2002

European bank shareholders are missing out on cross-border synergy benefits

By John Rushton

European Banker,  January 2002

Banks have proved that they can reward shareholders by extracting massive post-merger synergy benefits inside national borders. Measured by evolution of cost-income ratios, the scale and rapidity of value extraction following in-country merger can be dramatic.

'The targeted efficiency ratio is 50% . . . a sharp improvement on the 64% reported by the bank in 2000' Standard & Poor's on Danske Bank following Realkredit merger, June 2001 Standard & Poor's web site Market share of top three banks UK 60% Netherlands 65% Portugal 65% Sweden 70% Finland 90% Source: European Banker, June 2001

But in many European countries the market shares of leading banks are now so high that regulatory approval for more in-country mergers is unlikely. The market expectation is that the coming decade will see increasing numbers of cross-border mergers in financial services.

So far, bank executives have been remarkably successful in managing down shareholder expectations regarding synergy benefits from cross-border mergers. While European bank takeovers across borders have merged capital-markets operations, in most cases they continue not only to retain national brands but also to operate standalone national commercial and retail banking operations. They have neither targeted nor realised significant savings outside wholesale operations.

It is hard to imagine this situation lasting much longer, for two reasons:

• To continue to meet market expectations of value growth, managers will be obliged to do cross-border deals and to generate real cost and revenue synergies from them
• It is simply not the case that there are no role models for cross-border synergy realisation, and eventually this truth will dawn on shareholders and managers alike.

Adopting a standard operating model is the key vehicle for extracting value from cross-border banking mergers over the coming years.

This paper describes some of its features and highlights some of the challenges associated with its introduction.

The received wisdom is that it would be foolish for managers to try to realise cross-border synergies in Europe in the face of barriers such as:

• National regulatory regimes and clearing environments
• National product sets
• Differences in brand identity and customer segment strategy
• Linguistic and cultural barriers, and
• Human resources and government relations issues associated with moving jobs cross-border.

Managers believe this, and important non-shareholder constituencies want to hear it.

Yet major banks outside Europe have gone a significant way towards establishing common business models and systems for commercial and consumer banking across multiple countries.

A key approach used by these banks, which we predict European banks will increasingly be obliged to adopt, is the use of a standard operating model. Its key principles are described here.

Bringing science to bank operational strategy

Banks can deliver world-class operational effectiveness in a consistent way across borders by defining and rolling out a standard operating model. Such a model brings with it a number of benefits in terms of costs and revenue.

On the cost side, the anticipated benefit is unit-cost reduction through scale economies, reduced overheads and the forced dissemination of best practice. Key factors are:

• Maximisation of capacity utilization across business lines, functions and countries
• Extension of the central utilities concept beyond traditional shared service centres for group support functions (human resources, accounting, IT, etc) and into core bank transaction processes (credit, payment, etc)
• Consolidation of back-office activities, not only across the same business line globally, but also across different business lines (eg account opening for wholesale as well as retail clients)
• A smart sourcing approach, with selective use of outsourcing, and
• A readiness to locate processing in low-cost and tax- advantageous environments.

On the revenue side, the aim is to reinforce the brand while increasing agility. Revenue synergies come from:

• Willingness to homogenise product and service features to create a global product, and targeting of customer segments most receptive to "international" products
• Component-based product design, to meet local needs quickly and flexibly while retaining the benefits of once-only investment in training and systems, and
• Designing delivery around channels, to enable a simplified internal structure without significant duplication of support functions (as would be the case, for example, with a geographically-based design).

Both the revenue and cost side benefits are underpinned by developments in systems. Indeed, a standard operating model will only work with investment in:

• Flexible applications to permit local customisation of a common product set
• Customer data management to deliver common customer views across products, geographies and channels, and
• Standardised technology platforms and centralised technology operations.

In our experience, a standard operating model rolled out across multiple countries can deliver very substantial cost savings, above and beyond the benefits which could be extracted in a purely local context.

We expect these savings to increase, and the delivery risk to reduce, as experience is gained of making this type of transformation.

Getting from A to B

PA has worked with a number of banks in tackling elements of the cross-border synergy question and with one global bank in particular to design such a standard operating model and manage its implementation.

This experience convinces us that the prize justifies the effort, while recognising the significant challenges involved.

To tackle these challenges requires management teams to have the will and capability to design the blueprint and the stamina to implement it through a multi-year programme.

Some of the issues to be overcome include:

• Ambition: The business case for such a disruptive programme is probably difficult to make for a cross-border merger of two banks but is very strong for four. Do managers have the vision to plan for multiple mergers?
• Processing: How far is centralisation desirable, how far should common processing elements across diverse business units be integrated, and how tightly should service level agreements between central processing and local business units be defined?
• Governance: Are central units regarded as utilities or businesses in their own right with full value-creation accountability?
• Product management: How is a balance achieved between central product management responsibility for the core components of each generic product/service, and business unit responsibility for their packaging and localisation?
• Management development: Is it possible to build the management cadre with the background to tackle these issues, or will we see new model managers - the Sven Göran Erikssons of bank operations - hired internationally for their ability to deliver world-class operational effectiveness?

Summary

The market is looking to management teams to drive value enhancement in pan-European banking.

Revenue synergy alone is not going to deliver this and we need to see the exploitation of cross-border scale economies.

There is relevant experience outside Europe and banks need actively to explore both the theory and the practice of the standard operating model.

Those managers who can deliver operational synergies, and can replicate the process, will create a new paradigm for banking operations, generate superior value for their shareholders, and re-model the European banking arena.

John Rushton is an expert in banking operations and a member of PA's management group. Tel: +44 20 7333 5860
E-mail: john.rushton@paconsulting.com

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