Why banks are not ready to start sharing expenses

Elisa Martinuzzi

Three years ago, Tidjane Thiam stirred hopes that the banking industry was looking at new ways to tackle its bloated cost base. The chief executive officer of Credit Suisse Group said his company was working on a common platform with another lender to share expenses.

The project has made little visible progress since then, and it is not because the pressure on banks to become more efficient has eased; there is a deeper resistance at play here to the notion of combining or outsourcing certain functions. Neither is Thiam’s false start the exception. Citigroup and Clearstream Banking announced a shared settlement and custody system in 2016, but UBS Group AG is the only other bank to have joined.

Trying to share costs with your rivals rivals does present difficulties, but they should not be insurmountable. For a sector whose revenue outlook and profitability is deteriorating, the possible gains from outsourcing are not trivial, as was highlighted in a recent report from the management consultancy McKinsey & Co.

Outsourcing production

Almost half of banks’ costs come from doing stuff that does not 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 its 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 per cent.

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 would not be able to recover the VAT they had pay on outsourced services. That could offset some efficiency gains and potentially make some shared services less appealing.

Anti-money laundering

Then there are the regulatory concerns and demands. As much as 12 per cent of a banks 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 would not 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 its 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 should not be ignored.

Bloomberg

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