New game, new rules: how banks can re-invent utilities

In the old future, collaborative sourcing involved banks creating a single provider to deliver ‘the least common multiple’ at a lower/utility cost. A good example is cheque clearing. Once something banks had to do, cheques are now seen both as a cost and as a commodity. The industry spent decades standardising cheques to look the same and be cleared in the same way. Sharing as much of that cost made sense, and now the UK market has only two processors, and the number of clearing centres has collapsed to a fraction of what it once was. This makes maintaining or updating processes simpler, and implementation can be controlled to be convenient to banks’ budgets and priorities.

Gareth Lodge is senior analyst at the research firm Celent

Just a few years ago common utilities were seen as positive. Indeed, the UK Office of Fair Trading, in its Cruickshank review of the UK banking industry, referred to them as “benevolent monopolies”. In short, while there were aspects of a monopolistic situation, it was to the benefit of the majority of the market. At a European level, collapsing the number of European processors even further from more than 40 to a maximum of seven if not fewer players, was seen as a good thing.

The past was fewer, bigger, shared utilities, concentrating on common, non-competitive tasks. They have clearly served to deliver value to the cost side of the banking industry’s balance sheet. Service delivery aimed at cost containment, usually at the end of the process, rather than concept and design aimed at growing market and wallet share. Clearing, but not yet client onboarding; settlement, but not yet sanctions; implementation, not innovation.

In today’s faster-changing, customer-informed, global reach, regulation-inhibited world, can they deliver more value? Picture the leading global banks 10 years from now. Will there be utilities in the banks’ models and what will those utilities do? Will they inhibit and restrict, or act as enablers?

New world challenges are different. In the new future, banks face numerous challenges.

Firstly, there is a resource gap on at least two fronts. Banks no longer have the resources they used to have. Just look at the numbers of staff that banks have had to lay off, coupled with how many people are now employed in risk functions. Questions have to be asked about how much efficiency has been gained at the cost of agility or ability to innovate. Equally “run-the-bank” costs as a share of the total budget are at an all-time high, not just because of rising maintenance and regulatory spend, but also because the discretionary spend has been hit so hard.

Secondly, banks are so absorbed by what must be done – compliance, IT updates – that there is no freedom to innovate. People are indefatigable and many will try – but they won’t get far before some insurmountable internal barrier will be found.

Yet there are growing gaps that need to be addressed. There is an expectation gap that is getting wider as customers get more savvy and require faster services than ever before. FX rates, once taken for granted since there was no way of knowing whether they were fair, can now be compared online. Once the saviour, the internet now poses as many challenges as it does opportunities.

That creates a technology gap which is getting wider every second. The technology which customers use is changing faster than banks can update and provide for their staff, let alone support in their core technology. By 2015 2.4 billion people will have smartphones/tablets, pretty much representing 100% of the wealth in the world. Only a decade ago, banks invested heavily in their own delivery channels. Today, anyone can access all of the customers, in realtime, at no cost.

Since banks can’t deliver, update, and reinvent apps at the speed of Angry Birds a new strategy is called for.

There is a critical distinction in payments which doesn’t apply to most utilities: there are two ends to every transaction. In the Old World, banks provided connectivity between the ends. That had value.

In today’s world, everyone is connected. Country boundaries are fast diminishing.  Banks can no longer lay claim to value in the connectivity. Of course, the ‘ilities’ are necessary and costly in banking. But security, reliability and recoverability are less critical in voice, games, and information access and dissemination. They may be a little more so in social media, though users expect them to come bundled ‘as part of the package’ rather than explicitly costed in. The expectation, certainly in retail banking transactions, is the same. The opportunity to unbundle has gone.

Neil Burton is director of product strategy at Earthport

So how can banks best respond to the challenges of this New World? One approach might be to withdraw further into the fundamentals of the old model – command and control. In the Old World, banks felt they had to control the utility. It was owned by the banks, largely stuck to the knitting and did as it was bid. Its value was measured by cost take-out and reliability.

The alternative strategy is to require the utilities to create greater value. Perhaps to establish client onboarding best practices, incorporating KYC processes and data stores. These are things that all banks must do, and do themselves – yet there’s little competitive value in doing so.

Value could be created just because the utility is owned by the banks. For example, each bank owns half the puzzle of data relating to a B2B transaction – their utility sees both parts of the data. Internet technologies such as mini URLs for example are becoming increasingly adopted to connect sender and beneficiary. If the beneficiary wants to know what a payments is for, then they click on the URL. Perhaps it is part-payment of an invoice, or maybe it is an electronic birthday card.

Perhaps we might one day get ‘compliance central’, a single utility whose role is to ferret out the bad needles in the electronic haystacks, which today we do dozens of times over (while watching cash flow around the edges).

Having a central view means greater opportunity to see patterns, and to act quicker. And in a world of growing fines for non-compliance, a problem shared is a problem halved. Releasing resources through “commonalising” compliance functions would of course save cost, some of which could then be diverted into other ways to find bad needles.

If the payments industry is to flourish, the rules of the old game need to be challenged. Maximum economic value is generated by ensuring a large number of banks are using the service – it needs to be inclusive, not exclusive. Almost the first step is to lose the old terminology of utilities and benevolent monopolies, and start thinking about phrases around common platforms and components; innovation and inclusivity.

New commercial mechanisms would be needed. Banks have been used to the ‘command and control’ culture will need to allow – and indeed encourage – the utilities to go beyond their historic briefs.  Regulators will need to recognise that utilities need to operate more like commercial enterprises – perhaps seeking investment from the private sector as well as the banks.

Whereas in the past, utility-owning banks dictated almost everything, in the new model their role will look more like that of a venture capitalist. Control will come through governance and ownership, not through micromanagement. The management and staff of the utility will therefore be incented to invent and innovate, and the successful ones will be rewarded.

Banks need to learn how to harness other people’s innovation; but equally, de-harness it just as quickly, and move on. Lack of ownership means the relationship is much more on the value of the service given, than the value they have in the service provider itself. Banks will realise they have purchasing power which is just as powerful as ownership and control, if not more so. Just look at how banks approach outsourcers versus their utilities. The utilities are tasked to “stick to the knitting”, yet an outsourcer who only maintains the status quo will soon be shown the door.