Change, at what cost?

The case for industrializing business and technology change

2

33

The recent rise in bank profitability to near pre-crisis levels may be a welcome development for the financial industry, but some other key measures should give bankers good cause to be circumspect about the news. Industry capacity remains too high. Regulatory requirements continue to drive up costs. And return on equity (ROE) remains markedly and stubbornly below the industry’s aspirational 15 percent level.

In short, banking costs too much, and there’s too much of it to go around. Today banks face a structural issue of surplus capacity, which the extensive mergers and headcount reductions of recent years have not resolved. It’s estimated that one of the top eight banks could be taken entirely out of the equation, yet still leave enough capacity between the other seven to match industry demand.

Years of super-normal profits prior to the crisis and continuing central bank liquidity injections may have masked the depth of the problem to this point, but the industry now truly faces a tipping point: It must transform fundamentally to eliminate entrenched operational inefficiencies, battle a growing cast of competitors and revive bank returns. Capco believes “industrialization” of the financial services industry offers the key to addressing these challenges.

As detailed in the Capco white paper “The Industrialization Realization,” industrialization involves fully rethinking why activities exist and developing a deep understanding of all their component elements. This discovery equips banks to then pursue real efficiency gains by deploying innovative processes using all the tools and partnering models now available.

Change, at what cost?

The case for industrializing business and technology change

By Mark Reeves, Partner and Global Capital Markets Leader, Capco, and David Oxenstierna, Partner, Capco

The industry now truly faces a tipping point: It must transform fundamentally to eliminate entrenched operational inefficiencies, battle a growing cast of competitors and revive bank returns.

44

Through industrialization of key areas, banks can transform in the way Dell, Apple and IBM transformed the technology industry and how modern car makers transcended past industry practices. Rather than attempting to be all things to all customers as in the past, banks can focus on their core competencies and leverage partnerships to handle the risks and responsibility of commoditized products and operations.

One area that industry-leading banks see as a highly promising candidate for industrialization: the processes for making business and technology changes that drive development of new capabilities, products and services.

The role of business and technology change operations

The job of keeping a bank’s core systems for transaction processing, account updating and recordkeeping lies with IT professionals in “run-the-bank” roles. Other staff, typically in the operations and IT organizations, have business and technology change (B&TC) duties; their job is to undertake transformation projects such as adding processes, functionality and data models to accommodate new financial instruments, risks and regulatory requirements.

In the past decade, banks have outsourced certain elements of their run-the-bank operations, particularly back-office and infrastructure elements, to reduce cost and complexity. But as banks outsourced, typically to offshore locations, they often discovered that this piecemeal, non-strategic approach actually creates barriers to streamlining by binding them contractually to legacy solutions.

Meanwhile, B&TC projects, which require special skills to manage and execute, continue to be handled in-house. These projects are critical to a bank’s performance and prospects because they equip it to innovate and adapt to marketplace changes. But these projects are also expensive. Capable personnel can command premium compensation in the core, high-cost locations where banks’ project resources often reside. B&TC projects can also be intermittent due to budget fluctuations and other conditions, raising staffing issues for banks and job concerns for the people assigned to them.

A major cost and concern

Annual B&TC budgets in large financial institutions can reach hundreds of millions of dollars and spread across small-to-large projects and disparate

functional areas. Typically, a bank assigns B&TC resources to different functions within the organization in groups of up to 20 people. This approach is seen as facilitating alignment with the needs of the business, as well as supporting appropriate budget allocations.

Deploying resources in this manner can also create issues. Should sudden, large demand for change capabilities—such as new regulation, remediation, legacy replacement and business build-out—arise in a particular function, embedded change specialists are not easily moved into, or necessarily equipped for, the area with the greatest need.

Compounding the problem, budgets are still tight in the wake of the financial crisis and are likely to remain so for the foreseeable future. This both limits resources today and dims career prospects for B&TC professionals within the institution.

These conditions suggest the time is right for banks to consider a new B&TC model that taps the specialized, industry-focused capabilities of an external service provider. The model offers benefits beyond a typical business process outsourcing arrangement. Along with cost savings, the approach provides mobile, financial services-focused resources that can be tapped when, where and in the number needed, with the right skill sets for the task. The model also employs specialized tools and leading practices to enhance service delivery. And it offers career paths for project professionals who may face limited options within the bank.

The role of business and technology change staff is to undertake transformation projects such as adding processes, functionality and data models to accommodate new financial instruments, risks and regulatory requirements.

5

• StructurallytransformtheB&TC cost base

• Retainkeytalent

• Enhanceinnovationandservice quality

• Improveexecutionquality

Potential benefits of B&TC innovation

The case for change

Several catalysts could drive a bank to explore some form of B&TC transformation. The bank may simply want to lower costs. A divestiture or acquisition may be in the works, putting the structure of B&TC and other bank functions into play.

Or, the bank sees potential value in having change resources on demand— a pool of change professionals available who are focused on critical banking functions such as trading, middle- office operations, finance, regulatory reporting, trading, clearing and settlements. Should demand spike in an area, skilled resources can be deployed in the number needed, rather than trying to juggle B&TC staff immersed in disparate functions and projects. Nearshore and offshore resources are balanced to maintain execution quality while achieving cost savings.

Undertaking comprehensive B&TC transformation can help banks address four priorities:

Structurally transform the cost base

Continuing pressure to boost ROE is driving banks to fundamentally re-engineer their business and technical architecture to reduce costs. Banks increasingly recognize the value of a variable cost base to accommodate changing budgets, as well as access to a nearshore/offshore resource pool with advanced tools and up-to-date training.

Industrialization goes beyond traditional steps such as eliminating management layers and across-the-board budget cuts. Among its benefits, it enables a bank to replace an expensive, inflexible

onshore B&TC cost model with a fixed-rate, non-full-time-equivalent (FTE) model. The new, on-demand model offers contractual options for rapid, short-term increases and decreases in resources in response to budget fluctuations.

The new model has the potential to materially reduce costs by combining a long-tenured fixed-rate contract, typically five years, with nearshore and offshore staffing. Banks can use the model to reduce costs or to increase B&TC resources at the same total cost as today—or perhaps less. In addition, the model’s fixed-rate cost structure permits banks to fully realize cost savings from day-one of the contract, before transitioning resources to alternate locations.

Retain and access talent

One likely casualty of cost pressures is a bank’s investment in change resources. Yet change is still complex and requires talented people to manage and execute. Because employees view B&TC functions as offering limited upward mobility, talent and retention are challenges in traditional B&TC models.

Further, banks have to strike a delicate balance in allocating resources to run-the-bank and B&TC activities.

Day-to-day operational performance has to be maintained across complex architectures and processes. At the same time, it is essential to have high-caliber resources focused on change, without the burden of run- the-bank duties and distractions. Transformation can provide access to a wider pool of resources, strengthening service continuity. It can also help in establishing a culture that recognizes performance, rewards success and encourages talent retention.

The new B&TC model offers a new career path for a portion of a bank’s B&TC workforce. Employees can move to an organization fully dedicated to project and consulting work in financial services, with benefits including more training, coaching, mentoring and networking. B&TC professionals can be part of a rapidly growing organization that values and helps advance their skills as they work on bank projects, contributing to talent retention. And while it’s the outsourcing provider that retains the talent, the bank enjoys the benefit of consistent, high-quality service.

Add value through improved B&TC innovation and service quality

B&TC innovation has three vital components. The first is inventive use of traditional content-focused tools—for example, creating a stand-out Web application for customers or superior interfaces to exchanges.

The second component is process change. How can we execute B&TC better? What processes can we automate to enable change across a broader scope? Can we improve diagnostics to accelerate implementation?

6

The third element of change is improving the work-life balance of change agents. Providing resources to help B&TC personnel excel and grow, transparency regarding career opportunities, and strong networking and communication channels can contribute to a dynamic, innovative B&TC environment.

Service quality is critical in banking, of course. So as change occurs, the bank needs to strike a balance between maintaining control and pursuing transformative change in alignment with risk and compliance requirements.

Improve execution quality

Change initiatives too often follow a familiar pattern. They take longer than they should and cost more than planned, leading to necessary adjustments in program scope and objectives.

Execution quality means doing things right the first time. A transformative step in achieving this goal is re-pyramiding resources. This means putting people with the appropriate skills in the right roles, arming them with superior requirements scripts and testing frameworks, and applying appropriate tolerance levels. The ability and commitment to work with other groups within the organization is also essential to quality delivery.

The importance of a big bang

Transformation initiatives often start with pilot programs intended to capture small wins and build support for the effort. B&TC transformation, however, often warrants a different approach. Organizations can struggle to communicate across organizational and geographic boundaries. The lack of consistent tools, processes and staffing standards, or the existence of separate budgets, can add to the difficulty.

For these and other reasons, the benefits of B&TC transformation can best be achieved by undertaking the initiative globally. Certainly, some gains are possible with a local focus. However, an encompassing approach offers the best opportunity to achieve consistent performance and innovation leadership by capitalizing on a global, mobile resource pool.

In pursuing B&TC change, a challenging but vital first step is to clearly define the scope of the initiative. It is also important to formulate the change transformation plan with existing run-the-bank processes in mind, as they largely define the construct in which change will take place.

A promising path to changing change

Bank B&TC operations will likely remain under pressure to improve efficiency for the foreseeable future. At the same time, their role in adapting the bank to a dynamic future is arguably more important than ever. Together, these forces point to the need for structural transformation. By industrializing their operations—including the use of global resources and specialized capabilities available in the marketplace—banks can assume B&TC leadership. The new B&TC model and structure offered here can help equip banks to weather this industry tipping point, capitalize on industrialization and fuel ROE growth.

7

Mark Reeves, Capco partner and Global Capital Markets leader, has 20 years of experience in the implementation of change across the banking sector. He has worked for leading players in the industry and in consulting at the board level. Mark has a proven understanding of analyzing and identifying primary markets for the development of successful sales and marketing strategies, coupled with experience providing advice and assistance around the strategic visioning, process redesign, application architecture, build and implementation of integration and efficiency enhancement initiatives and technologies—leading to significant cost savings and an increase in profits.mark.reeves@capco.com

David Oxenstierna is a partner in Capco’s Capital Markets group in New York. David has more than 15 years of experience in capital markets operations across asset classes and markets, including the U.S., Latin America, UK and Europe. He also has eight years of corporate banking experience. Prior to joining Capco, David worked at Morgan Stanley in a variety of operations management roles in the London and New York offices, including global head of change the bank; Americas head of equity operations; head of Latin America, Mexico, and Canada operations; global head of cash equity operations; and global head of client service. Prior to Morgan Stanley, he was with Citibank’s Corporate Bank in the Global Transaction Services business in a variety of

product management and operations roles across London, Continental Europe and New York.david.oxenstierna@capco.com

8

About CapcoCapco is a global business and technology consultancy dedicated solely to the financial services industry. We work in this sector only. We recognize and understand the opportunities and the challenges our clients face. We apply focus, insight and determination to consulting, technology and transformation. We overcome complexity. We remove obstacles. We help our clients realize their potential for increasing success. The value we create, the insights we contribute and the skills of our people mean we are more than consultants. We are a true participant in the industry. Together with our clients we are forming the future of finance. We serve our clients from offices in leading financial centers across North America and Europe.

Worldwide offices

Amsterdam•Antwerp•BangaloreBratislava•Charlotte•ChicagoDüsseldorf•Frankfurt•GenevaJohannesburg•London•NewYorkOrlando•Paris•SanFranciscoToronto•WashingtonDC•Zürich

To learn more, contact us at +1 877 328 6868 or visit our website at CAPCO.COM.

© 2013 Capco. All rights reserved. T1113-0313-01-NA