reimagining global banking services in the …reimagining global banking services in the connected...

REiMAGiNiNG GLOBAL BANKiNGsERviCEs iN THE CONNECTEddiGiTAL MARKETpLACE

THE NETWORK FOR GLOBAL COMMERCE bankingcircle.com

20236 Burnmark Whitepaper V2.qxp_Layout 1 20/10/2017 14:50

CONTENTs

INTRODUCTION: THE FINANCIAL UTILITY MODELWhat is a Utility?.......................................................................... 3Transitioning to a Utility model................................................ 4Utility model saved Us$ billions.............................................. 5The banking industry’s ‘Utility’ moment................................ 5

DIGITAL GLOBALISATION FOR SMALL BUSINESSES AND MERCHANTS.............................................................................. 6

CORRESPONDENT BANKING AT A CROSSROADS.................... 7

LOOKING TO THE FUTURE................................................................ 8

KEY CHALLENGES FOR BANKS AND FINTECHSIN THE DIGITAL MARKETPLACE......................................................8

Cost.................................................................................................. 8Time................................................................................................10innovation.................................................................................... 12Geographic expansion.............................................................. 13Customer relationship.............................................................. 14

REIMAGINING GLOBAL BANKING SERVICES IN THE CONNECTED DIGITAL MARKETPLACE

bankingcircle.compAGE 2


Fig 1: Examples of businesses across industries depending on utilities to return to their core business

REIMAGINING GLOBAL BANKING SERVICES INTHE CONNECTED DIGITAL MARKETPLACE

iNTROdUCTiON: THE FiNANCiAL UTiLiTY MOdELWhat is a Utility?

bankingcircle.com pAGE 3

industry Geography Company Utility model impact

RailwaysUnitedKingdom

virgin Trains uses the railway tracks and signallinginfrastructure as utilities and focuses on customer-centric innovations such as customer informationscreens to show reservation levels, automatic delayrepay systems.

superiorcustomerexperience

ElectricityUnited states,Canada

direct Energy is a retail energy provider that collaborateswith transmission and distribution utilities to deliverelectricity to business customers. The firm introducedan energy insight solution, panoramic power to enablebusinesses to track energy consumption right down todevice level in order to reduce operational cost.

Costefficiency

postal servicesUnitedKingdom

Collectplus, a store-based parcel delivery service, usedpaypoint’s extensive store network and the reach of Yodel’sparcel delivery service to expand its network by 33% - from5,500 to 7,500 stores within 12 months, with a longer termaspiration of becoming a more convenient option to the post Office.

Geographic expansion

Telecommunications spain

in a highly competitive spanish mobiletelecommunications market, simyo, a MNvO, uses theOrange infrastructure and drives its differentiationstrategy through a unique diY offer with more than 2,000combinations, so each customer can build their owntariff, choosing their fairest deal.

innovation

Airlines irelandRyanair outsources the ground services andmaintenance services to reduce aircraft turnaroundtimes from 45 minutes to 25 minutes.

improveexecutionspeed

A ‘Utility’ is an organisation thatmaintains the infrastructure to deliver aproduct or service used in day-to-daylife - whether the customer is aconsumer or a business community.Traditionally, the term is oftenassociated with public sector industriessuch as power, water or natural gas.

Historically, utilities operated astructure in which a non-core activityof the industry was deliveredalongside potentially competitiveactivity, in most cases comprisingcustomer facing services. Thisstructure has been prevalent inrailways, postal services,

telecommunications, electricity,natural gas and many other regulatedindustries, for example. However, inrecent years many of the players inthese industries have undergone avertical separation - moving from ado-it-all to a do-only-what you-can-do-well approach.



TRANsiTiONiNG TO A UTiLiTY MOdELit is possible for an industry to become a utility, where it was not previously. One example of this is the Us electricityindustry, which transitioned to a utility model in the 1990s and 2000s following a wave of major regulatory reform.

An electricity market comprises three sectors: generation, transmission and distribution, and retail. As shown in the leftside of Figure 2 (below), all three sectors had been operated by vertically-integrated utility firms in the Us until the 1990s.Between 1995 and 2002 regulatory reform was introduced to increase competition and bring down prices whichtransformed the industry.

Fig. 2: The US Electricity Market before and after deregulation

The vertical-separation helped the industry bring about a great deal of innovation across different functions of theelectricity industry. For example:

DER

EGU

LATI

ON

Utility CUtility BUtility A

Retail territory ARetail territory ARetail territory A

VERTICALLY INTEGRATED VERTICALLY SEPARATED

Retail energy providers

Transmission & Distribution Utilities

Generators

Substation

Transmission& Distribution

Substation

Enterprise | Retail

Substation Substation

Generators

Substation

Substation & meters

Enterprise | Retail

Substation & meters

Substation & meters

Enterprise | Retail Enterprise | Retail

Generators

Substation


Substation

Enterprise | Retail

Generators

Substation


Substation

Enterprise | Retail

Electricityindustry function

innovation after deregulation Benefits to customers

Generation ● Move from centrally generatedelectricity from fossil fuels toelectricity generated (locally)from renewable sources

Availability of green energy

Transmission and distribution

● smart-grid ● demand response● p2p electricity

trading network

With p2p electricity trading network consumers are becoming ‘prosumers’ as they areable to produce electricity by installing solar panels, and supplying it to the energynetwork. This reduces energy costs for the consumer providing the electricity and caneven provide them with some profit from selling the excess electricity their solar panelshave produced.

Retail energy supply ● smart meters● panoramic power

smart meters keep consumers informed of how much they are spending on electricity to makebills more manageable. They also encourage consumers to switch their consumption patterns tooff-peak hours and reduce the amount of electricity used, reducing their bills.

panoramic power helps enterprises deal with potential equipment failures before they happen, andreduce energy inefficiencies and waste.



Utility model saved US$ billionsin december 2016, the EnergyResearch Consulting Group (ERCG)examined the electricity cost savingsachieved by commercial customerswho switched from the traditionalvertically-integrated utility rate to aretail energy supplier of the newderegulated structure. in the fivederegulated states investigated, hugecost savings were achieved, as shownin the table on the right.

The banking industry’s ‘Utility’ moment

The banking industry is one of the last vertically-integrated industries left. As an essential service used in everyday life byboth consumers and businesses, it meets the basic criteria of a utility, but has traditionally not held the same structure asother utilities. However, this has been changing in recent years due to the industry experiencing significant regulation andmarket competition challenges:

Learning from the electricity industry’s move to the utility structure, the banking industry is now too reaping the benefits ofoutsourcing non-core functions to a third-party utility, enabling it to focus completely on owning, managing and growingthe customer relationships.

Where the electricity industry allows the retail energy providers to access a centralised, open and shared grid to provideelectricity to customers without being responsible for the operating and maintenance costs of generation, transmissionand distribution infrastructure, banking service providers can use the utility platform and infrastructure to improve theircurrent services, launch new sets of products and services and expand to foreign locations.

• Regulatory focus on innovation: Theindustry trend towards openness isinherent in the European Union'spayment services directive (psd) 2regulation and ‘Open Bankinginitiative’ in the UK. This is seekingto encourage more FinTechs to usethe banking assets and customerdata to provide customers with moreinnovative services.

• Low profitability: While bankprofitability has somewhat recoveredin the past two years, it remains atvery low levels. As of October 2016,the average return on equity of allbanks in the EU stood at around 3%,and at around 5% for larger banksremaining below their cost of capital(estimated to be around 9%).1

• De-risking by global banks: Regulatorypressure in the form of newregulations and fines for non-compliance are proving to beprohibitive in conducting business inforeign countries. With more than 75%of global banks retrenching fromforeign geographies2 thecorrespondent banking network isunder enormous stress. Regionalbanks are running out ofcorrespondent banking partnersthrough which to offer their bankingservices to international customers.

• FinTech disruption: FinTechs areseizing the opportunity to disrupt thetraditional financial services model,with 55% of millennials in the UsA and52% in the UK preferring to do basic

payment activities using a FinTech3

firm rather than using similar servicesprovided by their banks. The Usmillennials highlight convenience(56%) and ease-of-use (55%) as keyreasons for this preference.

• Legacy technology overhead: despitethe claim of becoming technologycompanies, most banks still run oncore systems installed in the 1970sand 80s. According to an estimate byEuromoney, the total cost ofmaintaining legacy systems, investingin new systems and paying iT staffamounts to anywhere from 15% to25% of a typical bank’s annual budget.4

1 source: KpMG, October 2016: https://home.kpmg.com/xx/en/home/insights/2016/10/the-profitability-of-eu-banks-fs.html 2 source: international Monetary Fund, June 2016: https://www.imf.org/external/pubs/ft/sdn/2016/sdn1606.pdf 3 source: salesforce Connected Retail Banking Report 2017, January 2017: https://www.salesforce.com/uk/form/conf/industries/financial-services/connected-banking.jsp4 source: Euromoney, August 2017: https://www.euromoney.com/article/b143rj4dz3cd92/technology-investments-drive-up-banks-costs


deregulated states with Utility model

Total commercial savings Annual commercial savings

illinois $1.7 billion $337 million

Ohio $3.5 billion $706 million

pennsylvania $3.4 billion $682 million

New England $1.7 billion $347 million

Michigan & California $3.3 billion $650 million



diGiTAL GLOBALisATiON FOR sMALLBUsiNEssEs ANd MERCHANTsThe world has become moreintricately connected than ever before.For the first time in history, emergingeconomies are counterparts on morethan half of global trade flows. in 1990,the total value of global flows of goods,services, and finance amounted to $5trillion, or 24% of world Gdp. in 2014,$30 trillion worth of goods, services,and finance, equivalent to 39% ofworld Gdp, was exchanged across theworld’s borders5.

The internet is now a global networkinstantly connecting billions of peopleand millions of enterprises around theworld. small businesses worldwideare using digital platforms to connectwith customers and suppliers acrossborders. in 2014, more than 90% of

the Us-based sMEs with stores oneBay marketplace and annual salesgreater than $10,000 were exportinginternationally.6 The story is similaroutside the Us where a vast majorityof smaller technology-enabled firmsexport. According to a McKinseysurvey in 2016, 86% of tech-basedstart-ups report some type of crossborder activity7.

despite the explosion of global tradeand commerce that technology hasenabled, borders still matter when itcomes to making and receivingpayments. Geopolitical developments,evolving regulation, foreign exchangeand economic volatility and shiftingtrade corridors are some of theexternal factors affecting global

payment flows. A survey with sMEsacross 112 countries revealed thatthey made up almost 53% of allrejected trade finance transactions.8

sMEs and merchants across theworld are looking at the financialindustry to help them tackle seriouschallenges on the cash management,cross border payments and globalexpansion fronts. Most sME crossborder financing needs are stillunderpinned by the correspondentbanking network. As companiesbecome more global, there is anincreasing demand for businesses todisperse, receive, and transact acrossborders, without delay, withoutfriction, and using only a handful ofbank accounts to manage liquidity.

Fig 3. Managing cash flow, a top challenge for merchants and SMEs across the globe

CUSTOMER PURCHASE

CREDIT PRODUCTS

SUPPLIER PAYMENTS

EMPLOYEE EXPENSES

C2B PAYMENTS B2B PAYMENTS

Key challenges:• Long onboarding time for local currency accounts• Opaque forex rates• High transfer fees• Delayed settlements

Key challenges:• Long onboarding time due to complex credit scoring• Higher interest rates• Longer disbursal time

Key challenges:• Long settlement cycle with correspondent banking network• Opaque forex rates• High transfer fees

Key challenges:• Long onboarding time for local currency accounts• Opaque forex rates• High transfer fees

SME LENDING B2C PAYMENTS

MERCHANTSAND SMEs

Cash flow scenarios

5 source: McKinsey Global institute, digital globalization: The new era of global flows, March 2016: https://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/digital-globalization-the-new-era-of-global-flows

6 source: Merrill Lynch, Globalization’s digital Future https://www.ml.com/articles/globalizations-digital-future.html7 source: McKinsey Global institute, digital globalization: The new era of global flows, March 2016: https://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/digital-globalization-the-new-era-of-global-flows

8 source: international Chamber of Commerce, 2015 Banking Commission Global survey on Trade Finance, september 2015: https://iccwbo.org/media-wall/news-speeches/icc-banking-commission-global-survey-highlights-impact-of-trade-finance-gap-on-smes/




CORREspONdENT BANKiNG AT A CROssROAdsThe correspondent banking model haschanged very little in the last threedecades, but is now under immensepressure to deliver on the demands ofsMEs, supporting their global growthaspirations. And its evolution will beshaped by three dynamic andinterconnected forces.

The first of these forces is theregulatory environment which hasincreased the compliance cost ofmaintaining correspondent bankingrelationships across the world. Thishas particularly been the case in theenforcement of Anti MoneyLaundering (AML) and Counter-Terrorist Financing (CTF)requirements which have causedmassive de-risking by banks.

The second force is that the sMEs andlarger corporates need and expect amuch better response from banks interms of reducing the cost of crossborder payments. settlement times

must be improved and completetransparency of the paymentexecution process provided.

Lastly, the emergence of technologiessuch as blockchain, the cloud andcryptocurrencies will be criticalenablers in the transformation of thecorrespondent banking network.

We see three different models ofevolution for correspondent banking:

1. Following the lead from thesuccessful disruption of the retailcross border payment industry,many FinTechs are working to bringthe revolution to B2B cross borderpayments as well. sMEs, especiallythe tech start-ups, are quick toadopt these offerings from FinTechsin order to to accept payments incountries in which they operate.

2. The incumbent sWiFT model is alsotrying to fix the problems through

its Global payments innovation (gpi)initiative.9 Banks signing up to gpiare committing to improving thespeed, transparency and tracking ofcross border payments. 110 banksaround the world are already onboard, and are continuallymonitored to ensure they adhere tothe gpi rules. Ripple is anotherblockchain powered initiative,designed to fix the issues ofcorrespondent banking throughreal-time and transparentcommunication between bankspowered by inter-ledger protocol.

3. The last model is the emergence ofa super-correspondent bankingnetwork powered by a third-partyutility which offers theinfrastructure, liquidity pools andconnectivity with payment railsacross the globe to facilitatecheaper, faster and secure crossborder payments.

Fig. 4: Future: Cross border B2B payments

COLLABORATION-LEDINNOVATION

DISRUPTIVEINNOVATION

INCREMENTALINNOVATION

B2B CROSS BORDER PAYMENT SOLUTION FROM FINTECHS

STATUS QUO: CROSS-BORDER B2B PAYMENTSCORRESPONDENT BANKING 1.0

B2B cross border payment solution from Fintechs

TECHNOLOGY EVOLUTION

Correspondent banking 2.0 through advanced technologies

such as blockchain and cloud

OPERATING MODELEVOLUTION

Super-correspondent bankingpowered by financial utilities

REGULATION FINTECH DISRUPTION

DE-RISKING CUSTOMER NEEDS

Correspondent banking network

Receiver bank’scorrespondent

Receiver’s bank

Receiver

Sender bank’scorrespondent

Sender’s bank

Sender

9 source: sWiFT: https://www.swift.com/our-solutions/global-financial-messaging/payments-cash-management/swift-gpi



LOOKiNG TO THE FUTUREWhile each of these three trends willshape the future of the correspondentbanking network, their suitability andadoption will vary across both theservice providers and corporatecustomers using those solutions to meettheir financing and payment needs.FinTech offerings will continue to evolveand improve, attracting many morecustomers from the digital businesses.At the same time, the FinTechs will seeincreased regulatory engagement andscrutiny as the size and sophistication ofthese entities grow.

Blockchain technology has beenmooted as a potential challenger tothe correspondent banking model butthe technology faces significanthurdles in adoption, such as

integration with legacy back officeapplications and compliance withexisting and upcoming regulatoryrequirements. security and privacyare other areas of concern. Theinformation stored on the gpi cloudwill be subject to very high levels ofsecurity, but when the idea ofexchanging information betweendifferent clouds is considered, bankswill be concerned about securityissues as confidentiality levels varybetween different clouds. Also, giventhat gpi’s success will be contingenton all partner banks improving theirinternal systems to support straightthrough processing, this mode is onlysuitable for bigger banks with deeppockets who will offer the betterservices to large corporates.

The utility powered super-correspondent banking network hasthe potential to emerge as a greatalternative for FinTechs, forex players,challenger banks and tier 2 and 3banks to provide their customers withfaster and cheaper cross borderbanking solutions, without the need tobuild their own infrastructure andcorrespondent banking partnernetwork. The ability to outsource non-core activities to a third party canenable financial institutions toaddress the innovation and globalexpansion challenges, while enablingthem to focus more on the customer relationship.

KEY CHALLENGEs FOR BANKs ANd FiNTECHsiN THE diGiTAL MARKETpLACECost

Fig. 5: SMEs are reeling under the pressure of high cost cross border payments

Receiver

Nostro-Vostro liquidity costs, compliance cost

Sender

HOW COST OF CROSS BORDER B2B PAYMENT IMPACTS UK SMES

£4bn

96%

£2.7bn

UK banks charge SMEs in hidden transfer fees each year to make international payments

of cross border payment fees are hidden from the customer using the exchange rate o!ered

is the amount that banks charge more than independant cross border payment service providers

of merchants find transaction fees their

biggest concern when it comes to

cross border payments

50%are concerned with

getting the best FX rate, and 37% worry about the

risk of fraud

40%of respondents

(acquirers, PSPs, issuers and merchants) would change their payment provider if they found

a cheaper solution

79%

Data source: Money mover Jan 2016 report: UK SME International Payments Analysis

SENDER BANK’S CORRESPONDENT

FX spread, Payment operation cost, compliance cost

SENDER’S BANK

Nostro-Vostro liquidity costs, compliance cost

RECEIVER BANK’SCORRESPONDENT

FX spread, Payment operation cost, compliance cost

RECEIVER’S BANK

Improvement by outsourcing to a financial utility

Correspondent banking network

Improvement by replacing with a financial utility




Higher cost of executingcross border paymentsresults in high rates for customersAccording to the McKinsey report, theaverage cost for a bank to execute across border payment via legacycorrespondent banking agreementsremains in the range of Us$25 toUs$35, more than 10 times more thanan average domestic ACH payment.10

The fixed costs of compliance arehigh. in addition, bilateralrelationships require banks to holdidle liquidity and incur FX exposures.

Manual and personalised paymentoperations, including the processingof claims and disputes by the backoffice further add to these costs.Finally, the significant market powerof correspondent banks and capturingfirms allows them to extract revenuethrough direct fees and FX spreads.2015 research by McKinsey showedthat correspondent banks chargeanywhere between $23 and $70 for across border transaction.11 The FXrate provided varies based on size of

the transaction, time of day, currentvolatility level, future implied volatility,quality of the customer, currentmarket price action, and competitorquote levels. The diagram abovehighlights the impact of theunfavourable cost that UK sMEs incurwhile dealing with banks in executingcross border payments.

Banks’ B2B cross borderpayment revenue andprofits at risk Although cross border paymentsaccount for less than 20% of totalpayments volumes, they compriseabout 40% of global paymentstransactional revenues (i.e.,transaction-related fees and floatincome), and generated over $300billion in global revenues in 2015. B2Bpayments drive roughly 80% of crossborder payments revenues and are asegment in which banks retain a near90% share.12 Although thecompetition from nimble FinTechsoriginated in the high-margincustomer-to-customer (C2C) market,it is rapidly shifting to the commercialspace and corporate treasurers

expect to receive the same levels ofservice as on the consumer side.

Traditional money transfer operators(MTOs) are also shifting their attention.Western Union Business solutions, forexample, is moving from traditionalcustomer-to-customer (C2C) andcustomer-to-business (C2B) offeringsto disintermediate corporate bankingrelationships. According to BankingCircle research released in April 2016,79.39% of respondents (acquirers,psps, issuers and merchants) statedthat they would change their paymentprovider if they found a cheapersolution. But 60% of the overallrespondents have not looked at otheroptions, either because they don’t havetime to dedicate to the research, or toomany resources are required toimplement the change.13

in order to capitalise on the burgeoningsME sector, banks therefore need tomanage their operational cost forfacilitating cross border transactions.Not only will this mean they can delivera more efficient service, but they canpass some savings on to theircustomers, adding value to thecustomer relationship.

10 source: McKinsey Global institute, digital globalization: The new era of global flows, March 2016: https://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/digital-globalization-the-new-era-of-global-flows

11 source: McKinsey Global institute, Rethinking Correspondent Banking, June 2016: https://www.mckinsey.com/industries/financial-services/our-insights/rethinking-correspondent-banking12 source: McKinsey Global payments 2016: strong Fundamentals despite Uncertain Times, september 2016:

https://www.smefinanceforum.org/sites/default/files/post/files/McKinsey_Global_payments_Report_2016.pdf 13 source: Banking Circle, Cross Border B2B payments - Today’s landscape, tomorrow’s opportunity, April 2016: https://www.saxopayments.com/todays-landscape-tomorrows-opportunity



Time

Fig. 6: SMEs across the globe experience long onboarding and payment settlement time

CUSTOMER ONBOARDING TIME

PAYMENT SETTLEMENT TIME

SIN

GH

K

RS

AU

SA

UK

AU

SG

ER

SIN

G HK

RS

A US

A

UK A

US GER

SIN

G HK

RS

A US

A

UK A

US

GER

SIN

G

HK

28%

28

16

28%

30%

27%

43%

42%

49%

46%

50%

47%

RS

A

US

A

UK

AU

S

GER

On average, survey respondents were contacted eight times during each onboarding process, with UK companies seeing this rise to 11

SMEs face significant cash flow problems while 67% of those agree late payments lead to some SMEs going bust

Companies consider speed of settlement to be the most important issue (apart from cost)

41% 47% 63%

On average, survey respondents were contacted eight times during each onboarding process, with UK companies seeing this rise to 11

Net: up to 1 week

Source: http://share.thomsonreuters.com/assets/forms/kyc-corporations-2016.pdf

Source: Atradius payment practices barometer 2016

Payment duration in the Americas (avg. days) Past due B2B receivables in the Americas (avg. %)

2012 2013 2014 2015 2016

2012 2013 2014 2015

payment delay

invoice due date

2016

Net: up to 1 month Net: up to 3 months Net: up to 4 months or longer0

20

40

60

80

100

20

30

40

50

28

37

28

37

28

32

39

30

28

16payment delay

invoice due date

28

30

28

31

32

29

34

28

DomesticForeign

14 source: Atradius payment practices Barometer Americas 2017, september 2017: https://atradius.co.uk/reports/payment-practices-barometer-americas-2017.html 15 source: Atradius payment practices Barometer Western Europe 2017, september 2017:

https://atradiuscollections.com/global/reports/payment-practices-barometer-western-europe-2017.html 16 source: Atradius payment practices Barometer Americas 2017, september 2017: https://atradius.co.uk/reports/payment-practices-barometer-americas-2017.html




Merchants face lengthyand complex processesto get onboardedA typical merchant onboardingprocess takes anywhere from 2-34weeks from the point of acquiring totheir merchant id being generated inthe core system of the acquirer bank.sMEs across different regions facesimilar challenges of delayedonboarding. The complications ariseas a merchant entity can be ofdifferent types; for each entity type,there is a different kind of Know YourCustomer (KYC) validation required.Most of the KYC process is manual,which, along with verification, takes along time. This not only increases thetime required for onboarding but alsosignificantly increases the costs ofacquiring and onboarding themerchants. This is one of the majorreasons why acquirers (banks) focuson larger corporates and do not find itviable to onboard smaller merchants.

Delayed paymentsettlement impactsbusiness cash flow and operationssending money across borders istraditionally very slow. payments can

be routed through many banks beforethey reach their destination, causingdelays and incurring fees at eachstage. settlement times for crossborder payments can take five days ormore, even for the most commoncurrency pairings.

The frequency of late payment andthe total value of past due invoicesvaries widely by country. According tothe Atradius payment practicesBarometer 2017, foreign latepayment amounts to 44.7% of thetotal value of foreign sales on creditin the Americas.14 This compares to39% recorded in Western Europe,15

which is still very high. The surveyalso indicates that despite the lenientpayment terms averaging about 27days from the invoice date offered tobusinesses by suppliers, the latepayment trend is on the rise in theAmericas with firms on averagetaking 31 days to settle past due invoices.16

According to Amicus research in 2016,carried out with over 500 UK sMEdecision makers, 38% of sMEs facesignificant cash flow problems17 whileZurich’s 2016 sME Risk indexrevealed that 67% of sMEs agree thatlate payments are leading to somesMEs closing down18. Businesses areturning to invoice finance or business

credit lines to deal with cashmanagement problems.

in 2016 Banking Circle research, 63%of businesses stated that they wouldchange their payment provider if theybelieved it would help enable fastercross border transactions.19

Small businesses needa big solution for crossborder payments Tracking and visibility are hugelyimportant for B2B payments ingeneral because there are manyways in which payments can gowrong. According to the internationalChamber of Commerce (iCC) BankingCommission’s 2015 Global survey, of482 respondents from 112 countries,sMEs made up almost 53% of allrejected trade finance transactions.

The opportunity for error is evenhigher when sMEs have to deal withbanks in different countries, withdifferent regulations to manage.sMEs therefore seek the ability totrack the payment, know when it’sgoing to arrive, and find out quicklywhen something has gone wrong,and where the error has occurred, inorder to optimise paymentsettlement durations.20

17 source: Amicus Commercial Finance, October 2016: https://amicusplc.co.uk/news-and-media/07-12-2016/cashflow-problems-undermine-four-in-ten-small-firms18 source: Zurich sME Risk index, January 2016: https://insider.zurich.co.uk/risk-management/smes-owed-225bn-from-late-payments/ 19 source: Banking Circle, Cross Border B2B payments - Today’s landscape, tomorrow’s opportunity, April 2016: https://www.saxopayments.com/todays-landscape-tomorrows-opportunity 20 source: international Chamber of Commerce, 2015 Banking Commission Global survey on Trade Finance, september 2015: https://iccwbo.org/media-wall/news-speeches/icc-banking-

commission-global-survey-highlights-impact-of-trade-finance-gap-on-smes/



Innovation

Fig.7: Collaboration is the way forward for banks and FinTechs to drive innovation

BANKING INDUSTRY LAGS ON THE INNOVATION CURVE

23% 53%Banks expect to collaborate

with FinTechsBanks want to invest in

customer facing technology

Source: The disruption house report – Why Banks are failing Source: EY European Banking Barometer – 2016

Comparison of key capability indicators top 10 all companies, top 10 all financial companies, top 10 banks and top 10 systemically important banks

FINTECH COLLABORATION WILL ENABLE BANKS TO INNOVATE

100

87.5

75

62.5

50

All co

All fin

Only banks

Top 10 SIB

Banks of all sizes needto focus on innovation toserve customers Banks, particularly systemicallyimportant banks, have a lowinnovation capability when comparedwith companies overall. Banks arelagging by 10-15% in comparison witha generic all-companies index, butmore importantly the top 10 globalsystemically important banks (G-siBs)lag the index of all companies asmeasured by key capability indicatorsby 23%, and lag other banks by 10%.21

psd2 in Europe and the Open Bankinginitiative in the UK, promise to affectthe sole ownership of the customerrelationship by banks. But theseregulatory initiatives also allow non-bank entities to deliver innovativefinancial services to customers by

using the customer data and accountinformation held by banks. Thismeans banks of all sizes need torapidly accelerate their innovationefforts to ensure their ability toremain competitive by offering thenext generation of financial services.

Banks collaboratingwith FinTechs for digitalbanking innovationsin the last two to three years, bankinggiants have invested in FinTech start-ups, partnering with them in variousforms. They’re opening expensive newinnovation labs and digital hubs andcreating C-suite roles dedicated toleadership in innovation.

Companies that participated in the ACisurvey indicated payments (68%) andbanking infrastructure (43%) are the

areas they’re most interested inworking on with start-ups. some 40%indicated they’d like to partner for e-commerce opportunities, 37% forremittances, 32% for security and fraudmanagement and 29% for coreconsumer banking operations.22 Of themore than 100 banking executivessurveyed by industry strategist JimMarous, 71% cited improving the digitalexperience in their top three prioritiesfor 2017; half also identified enhancingdata analytics as a priority and 41%cited reducing operating costs.23

Most smaller banks, with fewercustomers and less capital, are stillputting together their long-termdigital strategies. As the smallerbanks lack the resources to invest inFinTech initiatives and don’t have themassive customer base to test pilots,they’ve been slower to move.

21 source: The disruption House, Why banks are failing the innovation test, November 2015: http://thefinanser.com/2015/11/why-banks-are-failing-the-innovation-test-and-how-they-could-do-better.html/

22 source: ACi 2017 FinTech disruptors Report, November 2016: https://www.aciworldwide.com/-/media/files/collateral/trends/2017-fintech-disruptors-report.pdf23 source: digital Banking Report, 2017 Retail Banking Trends and predictions, december 2016: https://www.digitalbankingreport.com/dbr/dbr245/




Geographic expansion

Fig. 8 Banks retrenchment, a significant hurdle in SME expansion plans

GLOBAL BANKS RETRENCHMENT IMPACTS SME BUSINESS SMES BULLISH ON INTERNATIONAL EXPANSION

74%¹

27%²

66%³

of small businesses in EMEA planning to expand into another country over the next five years

SMEs in USA believe expanding into new international markets will be a contributor to financial performance

of UK SMEs expect international revenues to grow from 40% to 66% in the next 3 years

129%4UK SMEs doing business in at least six countries will jump 129% in next three years.

of merchants claim they have been stopped from expanding into new international markets, even though they already trade across some borders

of merchants only use one currency which could be a potential deterrent to new customers and suppliers

of merchants use two currencies39% 18% 32%

Source: 1. Ricoh Report March 2016: SMEs starting small going global 2. Global Research from American Express Feb 20173,4. Money mover Jan 2016 report: UK SME International Payments Analysis

of large banks withdraw correspondent banking relationships

80% of international wire transfers

35% of cash management services

Impacts

75%

Impacts

24 source: international Monetary Fund, June 2016: https://www.imf.org/external/pubs/ft/sdn/2016/sdn1606.pdf 25 source: Euromoney, June 2016: https://www.euromoney.com/article/b12kmv8h21wln0/rbs-leaves-international-transaction-services26 sources: FT.com and independent Online, september 2015: https://www.ft.com/content/510111b4-5dd5-11e5-a28b-50226830d644?mhq5j=e6 and

http://www.independent.co.uk/news/business/news/deutsche-bank-cuts-35000-jobs-by-2020-and-exits-10-countries-a6713246.html27 source: FT.com, september 2013: https://www.ft.com/content/780a7db6-253f-11e3-9b22-00144feab7de?mhq5j=e6 28 source: FT.com, september 2013: https://www.ft.com/content/2b909272-2508-11e3-9b22-00144feab7de?mhq5j=e629 source: FT.com, October 2016: https://www.ft.com/content/a03d231e-cd5a-31a9-ac76-61b5791445a7?mhq5j=e6

With rising compliance cost and risksglobal banks are retrenching

After years of expansion, more than75% of the larger global banks thatonce boasted of their globalcapabilities and scale are withdrawingtheir correspondent bankingrelationship in international markets,to reduce operating expenses and thechance of extraordinary legal costs.24

At the beginning of March 2015, RBsannounced that it would exit its GTs(Global Transaction services)

operations outside of the UK andireland,25 implying that cashmanagement and trade financeactivities will be wound down globally.

deutsche Bank, to take anotherexample, simply closed its marketsbusiness in Russia and plans to alsoretreat from 10 other so-called high-risk countries. Barclays has beenpulling out of more than 100 wealthmarkets and aimed to reduce thenumber of countries in which itprovides wealth and investment

management services from about 200to 70 by end of 2016.27 Credit suissewithdrew from about 50 marketsworldwide by 2014.28 ANZ sold theirwealth management and retailbusiness in Asia to dBs in 2015.29 Asthe retreat continues, regional banksare running out of partners to supporttheir international operations andfinancial services to sMEs such asinternational payments, forex servicesand cash management services arebadly affected.


Customer relationship

Fig. 9: SME banking at cross-roads for a customer-centric evolution

NUMBER OF BANKING RELATIONSHIPS FOR CORPORATE, GLOBALLY FINTECH PHENOMENON IN SME BANKING

USA

Singapore

Australia

UK

1413

12

11

FinTechs for supply chain finance

FinTechs for SME financing

Challenger banks for SMEs

Orbian, Prime Revenue, C2FO, Taulia, Ariba

Iwoca, Funding Circle, Dealstruck, Bond Street

Tide, Holvi, Kontist, Paragon Bank, Civilised Bank

of merchants surveyed currently use a traditional bank to complete cross border payments

of merchants use a merchant acquirer

of merchants use FX specialists for cross border payments

of merchants use a dedicated payments service provider (PSP)

87% 13% 14% 9%

Source: Thomson Reuters February 2016: KYC: A sound principle, but complex reality Source: Burnmark


30 source: Ricoh, March 2016: https://www.ricoh-europe.com/news-events/news/smes-starting-small-going-global.html31 source: American Express, Feb 2017: http://about.americanexpress.com/news/pr/2017/amex-sme-survey.aspx

The FinTechphenomenon in SME banking sMEs across the world are lookingbeyond traditional financialinstitutions to meet their evolvingneeds. A report by ThomsonReuters36 highlighted the fact thatsMEs and corporates across theworld, on average, have to

maintain relationships with morethan 10 banks to run theirbusiness. A report from McKinseyreveals that FinTechs alreadycontrol almost 10-15% of thesupply chain finance market withsMEs.32 Another McKinsey report,‘Global Banking Annual Review2015’, reveals that as much as40% of revenues and up to 60% ofthe profits in retail bankingbusinesses – consumer finance,

mortgages, small business lending,retail payments and wealthmanagement – are at risk from acombination of factors such asdwindling margins and competitionfrom FinTech start-ups.33

A suboptimal response fromincumbents in many countries hasopened the doors to FinTechinsurgents in payments, tradefinance, traditional lending, invoice

sMEs across the globe understandthat one of the fastest routes to growthis through exposure to new marketsand more customers, and globalisationis a key component in this process.Research commissioned by Ricoh30 in2016 reveals that sMEs in EMEA areconfident in their expansion plan –74% of small and 86% of mediumsized businesses plan to expand intoanother country during 2016-21.

2017 global research from AmericanExpress31 found that 27% of sMEs in the

Us believe that expansion into newinternational markets will be acontributor to financial performance.Easy access to digital communicationand collaboration technologies,digital marketplace and digitallifestyles of consumers has improvedthe ability of sMEs and merchants toreach out to customers in newmarkets. At the same time asignificant payment hurdle stands intheir way: Consumers prefer to pay intheir local currency.

Global expansion requires multi-currency conversion and settlement incurrencies defined by card schemes,including exchange rates. Banks andpayment service providers whoextend the payment capability ininternational locations, along with theflexibility to settle multi-currencytransactions, can help sMEs andmerchants in their internationalexpansion through cross borderecommerce.

SMEs looking to go global face cross border payment hurdles




32 source: McKinsey, October 2015: https://www.mckinsey.com/industries/financial-services/our-insights/supply-chain-finance-the-emergence-of-a-new-competitive-landscape33 source: McKinsey, september 2015: https://www.mckinsey.com/industries/financial-services/our-insights/the-fight-for-the-customer-mckinsey-global-banking-annual-review-201536 source: Thomson Reuters, February 2016: http://info.risk.thomsonreuters.com/COB-Fi-survey-Gated

discounting and even narrowerniches. FinTechs and other newmarket entrants have usedsuperior experiences to capturesignificant market across product lines.

These firms’ products are, at theircore, similar to what traditionalbanks offer, but the way in whichthey offer them and servecustomers is closer to theexperiences offered by Apple,Amazon and other digitalexperience leaders. Along with theadvent of a number of new B2BFinTechs, the existing B2CFinTechs are also expanding into

the underserved sME market withinnovative products and digitalexperiences, which has furthereroded the sME banking revenuestreams for banks.

Banks need to own thecustomer relationshipto survive and thriveMany banks have taken anambivalent stance toward sMEsso far. Large Us banks, forexample, are making fewer smallbusiness loans than a decade ago,forcing sMEs to turn to higher-priced alternatives. Banks have

also been slow to invest in digitalplatforms for sMEs, focusinginstead on their retail andcorporate customers.

sMEs, if nurtured, can become asignificant revenue and profit poolfor banks. sMEs represent 50-60%of corporate revenue for banks inEurope. But, as sMEs’ business canbe relatively complex, they requirecustomised financial capabilitiesand are less susceptible tocommoditisation than retailbanking. it is time banks activelydefended and sought to grow thesME banking business with acustomer-centric approach.


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