Shrinking Margins Expand Private Bank’s Business Models

Regulatory pressure to enhance transparency is shrinking margins and increasing costs, pushing banks towards an outsourcing model, which has long been considered taboo.
Private banks must become more efficient in the face of tighter margins and rising costs. The pressure from regulators to improve transparency within financial services is changing banking business models, as well as imposing new levels of administration which impact revenues. In Switzerland the breakdown of bank secrecy has effectively removed a selling proposition for a number of country’s banks, under which clients were able to save some taxes in their home countries.

The change in Switzerland’s banking secrecy value proposition reflects a wider global trend; increasingly banks have to deliver transparency and work more closely with authorities. Furthermore there is greater legal pressure in the areas of data and customer protection. Private banking is not distinguished from retail investment under most European regulation, e.g., MiFID, and so private banks will not be able to provide complex products to the customer without some form of professional investor intermediary.

Combined with the removal of other services such as offshore banking , which allowed banks to charge a much higher margin than their peers, these rules are making it much harder for private banks to differentiate themselves.

Increased transparency and democracy are also impacting revenues in other ways. Transparency allows customers to compare prices more easily; the situation is comparable to that of travel agents pre- and post-internet; the cost of a package holiday is no longer taken at face value with hotels, car hire and travel all provided as customisable options via comparison websites. In the same way, a lot of banking activity can be carried out by a customer online. You don’t need a branch to get credit and other services so prices are lower as a result. Trading fees are under pressure so banks are likely to see diminishing margins from executing trades in future.

Many private banks question whether they can survive using existing models in the face of reduced margins, which worst case have fallen by 50 percent. This means they have to reduce staff or become more efficient by discarding systems they cannot afford to support. On the other hand good people and systems are key to addressing increasing user demand so banks need to redefine themselves and their offerings in order to keep existent customer and attract new prospects

New players face the cost of providing infrastructure and performing basic business processes, getting certified by the authorities and the provision of capital. Operational costs can be kept under control by outsourcing. Handing operations over to a third party provider allow an economy of skills with access to qualified and scalable resources: if regulation changes the bank doesn’t have to keep up with it and issues like staff turnover are handled off site. The maintenance costs on hardware, software or the support costs for staff are moved to a single fee.

Until recently banks were working the other way around, buying datacentres, hiring IT staff, along with hardware and software.

Today there is still understandable apprehension towards outsourcing in banking because of security concerns. Primarily private banks are keen to keep data inside the bank. This is psychological resistance to outsourcing is being overcome by the availability of innovative systems that separate transactional data from confidential data, ensuring the bank has control of its data.
For start-ups the main reasons to outsource may be cost reduction or time to market but for established banks there are other motivations. Often outsourcing has been seen as a way of reducing costs but it has other advantages. Business process outsourcing is analogous to outsourcing your kitchen at home to a restaurant. You do not pay less, in fact it may even cost you slightly more; but what you get is flexibility and skills you could not afford to acquire, good quality standards and rapid service without a requirement to manage or support the resources needed. The point about outsourcing is that you get more flexible, scalable and professional infrastructure and access to experts.

In the reality most of the banks did not outsource for those reasons, they outsourced because they had a problem, like leaving of skilled staff or to deal with M&A activity or in order to introduce new technology. This was a more reactive approach. However as pressures grow on margins and cost, bank outsourcing has become more strategic.