Trying to share costs with your rivals rivals does present difficulties, but they shouldn’t be insurmountable. For a sector whose revenue outlook and profitability is deteriorating, the possible gains from outsourcing aren’t trivial, as was highlighted in a recent report from the management consultancy McKinsey & Co.
Almost half of banks’ costs come from doing stuff that doesn’t set them apart from their competitors, McKinsey finds. Much like the car industry in the 1990s, the consultants argue that banks could outsource much of their “production” to third parties. Trade processing, collateral management and “know-your-customer” functions are just some of the things that could be farmed out.
While one should bear in mind that consultants are always eager to promote outsourcing projects, seeing as it’s a service they offer, the financial benefits for the industry are tempting: Lenders could see their cost-to-income ratios improve by 4 percentage points and their return on equity (a key measure of profitability) could increase by as much as 1 percentage point, according to McKinsey. The industry’s average ROE has plateaued at about 10.5%.
In Europe especially, where bank valuations are much lower than during the 1990s, every penny counts. So why have bankers not pushed harder on sharing costs?
There are some practical reasons. Because financial services are exempt largely from value-added tax, they wouldn’t be able to recover the VAT they’d pay on outsourced services. That could offset some efficiency gains and potentially make some shared services less appealing.
Then there are the regulatory concerns and demands. As much as 12% of a bank’s costs are soaked up by anti-money laundering processes and the monitoring of customers, making it a possibly fruitful area for cost savings. But sharing these processes with other banks wouldn’t shelter a lender from its legal duties. If anything went wrong, the responsibility would still lie with the individual bank. As such, it would still feel beholden to check this information even if it’s held on a common platform.
That said, a raft of money-laundering scandals in Europe — and the hefty fines that will almost certainly follow — have added a sense of urgency. Six Nordic banks are creating a joint company to handle “know-your-customer” data.
Generally, the biggest obstacle to shared services is getting buy-in from banks, with the efficiency gains often not deemed enough to offset the loss of control and flexibility.
Until a year ago, executives were counting instead on a possible increase in interest rates to improve revenue. And for wholesale banks, saving a little here and there through complicated outsourcing projects is less attractive than trying to push their bankers to win a big-ticket initial public offering or a merger that can pay tens of millions in fees.
But the industry outlook — especially in Europe — has become sufficiently grim to warrant a rethink. More than one-third of the world’s banks are sub-scale, according to McKinsey, while their business models are broken and they may have no option but to sell themselves in an economic downturn. With such a background, any chance to cut expenses shouldn’t be ignored.
“Some banks would rather die than cooperate,” one senior bank executive told me recently. Too often they’re not willing to give up autonomy or write off legacy assets. While technology advances should make sharing easier, a round of banking M&A may come sooner than a reckoning on costs.
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Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.