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Banking and Capital Markets
Transaction banking takes off*Transaction Banking Compass
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Transaction banking is set to becomeone of the rising stars of the financialservices industry
Although the nature and scope of transactionbanking varies across different organisations,most definitions feature some commoncomponents. Figure 1 shows that transactionbanking businesses, which have historicallybeen focused on payments and cashmanagement, now often include trade-relatedservices, securities processing and fundservices.
In the next two to three years and asunderstanding of transaction bankingimproves, it will become normal for analysts tofocus on transaction banking business whenreviewing large financial institutions. Theleading international banks will meet thoseexpectations in both organisation and reportingterms, which will be to the ultimate benefit oftheir shareholders, customers and staff.
Are you leveraging this opportunity and makingyourself part of a potential good news story?
How high will the transaction banking star riseand how bright will it shine? That depends inpart on the depth and malignancy of thestresses that are currently affecting the financialmarkets. At the time of writing, the recordinterim results statements of 2007 have beenreplaced by record swings in 2008. Against thisbackdrop, the businesses of transactionbanking, trade finance and securitiessettlement look a lot more attractive toinvestors and banking CEOs than they wouldhave done two to three years ago.
While many high-profile revenue streams havelargely dried up in a market battered by theliquidity crisis, transaction banking businesslines are proving their value and demonstrating:
• Year-on-year growth patterns in volumesand values;
• Attractive performance results;
• The value of core banking relationships;and
• Clear alignment with traditional brandvalues.
A clear business benefit doesn’t meanan easy management challenge
If transaction banking offers such compellingvalue, then why hasn’t the idea already takenhold in more organisations?
Definition and scoping is a key challenge sincebanks organise and structure themselves in somany different ways. Often the explanation isrooted in the genealogy of an organisation, butthere are two main factors that determine theextent of the challenge:
1. The nature of leadership, in particularwhether the leadership style is federalist,centralist, entrepreneur or administrator;and
2. The nature of the barriers to change withinthe organisation.
Transaction banking is a risingstar of the financial servicesindustry, even if reorganisingseveral disparate transaction-basedactivities into a single commercialbusiness unit is a dauntingprospect. Banks that can give theirtransaction businesses a morecoherent approach, global reach, moreintelligent customer segmentation andbetter external communication willunlock significant value forshareholders. In an extraordinarilydifficult time, this is potentially a goodnews story for the markets and theinvestor community alike.
PricewaterhouseCoopers Transaction Banking CompassTransaction banking takes off
Figure 1: Nature and scope
Common components
Transaction banking does not have a generally accepted definition, but an analysis of company reports indicatesthat in most cases banks with discrete transaction banking businesses have some combination of the fivecomponents above.
Source: PricewaterhouseCoopers1
Payments
Clearing/Settlement
Transaction banking Cash management
Trade finance
Trust and securities
Julian Wakeham+44 20 7804 [email protected]
Peter Simon+44 20 7213 [email protected]
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1 PricewaterhouseCoopers’ refers to the network of member firmsof PricewaterhouseCoopers International Limited, each of which isa separate and independent legal entity.
PricewaterhouseCoopers Transaction Banking CompassTransaction banking takes off
The range of barriers can be significant, andtypical examples are set out in Figure 2 above.These illustrate that the person advocating thecreation of a transaction banking capabilityneeds to be in a sufficiently senior position ifthe idea, rationale and business case are to begiven a fair hearing. If not, then the responsefrom their affected colleagues will beambivalent at best and hostile at worst.
Many factors determine the willingness and theability of an organisation to carve out atransaction banking business, which oftennecessitates the extension of a shared serviceutility. Whether these factors can be overcomeclearly depends on the basis and the manner inwhich the reorganisation is first proposed andsubsequently undertaken.
Motivating existing revenue holders to engagein the idea is a delicate task, and one thatinvolves reviewing the incentive criteria andexpectations of the business activitiesremaining under their control. Effective
leadership is needed to carry this changethrough, and effective management to ensurethat its latent potential is realised.
A chance to break the mould
Many core components of transaction bankingsuch as cash management, custody paymentsand trade finance have one feature in common:they all involve large transactional volumes thatare amenable to automation.
However, the differing genealogy of thesecomponents often results in an unwieldy mixof concentrated and fragmented operationalmarkets. The differing components also tend toserve several important customer segments,including retail consumers, financial institutionsand corporate bodies.
For example, cash management is a highlyfragmented business in which many bankscompete and where there do not tend to beany obviously dominant banks or groups of
banks. In contrast, the custody market isdominated by three or four global players.This means that the way in which differenttransaction banking components have tocompete, and therefore their formulas forsuccess, can be quite different.
During the late 1990s and early 2000s, manybanks sought to address the inherentinefficiencies that resulted from this history bycreating strategic business units. These weresupported by shared service centre models,used more ambitious sourcing strategies andoften involved deploying more technology tothe issues. However, few of these strategiesaddressed the internal paymentsinfrastructures on which the businesses inquestion were based, and fewer still addressedthe actual business architectures that theinfrastructure existed to serve.
Too often banks’ internal transactionprocessing capabilities are treated as costcentres and financed by complex internalcharging structures. Typically they are alsoindependent of product development andrevenue-earning responsibilities. In short theyare not run as a business, but as a utility, whichcan be seen in functional organisationalstructures as opposed to business line ormarket structures with common components.For many this has resulted in:
• Constrained research and development;
• Infrastructures that are difficult andexpensive to adapt;
• Processes that inhibit regular infrastructureinvestment;
• Change agendas that are dominated bycompliance expenditure;
• Scaled down, delayed or ‘cool-boxed’commercial strategies; and
• High levels of customer complaint andoperational incident.
If it is indeed to be a business in its own right,a transaction banking business needs to havea revenue stream. Where this is not already thecase, this will normally involve a restructuringof existing business lines in order to reallocateappropriate revenue-generating activities intothe new transaction banking business line. Thismay look like ‘robbing Peter to pay Paul’, butthe potential for improved performance meansthis is a price worth paying.
Treating transaction banking as a businessoffers the prospect of better alignment ofrevenue, cost and investment. In short, a newway of doing old business.
Stay ahead of the pack – go global
An increasing number of leading banks arebeginning to recognise the potential valuehidden in their transaction activities. They cansee an opportunity to exploit this asset and arenow working hard to leverage it. Others arecontent to ape the business activities ofcompetitors, and to set their aspirationsaccording to relative performance measures.The key questions for management should bewhether their chosen strategies:
• Are sufficient to break away from the pack;
• Are likely to maximise total shareholderreturn in the long run; or
• Are going to expose the organisation tobusiness risk in the real economy?
Figure 2: Management challenges of formation
Ability to define andagree scope
Existing ownershipand organisation
Barriers
Managementinformation systems
Pre-existing incentivestructures
Talent loyalties
Embedded culture andestablished processes
Let me get back to youIt requires a more sophisticated sell than simply arguing that you can make a great business if you can take keyparts of your colleagues’ sales force, product teams and revenue streams.
Source: PricewaterhouseCoopers
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PricewaterhouseCoopers Transaction Banking CompassTransaction banking takes off
Even for institutions based in the heavilyregulated economies of the northernhemisphere, there are ways for some players toget ahead of the pack. To achieve optimalgrowth in transaction banking, financialinstitutions need to hitch their cart to theworld’s fastest growing economies. It is time tolook abroad.
In terms of trade flows, it is crucial tounderstand that since around 1994 there hasbeen a break-out in global trade as apercentage of GDP. Significant liberalisation
has taken place, and over the past decade orso trade volumes have soared on a long-termaverage from about 4% to 16% of GDP. In thesimplest terms, countries are importing andexporting more goods and services than everbefore and a lot of that growth involvesemerging markets. Figure 3 illustrates thescale and geographical scope of some of thesetrade flows.
Obviously, a transaction bank business that isfocused exclusively on the US or Europeanmarkets risks missing out if it does not have a
presence at both ends of the global supplychain. Growth in the transaction business isbeing driven by emerging economies, whichalso have a higher propensity to use tradeproducts than their Western counterparts.The ‘E7’ emerging economies (China, India,Brazil, Russia, Mexico, Indonesia and Turkey)are expected to be around 50% larger than thecurrent G7 countries by 2050.2
Upping the game
As well as positioning themselvesgeographically to take advantage of globaltrade flows, transaction banking businessescan also achieve great benefits from a moreinnovative commercial strategy.
A fresh approach to customer segmentationcan drive up product margins and contributionper customer. Transaction banking businesseshave traditionally segmented customers byturnover, sector and location. Similarapproaches by competing banks have resultedin limited differentiation, and the end result hasbeen a lack of real competitive advantage.
To be truly innovative in their customersegmentation, banks need to be present atboth ends of the supply chain. This gives thembetter visibility of the total credit risk, includingthe transaction itself, not just the customer.It is also vital to assess the sophistication ofthe corporate treasurer. For example, doeshe or she understand derivatives andstructured finance? Reviewing the customer’slevel of operational sophistication andinternal organisation is another importantpreparatory step.
By segmenting the market on the basis ofcustomers’ needs, financial sophistication,credit dependency and operational capability,
banks can identify different targetingopportunities. If they can then map thoseneeds against specific products, banks canpinpoint the most attractive opportunities topursue. These can then be targeted withsystematic strategies based on relationship,price and product.
Historically banks have tended to give bigborrowers many other services free of charge.This is akin to standing logic on its head. If acompany is a big borrower from a bank, itprobably means it cannot borrow the moneyelsewhere. If a bank becomes a hub for asignificant proportion of a particular industry’snetwork of transactions, it will have excellentvisibility of transaction data and be able toprice its services more effectively. This will helpthe lender to charge its customer a fair marketrate for transaction services, rather than givingthem away. The end result will be a positiveimpact on revenues and earnings.
What every analyst and FinanceDirector needs to know
Currently analyst coverage of transactionbanking, when it is reported at all, tends to be rather light: even though the transactionbanking business of global institutions could be contributing 50% of their profit growthwithin the next few years. It is therefore vital tosee the importance of this business if you are an analyst. For corporate planners there is also a great opportunity to increaseenterprise value through reorganisation and better communication.
2 The world in 2050, PricewaterhouseCoopers.
Figure 3: Significant trade exports from the EU. All figures in billions
Selected economies1. Iran, Saudi Arabia2. Brazil, Venezuela3. Indonesia, Japan, Singapore, South Korea, Thailand4. China, Hong Kong
Source: Eurostat, EU Exports 2006
WesternEurope
NorthAmerica
€805
SouthAmerica2
€169
Russia€231
MiddleEast1
€284
India€97
SouthAfrica€41
AsiaPacific3
€1002
China4
€999
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The message is clear: investors should bemade aware that transaction banking earningsare significant, core and growing.
Unfortunately the message doesn’t always getout. Even among those banks that have put astrategic wrapper around their transactionbanking business and made this structurevisible to shareholders, some could still domuch more to communicate future earningspotential to analysts.
There are therefore a number of ways to createand improve the value of transactionbusinesses, notably:
1. Create it;
2. Report it clearly;
3. Commercialise the cost base;
4. Brief analysts effectively;
5. Communicate key ratios transparently.
In this way analysts will be encouraged toascribe more value to it. For example, and assummarised by Figure 4:
1. A bank’s share typically trades at 6 to 8times earnings. In contrast the price-to-earnings ratio of a processing business isusually more than 20 times.
2. Assume that the transaction bankingelement of a bank is a $2 billion businessgenerating earnings of $700 millionper annum;
3. Taking a conservative approach to theaverage ratios shown above, a bank shouldbe able to persuade an analyst to value itsprocessing business at, say, 15 timesearnings rather than valuing it by default at,say, 8 times earnings; and
4. This has the potential to create a valuationuplift of $4.9 billion.
The key is to see the sum of the parts
The sources of income in a transaction bankingbusiness are essentially interest margin andfees. In the example shown above, if the feesegment is broken out and sold off as aprocessor, it could create a business worth $4or $5 billion depending on the multiplesassigned. Equity investors tend to favourprocessors over banks, owing to their highlevel of transparency, low regulatory oversightand relative cost, as well as their operatingleverage and scale.
Furthermore, many banks are currently short ofcash and looking to sell off non-core assets,without fully realising that they are sitting on ahuge operational asset. This is effectively abusiness that a bank does not need to ownand one that many private equity firms wouldlove to get their hands on. Is it therefore nowtime for banks to treat payments as theinformation processing business that it is andto concentrate instead on treasury andsettlement risk elements?
This could be a compelling business case for abank, provided that it avoids the pitfalls ofprevious deals and does not simply seek tooutsource a problem. A more prudentapproach would be to address the underlyingoperational, technical and people issues, all ofwhich are within management control andscope, with a view to divesting the asset andto realising the gains that are created.
Conclusion
Transaction banking is a business, but one thatis underleveraged. With significant upsides totreating it as a business, positioning it properlyin the corporate structure and to managing itas a commercial asset, transaction bankingshould be on the agenda of every major bank.
PricewaterhouseCoopers Transaction Banking CompassTransaction banking takes off
Figure 4: Transaction banking valuation(simplified example)
Annual revenue: $2bn
Annual earnings: $700m
Typical value: $5.6bn
Potential value: $10.5bn
Valuation uplift: $4.9bn
Where:• Typical is based on 8 times earning• Potential is based on 15 times earnings
Source: PricewaterhouseCoopers
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ContactsTo discuss any of the issues raised in more detail, please speak to your usual PricewaterhouseCoopers contact, the authors of this article or one of the people listed below:
Transaction Banking Practice Lead (Europe)
Julian Wakeham+44 20 7804 [email protected]
Transaction Banking Practice Lead (US)
Patrick Giacomini+1 646 471 [email protected]
Cards
Jonathan Turner+44 20 7213 [email protected]
Payments
Mark Hale+44 20 7804 [email protected]
Securities
James Chrispin+44 20 7804 [email protected]
Trade Services
Peter Simon+44 20 7213 [email protected]
pwc.comPricewaterhouseCoopers provides industry-focused assurance, tax, and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 155,000 people in 153 countries across our network share their thinking, experience and solutions to developfresh perspectives and practical advice.
Transaction Banking Compass: Regulation dominates the transactions agenda is produced by experts in their particular field at PricewaterhouseCoopers, to address important issues affecting the transaction banking industry. It is not intended to provide specific advice on any matter, nor is itintended to be comprehensive. If specific advice is required, or if you wish to receive further information on any matters referred to in this publication, please speak to your usual contact at PricewaterhouseCoopers or those listed in this publication.
For information on the PricewaterhouseCoopers Global Financial Services Transaction Banking Programme please contact Áine Bryn, Marketing Director, Global Financial Services, PricewaterhouseCoopers (UK) on 44 20 7212 8839 or at [email protected]
For additional copies please contact Russell Bishop at PricewaterhouseCoopers (UK) at [email protected]
© 2009 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.
PricewaterhouseCoopers Transaction Banking CompassTransaction banking takes off HomeQuitPrint
