Since 2007, return on equity has been nearly halved and prospects of growth remain uncertain. The result? Banks have no choice but to explore new ways of reducing costs. The utility model, still in its infancy in banking, but already mature in other industries, including aircraft and car parts manufacturing, offers a solution to cutting costs by ‘mutualizing’ them.
Utility model explained
The utility model is based on pooling, which enables several banks to share their processing costs and the weight of investments by entrusting them to a third party.
By delegating their processing to a service company – or financial technology business – a bank agrees to share resources and common IT architectures with other banks. This approach generates economies of scale, limits the impact of indirect costs and can more easily absorb the variability of volumes of each bank.
The scope of mutualization can be customized and applied to different areas depending on the needs of each bank. Options include: IT platform only or combined with processing activities (middle / back office); and function specific activities, e.g. detailed analysis of customer profiles (Know Your Customer).
Pooling implies that each respondent bank’s shared services center recognizes that the evolution of the entity, together with its structures and mode of operation, is achieved in accordance with the general interest of the group.
Why the need for drastic change?
Conventional cost-reduction levers in banking are not enough to preserve and increase profitability. Even the classic outsourcing model (where a provider has a team and resources dedicated exclusively to a bank) has limitations and does not enable a group of banks to reach the critical size to achieve economies of scale.
Mutualization also enables banks to tackle head-on the challenge posed by lower transaction volumes, combined with historical infrastructures capable of handling large volumes from the pre-crisis era, resulting in extra-capacity situations that increase the cost per transaction.
In addition, Dodd Frank, Emir and Basel III, among other regulations, require heavy investment while banks no longer have the means to invest heavily. Add to that the regulator’s concern for standardization and demand to create identical devices for each bank (whether transaction processing, monitoring or reporting) and the case for pooling becomes even stronger.
Utility is likely to soar in 2015
Although the utility movement is still new for banks, we expect that the drive to preserve and increase profitability will accelerate the model’s adoption in the coming months. As banking is becoming more standardized, it is naturally a perfect candidate for this approach. The crisis may ultimately help banks to reinvent themselves.