the industrialization of banks - sapient

1© SAPIENT CORPORATION 2013

THE INDUSTRIALIZATION OF BANKS

David Donovan August 2013

2THE INDUSTRIALIZATION OF BANKS

Since the Civil War, investment banks have survived and thrived as global banks, boutique shops and regional players. The financial crisis shook investment banks to the core and showcased that the existing model no longer operated efficiently or adequately compensated shareholders for risk. Well-established and respected institutions, such as Lehman Brothers, a one-hundred-year-old bank, and Bear Stearns, an eighty-year-old firm, collapsed. To survive, other investment banks, such as Morgan Stanley and Goldman Sachs, converted to bank holding companies. Regulations became the driving force, and with that came the burden of higher government oversight and increased scrutiny on operations. To maintain solvency, banks received billions in tax payer dollars and the Troubled Asset Relief Program (TARP) put in over $700 billion to stabilize the economy. Its goal was to overhaul the financial system, resuscitate the economy, and improve risk management within organizations. Unfortunately, the economy continued to stagger, and investment banks shut down products facing increased regulatory scrutiny, such as commodities trading, in order to survive the crisis.

The financial crisis shook investment banks to the core and showcased that the existing model no longer operated efficiently or adequately compensated shareholders for risk.

When ICE, a twenty-year-old company, acquired the New York Stock Exchange, a two-hundred-year-old financial pillar, it sent a shockwave through the industry and highlighted the power of younger, more agile firms. For many, it demonstrated the problems with “business as usual” operations and underscored the need for a significant change in the investment banking industry. In an industry flooded with newer, tech-savvy players that are unencumbered by legacy systems, processes and business models, how can established investment banks more effectively compete? To find the answer, banks must look back in time for inspiration to the Industrial Revolution as they rebuild both their images and infrastructures. The notion of substituting machines for human power is still applicable in today’s banks where manual processes and paper trails remain firmly in place. Today’s investment banks need to undergo an industrialization transformation of their own, leveraging increasingly sophisticated technology and adopting lean operating principles in order to effectively compete and thrive in the post-financial crisis market. This article discusses the current state of investment banks, key challenges facing C-suite executives and introduces specific changes that banks must make as part of a greater industrialization transformation.

THE CURRENT STATE OF INVESTMENT BANKS

INTRODUCTION


While investment banks have always faced market volatility, they must now address additional challenges, which include:

Increased regulatory oversight—The increasingly complex regulatory environment has had a direct impact on the operating costs and revenues of banks. Keeping up with the dynamic regulatory environment at home and overseas, while providing a higher return on equity, is now one of the biggest challenges facing banks today.

Technological advancements—The crossover of consumer technologies into the enterprise, multi-customer channel growth and the commoditization of infrastructure have greatly challenged the traditional bank operating model. The cost of modernizing and replacing core systems involves large outlays at a time when investment banks are looking to reduce operating costs. Technology continues to be at the core for financial institutions, but Chief Information Officers are facing conflicting priorities and must justify the investment needed to modernize their infrastructures.

Higher consumer expectations—The market crisis, bail out of large banks and constant media attention on Wall Street salaries, among other things, has changed the customer’s perception of banks. Once considered trustworthy and stalwart, banks today are dealing with retail and corporate customers that are wary and distrustful. What’s more, with ready access to a wide range of resources, customers are now more well-informed. This is driving a shift in the market and forcing banks to develop user-led offerings that cater to the customer’s desire for personalized service and improved care.

Market uncertainty—Although stock market performance has improved so far in 2013, C-suite executives are taking a cautious approach in rationalizing their business portfolio and have adopted a more structured and rigorous process when evaluating new business opportunities. Even so, the C-Suite

NEW MARKET, NEW CHALLENGES

continues to take informed risk decisions by investing in opportunities where they believe the organization has an edge. Uncertainty in the global economy, combined with global changes such as the European crisis, has continued to impact the market. As a result of the market slowdown and uncertainty, companies continue to preserve their cash and are conservative in their growth plans. This reticence to invest continues to impact the flow of capital in the marketplace.

Increased competition—The competitive landscape for investment banks is multi-dimensional, involving traditional and non-traditional players. As large banks struggle with regulatory challenges, nimble competitors are emerging and are chipping away at more established banks’ revenues. Smaller companies are leveraging technology to build better analytical engines to process big data and are using the cloud as their platform to reduce the barrier to entry.

The following key challenges are influencing investment banks and precipitating the need for change. While it is difficult to predict exactly how investment banks will evolve, some common themes are emerging, which include:

• The bank of the future cannot take excessive risks withtax payers’ money. All customers and counterparties need to be treated equally in terms of advisory, execution and pricing of client services with the goal of maximizing client-driven business success.

• New players will emerge that will leverage technologyin a way that delivers financial services at a much lower cost and targeted towards customer needs.

• The use of mobile, e-commerce platforms and portalswill replace the old way of transacting—and have an emphasis on lean solutions for the front office.

• Banks’ future goals will be focused on returns abovethe cost of equity. To do this, they must control costs as revenues will be lower and the cost of capital higher.


Similar to the automobile industry in the 1950s, investment banks must deal with unprecedented change and enable transformation at the core. Faced with a lower than optimal return on equity in some asset classes, banks have either curtailed trading in those areas or exited them altogether. The loss of these revenue streams, coupled with multiple challenges, such as regulatory compliance and capital requirements around risk-weighted assets, are forcing firms to seek cost savings and efficiencies wherever possible in a drive to increase the return of equity for the shareholders. Forward-thinking firms will lead the industrialization of the financial industry by leveraging a factory model that encompasses processes, technology and people to build profitable, cost-effective organizations. Firms that do will be best equipped to bolster innovation, uncover new products and grow their client base.

Many of today’s investment banks are already running separate cost-saving and revenue-enhancement initiatives. But they are doing so in silos and are spending money building non-core capabilities within the organization. These initiatives are being run within technology, operations, sourcing and front-office departments with a loosely defined governance model and no good way to measure and report on the strategic tie-in with board mandate. In the end, these efforts will create limited value and could hamper future growth. The industrialization of banks is an initiative that must start at the executive level and flow throughout the firm, encompassing every department and function. It is a multi-dimensional effort that must involve:

Leveraging technology to drive innovation and efficiency.

For banks, innovation should be at the core of all initiatives—not an afterthought. An example of the innovative technologies firms can build into standard software development projects is User Experience (UX) design and data visualization. UX design is the practice of incorporating how users access, interpret and relate to data in the overall design of a particular system or piece of software. By aligning software with how users typically manage information in their daily tasks, UX design provides a more natural way to search and analyze information. This, in turn, allows analysts to more effectively and efficiently find and consume data. Analysts will find themselves equipped to make better decisions because it is easier to find and analyze what’s relevant.

THE INDUSTRIALIZATION OF THE INVESTMENT BANKING INDUSTRY

Forward-thinking firms will lead the industrialization of the financial industry by leveraging a factory model that encompasses processes, technology and people to build profitable, cost-effective organizations.


automating processes through the use of technology or implementing a central data repository that makes it easier to access and share data across the firm. In fact, with the recent explosion of data powered by the internet and flowing through a variety of devices, how firms manage their data is going to be critical. The key will be to harness the data, much of which is unstructured, so that it can be an effective tool for each user in the organization. Banks that can create an efficient way to process and structure data so that it is in its most effective form for each type of user will have an advantage in the market. Data management processes and technologies, such as visualization, will be critical to those efforts.

Introducing a cultural shift within the organization.

In the past, a bank employee’s compensation was tied to profits, encouraging employees to push products that had a greater impact on bank revenues, regardless of client needs. In the wake of the financial crisis and in the face of growing client mistrust and cynicism, banks are not only being forced to change business models and processes, but also the very culture within the firm. In their book Lean Thinking, Jim Womack and Daniel Jones largely attribute achieving truly significant business improvements to having the right culture and mindset. Without a shift at the core, efforts to create efficiencies will not garner the desired results. Therefore, to restore client trust, banks must define a model for managing and sustaining client relationships. A key element of this model is to tie employee compensation to customer satisfaction—not profits.

Going beyond traditional cost savings.

For decades, banks have outsourced back-office functions. But, there is so much efficiency to be gained by this approach that organizations are now looking beyond the back office to outsourcing middle-office processes as well, such as trade management support, position and valuation and risk management. Banks must look at their enterprise and take stock of their portfolio and the processes associated with it. Which of these are common across all banks and could, potentially, be commoditized and shared? One such strategy is to identify non-core functions that are common across all banks and leverage a utility model to cost-effectively manage them. For example, all banks must onboard new clients, which includes a wide range of customer acquisition activities, such as account set-up, Know Your Customer (KYC) and anti-money laundering requirements, etc. This is a function that can be easily outsourced to service providers. Another example is market data. All banks get the same market quotes on a daily basis from the same data service providers and spend significant resources processing that data and dispersing it into the various trading silos. Instead of maintaining the IT infrastructure and people costs to do this, banks could pay a service fee and focus more resources on core business functions. Firms must build a better target operating model and work towards an integrated implementation of cost saving across the enterprise. Doing so will require banks to look beyond traditional cost-saving opportunities.

Leveraging a lean manufacturing model by creating an efficient system.

Many banks still rely on manual processes for key functions and maintain data in silos throughout the organization. Banks that want to create a lean manufacturing model must first identify these inefficient processes and IT infrastructure elements and create a plan to make them more efficient. This could entail


Improving best practices around collateral management and re-tooling risk models.

Swaps trading has long been a key activity and source of revenue for financial institutions. Recently, regulations, such as Dodd-Frank and EMIR, have increased the amount of collateral required to back a trade. With reserve requirements raised, banks must now commit more assets as collateral, which in effect, negatively impacts the revenue earning potential for those assets. Therefore, the ability to optimize the collateral process in a way that allows banks to precisely meet regulatory requirements without tying up any more assets than necessary will be critical to the bank’s overall performance. This will involve establishing a highly efficient approach to managing the collateral allocation process, making it easy to see which assets are committed to specific trades and when they will be available to be moved to support another trade without minimizing the drag on the bank’s portfolio.

Closely analyzing portfolios with the aim of culling non-performing assets.

In the past, global banks felt pressure to be in all asset classes. Over time and with trading and operational costs on the rise, not all asset classes continued to be profitable. Therefore, banks will need to review each business area in terms of return on equity and cost—and ultimately determine whether the particular activity is worth the investment. Many banks have already begun this process. For example, UBS and Morgan Stanley recently announced that they were completely getting out of—or significantly reducing—their fixed income trading activities. UBS is shifting focus to wealth management and equities and Morgan Stanley is focusing on wealth management. And many firms are exiting commodities trading due to its high cost or selling off non-core business lines. Going through this exercise will help banks free up capital that can then be re-allocated to higher margin businesses or invested in identifying new revenue streams. Tier 2 banks are also looking at their portfolios for ways to minimize the cost of trading. Some are willing to pay a service fee to leverage Tier 1 banks’ existing trading systems to avoid the IT and people costs required to trade certain assets.

Embracing a multi-channel distribution approach to engage with customers and sustain customer relationships.

Today’s customer is much more knowledgeable and involved in their investment strategies than ever before. And with the preponderance of mobile phones and other devices, they can and want to access their accounts in a variety of ways. When developing new products or updating existing ones, banks must consider these preferences and engage with customers through a variety of channels—whether they be traditional or mobile.


Firms throughout the capital and commodity markets are learning to survive and grow in a marketplace of new realities. These include increased regulatory oversight, advancing technology, better informed customers, reduced flow of capital in the market and increased competition. To address these challenges and thrive in this new environment, it’s imperative that firms make holistic changes, similar to those taken by the automobile industry in the 1950s. The adoption of lean principles that form the foundation of “industrialization” requires a fundamental cultural shift that must be sponsored and supported by the bank’s executives in order to be successful. Firms that don’t wholly commit to establishing a lean operating model will be so mired in rising costs, their ability to establish a competitive advantage will be compromised—and their future will be questionable.

Creating the role of a Chief Industrialization Officer (CnO).

A key role for banks embracing industrialization is the Chief Industrialization Officer (CnO). The CnO is a senior executive with C-suite sponsorship and strong operational experience whose main focus is to implement the vision of an industrialized bank. Residing in the CEO or the COO office with responsibilities across the organization, the CnO must have the business acumen to effectively cross lines within business, operations, technology and risk management. In addition, the CnO should be able to operate within a large-scale business and influence change across the organization effectively. The CnO should have deep operational and technology experience, a strategic mindset and the ability to manage key stakeholders to help navigate and break through organizational silos with ease. Firms that don’t have someone accountable at the C-level to drive these initiatives will struggle to be successful.

INDUSTRIALIZATION— A PREREQUISITE FOR THE FUTURE

AUTHOR’S PROFILEDavid Donovan Jr. is a Vice President with Sapient Global Markets. David brings 25 years of experience working with investment banks and asset managers and has a deep understanding of business, regulatory, operations and technology challenges facing C-suite executives. As a trusted advisor, David has been involved in a number of key industrialization initiatives, helping banks to optimize their operating platforms and leverage globalization to reduce costs and grow revenues.

Resources

› Global Investment Banking’s Long Road to Industrialization, Alix Partners› Lean Thinking, Jim Womack and Daniel Jones› 2012 CEO Global Survey – Price Waterhouse Coopers › October 2012 C Suite Survey – Addeco Corp› CIO Survey 2010 – Banking Systems and Technology


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the industrialization of banks - sapient

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