Maintaining profitability and business growth is a struggle for banks today as they face growing constraints on capital and operating models resulting from new regulation from Basel III, EMIR and MiFID II. Banks can continue to make incremental procedural changes to meet new regulatory requirements, but reliance on legacy systems and quick compliance fixes is only increasing both the complexity and cost of operating. In a Q&A, Denny Dewnarain of Misys talks to DerivSource about how banks can transform their business and operating models to establish a better foundation for growth beyond these tough times and to address common challenges such as data disparity.
Q. For tier-two, three and four banks, what are the most significant external and internal challenges banks face today as they adjust to the changing market place?
A. The most significant external challenge for tier-two, three and four banks comes from and the scale and pace of change in the regulatory environment. Also, as the tier-one banks change their business models and withdraw from non-core regions and business areas, this opens up new opportunities and challenges for the lower-tier banks. They need to become more agile in order to respond to these.
Internally, many banks are constrained by their systems landscape—the technology that they have been building or putting in place over the years—and a disparity of data, where data they are working with is either incoherent or not validated.
Q. Tell me more about the challenges with data disparity? What is the impact of this on banks?
A. Capital markets organisations have historically been divided by business silos or asset classes. Equities, interest rate, and fixed income desks all had their own solutions and pricing frameworks that may not have been fully compatible with one another. At the same time, there was an overlapping of hedging instruments across different asset classes, where different business lines would use different data inputs.
Data disparity is inefficient, and leads to higher operational costs. Tier-one banks are adjusting their models in order to react appropriately, but tier-two, three and four banks also need to have a quality view of their business with coherent data across the entire organisation. If they don’t, it becomes much harder to look at the overall structure of the bank and determine where to put their business focus.
Q. Banks of all sizes are familiar with the challenges they face (regulation, cost hikes etc) in today’s changing market. How have the majority of tier two and three banks been tackling these challenges to date and why?
A. In the past, banks were forced to react quickly to market and regulatory changes. They were not always able to look at the big picture. This enabled them to deliver and address changes fast, but it also came with a high cost related to increased systems maintenance and redundancy.
Many firms reacted to the need for change with “quick-and-dirty” internal development, making small incremental changes to rationalise or use what they already had to cover new requirements.
Increasingly, this way of doing things is in the past; many firms are now trying to look more at the complete environment. They know they have to invest in their landscape of solutions and the way they comply with regulations, but they need to try and see things from a functional perspective. Tier-two, three and four banks are trying to kill two birds with one stone, by leveraging and optimising the investment around regulatory changes to review and improve the business functions around it.
Q. What will be the trigger point to get banks away from focusing on incremental change to support regulatory compliance to a more significant overhaul of the business operating models (front to back office processes)? Do you think 2016 will be the year for banks to change their plans?
A. I think 2016 will be the year banks start making strategic changes because they have realised there is no ending point to regulatory change. It is part of the normal environment and they will need to adjust constantly. Banks have been reacting in an ad-hoc way—a new demand comes and they comply with it. They run it as a project and when it is done, they try to leverage it. Now, if we assume that there will always be changes, trying to use existing systems, or making “quick-and-dirty” adjustments in-house, is not sustainable over time. Because new rules are always coming, the cost of developing and maintaining the infrastructure to support these incremental changes will eventually be higher than the banks’ revenues.
Tier-one banks started to realise this a year to 18 months ago. But in late 2014 and 2015, tier-two, three and four banks have also understand they need to do something more drastic than before—rather than incremental change they need to think about transformation, which has to come from the executive management at the top of the firm. These things used to be tackled business line by business line—now it’s more driven from the top, because this transformation requires a whole new business model.
Q. Are there any lessons tier-two, three and four banks can learn from how the top-tier banks are tackling challenges? How are the challenges and solutions different?
A. Tier-one banks have been getting really granular in terms of defining horizontal business layers, or services, across all their business lines, which enable them to be more agile and more reactive. As they have defined these services, they have begun to think about leveraging them and offering them to the financial community as business utilities. Tier-two, three and four banks need to decide if they want to figure these things out on their own, utilise the services that the big tier-one banks are putting in place, or go to a vendor.
Q. What one technological investment should banks be making that they haven’t so far, and why?
A. Banks clearly have to simplify their architecture. They have to start looking at things at a bank-level perspective instead of a business-line perspective. They need a global regulatory hub across their capital markets, lending and banking departments. Pricing, for example, goes across all the different business lines—and the Fundamental Review of the Trading Book (FRTB) brings that into play. The Basel Committee on Banking Supervision rule about transparency (BCBS-239) also goes across business lines. It’s about data quality, how you aggregate, how you define a coherent workflow validation across domains. From an architecture perspective, banks definitely have to think about their workflows, their data management and how they bring transparency into the organisation.
Q. What does a transformed and future-proof operating model look like? How is this different than the way banks have managed processes in the past?
A. In the past there was a vertical focus or approach for a specific business line. We’ve seen the tier-one leaders start to think horizontally about the various functions. Take collateral pricing, for example. I think in the future we will see these horizontal business layers, which give the bank the freedom to change and evolve as necessary.
The other big implication of the future-proofing model will be around connectivity. As the market is defining services or utilities that may be consumed, used, or sold, connectivity and inter-productivity across these business horizontal services and components will be key. And this could be internal to the tier-two, three and four banks, or external. It can come to them from the tier-one banks, or from vendors like Misys.
Q. What should tier-two, three and four banks be focused on in 2016 and why?
A. The changes happening in the market don’t just affect the banks—they impact their customers as well. Banks must focus on their clients’ needs to be able to offer all the levels of services, whether they are built in-house or outsourced. The same person might be a customer from a trade-finance, lending, treasury, or retail perspective. A customer-centric outlook will help them leverage their business interactions and their customer contracts and add more value to the customer relationship. This will involve some re-architecturing, but it’s worth it to provide the level of customer centricity clients are looking for.
