strategy for cash management needs to address the needs of those customers a bank believes it can keep or win.
In some cases banks are exposed to serious concentration risk, with the whole direction of the cash management product driven by a few large customers which may not even be profitable. The issue here is whether to strive to improve margin in this segment or to focus on small and medium sized enterprises (SMEs) which may be more profitable.
In other cases banks have an ageing 'me too' product which fails to satisfy either large corporates or SMEs. Still other banks cannot decide whether to view SMEs as unsophisticated corporates or as sophisticated retail customers, and consequently they are unable to develop a credible electronic banking offering for them.
Banks in any of these situations need to clarify which customers offer the best long-term profitability, what features these customers will want in future, and how far rebundling of existing features and introducing new ones will make the offering more attractive to them. The result is a revenue-based business case for action, identifying the relationships and quantifying the revenue streams, which are to be defended, discarded or targeted.
Many banks are likely to discover an untapped SME market if they think beyond the capabilities and economics of the existing electronic banking platform. This is because the key to the future lies in a new and far cheaper delivery vehicle.
Fighting back
Web technology is a great leveler, eroding the competitive advantage of larger banks and reversing the trend towards consolidation in corporate banking. This technology offers mid-sized banks a powerful weapon, not only to defend corporate market share but also to win new customers.
In the past, physical implementation of the electronic banking terminal at the customer site has crippled the economic model for cash management because:
- The costs have been fixed, highly visible, and not scalable
- Direct fee revenue has been marginal, while the indirect revenue has been largely unmeasured.
It has often been uneconomical to consider rolling out this technology to any but the largest corporate segment. Two new developments change the cost dynamic however:
- Web-based 'thin client' systems massively reduce roll-out and support costs since there is no longer any physical implementation. This means that banks can roll out improved functionality rapidly. They can bring cash management services to smaller corporates. And they can now create an investment case for new improved technology where previously this was difficult
- White labeling – or use of packaged software acquired on an application service provider (ASP) basis – makes fixed costs variable, and offers a route to securing new functionality for customers on an ongoing basis.
Putting the two together means many banks can now afford to deliver competitive cash management functionality through a low fixed cost electronic banking channel. The result can be a significant uplift in the competitive advantage of mid-sized banks compared to their larger competitors.
The possibility of a 'mix and match' sourcing strategy is now emerging, combining white labeled services (such as international cash management) and internal provision (for example domestic cash management). Nevertheless the challenges in going down this route are significant and banks need to think them through carefully. They include:
- How revenue-sharing possibilities might alter the economic attractiveness of various customer/product combinations
- Technology compatibility between internally and externally sourced services, as well as between cash management and other electronically-delivered services such as treasury
- The need to ensure aggregated reporting across multiple providers, so that the core relationship is retained.
Conclusion
We are seeing an intensification of competition in corporate banking. But this time the result may not be a sweeping victory for the largest banks.
Instead we may see a comeback by those mid-sized banks which are able to exploit the new economics of cash management: to defend the corporate banking franchise against larger competitors, and to extend it at the expense of other banks which fail to seize the opportunity.
