volume 8, number 21 may 2015 mckinsey on payments/media/mckinsey... · mitigate country and...

May 2015Volume 8, Number 21

McKinsey on Payments

Foreword

Gauging the disruptive potential of digital walletsWhile they have established a solid foundation for growth, digital wallets are by nomeans a guaranteed success. They must continue to evolve if they are to have a trulydisruptive impact on the payments landscape. Providers can improve their chancesby focusing on six “markers” for success in payments innovation.

New partnership models in transaction bankingA number of trends are leading to a fundamental rethinking of the traditional modelby which banks offer transaction banking services to clients outside their establishedmarkets. Four distinct partnership models offer the best opportunities for banksseeking to succeed in an evolving landscape.

Toward an Internet of Value: An interview with Chris Larsen, CEO of Ripple LabsMcKinsey on Payments sits down with the co-founder of Ripple Labs to discuss thenuts and bolts of the Ripple protocol, the implications for the correspondentbanking model, and the emergence of an “Internet of Value.”

Faster payments: Building a business, not just an infrastructureA faster payments infrastructure is not an end in itself, it is an opportunity for banks to deliver innovative products and services in both consumer and corporatepayments. To monetize this opportunity, financial institutions should focusrelentlessly on design, customer experience, accessibility and convenience.

1

3

11

19

23

Historically, banks built geographic coverageand product capabilities for transaction bank-ing in-house. In cases where a company’sneeds exceeded the reach of the bank’s net-work, banks have relied on correspondent re-lationships. Some have agreements withhundreds of institutions around the world,any one of which may expose the bank to sig-nificant operational risk, bring high complex-ity costs, and deliver low levels of service.

Compounding these risks, emerging tech-nologies are now posing serious challengesto the correspondent banking model, includ-ing new threats of disintermediation by nim-ble non-bank attackers. Intense competitionand low interest rates are both pressuringtransaction banking margins, requiringbanks to eliminate waste and manage prof-itability rigorously.

In this challenging environment, banks mayseek to reduce the complexity of interna-tional networks by streamlining correspon-dent relationships and rethinking the overallstrategy for partnerships. This article exam-ines the market forces leading to the emer-gence of four new archetypes of bankcooperation and highlights the critical fac-tors banks must address as they implement a global strategy for partnering.

Structural trends reshaping themarket

The combination of an increasingly competi-tive market and reduced net interest income(NII) in a low-interest-rate environment isthe most obvious factor contributing to thesteady (and unsustainable) erosion of mar-gins. At a deeper level, three interrelated

11New partnership models in transaction banking

New partnership models intransaction banking

Transaction banking—which typically includes domestic and international

payments, cash management and trade finance—is vitally important for

corporate banks, accounting for approximately 40 percent of total corporate

banking revenues, contributing to liquidity and delivering attractive returns

on risk-weighted assets, as well as enhancing client stickiness. However, a

number of trends are leading to a fundamental rethinking of the traditional

model by which banks offer these services to clients outside their

established markets.

Alessio Botta

Steve Krieger

Raffaela Ritter

12 McKinsey on Payments May 2015

structural trends are exerting pressure onthe transaction banking business and pointto the urgent need to rethink the businessmodel for cross-border trade and transac-tion services: globalization, multiple regula-tory regimes and digitization.

• Globalization: Cross-border trade ac-counts for a growing share of world GDP.One reflection of this trend is the increas-ing number and type of companies requir-ing cross-border services to reach moregeographically diverse markets (also dis-cussed in “Insights into the dynamics ofnew trade flows,” McKinsey on Payments,May 2014). The biggest new trade growthis along corridors linking established mar-kets of “the North” (North America, West-ern Europe and mature economies in Asia)

with emerging economies of “the South”(Asia, Latin America, Africa and the Mid-dle East). This trend is due in part to theexpansion of the middle class in largeemerging market countries, which is turn-ing once uni-directional trade corridorsinto bi-directional corridors. Trade flowsbetween mature and emerging markets areexpected to grow 9 percent annually overthe next few years and account for half ofglobal trade flows by 2017 (Exhibit 1).

• Multiple regulatory regimes: As they in-creasingly provide access to diverse mar-kets, banks must comply with differing(and not always compatible) regulatoryregimes, some national, others regional inscope. National standards may also differfor domestic and foreign institutions,

Trade flow volumes by type of corridor (excluding services)€ trillion, percent

CAGR, 2012-17Percent

South-South1

20

2017F

100% = 14

North-South1

North-North

12

2012 2010 2005

8

2000

13111075

504846

4136

37414452

59

5 8

5

12

9

1 Emerging markets of the "South" include Asia, Latin America and Middle East, excluding Japan, China, Hong Kong and Singapore.

Source: IMF Direction of Trade statistics; Global Insights; McKinsey Global Payments Map

Exhibit 1

Emerging market trade corridors drive growth

while regional regimes aim to harmonizestandards across multiple countries. Forexample, an updated version of Europe’sPayments Service Directive is expected torequire all parties to a transaction—eventhose outside Europe—to be in compli-ance. The global patchwork of nationaland regional regulatory standards poseschallenges for international players, par-ticularly as they seek to establish a foot-print in new markets to meet client needs.

• Digitization: Gradual yet steady improve-ments in industry standards and platformsstrengthen the impact of digitization, en-abling banks to automate processes andintegrate systems. In recent years, indus-try organizations have released new elec-tronic standards to reduce paper andspeed the flow of electronic data across di-verse platforms (e.g., ISO 20022 for pay-ments, released by the InternationalOrganization for Standardization; and nu-merous enhancements to SWIFT messag-ing, including EBAM for informationreporting and account management, MT798 to support trade-related messaging,3SKey for secure authentication and au-thorization across multiple banks). Addi-tionally, industry groups and third-partytechnology providers have introduced newplatforms offering streamlined integration

with bank and corporate systems. Initia-tives such as the bank payment obligationand Bolero offer entirely electronic meansfor trade services, and numerous organiza-tions support diverse supply-chain financecommunities with cloud-based multi-bankplatforms. It remains to be seen which, ifany, of these new initiatives will gain criti-cal mass. The potential game changers arehighlighted in Exhibit 2 (page 14).

Together, these developments point toward astep change in digital channels, which prom-ise to create opportunities on three levels oftransaction banking service delivery: salesand channel access (anytime, anywhere ac-cess across integrated channels); data ana-lytics (leveraging data from internal, publicand third-party sources to gain client-specific insights into sales leads, emergingproduct needs and improved service levels);and processes (including the reduction orelimination of manual intervention in opera-tions and the adoption of agile solutions de-velopment, where solutions prototypes arelaunched within a matter of weeks to reapthe benefits of live market testing early inthe development cycle).

Digitization also poses new risks of disin-termediation. For instance, a cornerstone ofthe traditional correspondent bankingmodel is banks’ exclusive access to interna-tional networks for cross-border clearingand settling. However, third-party platformsare making it possible for banks, non-bankfinancial institutions, payments processorsand other organizations to customize cross-border services in ways that go beyond theoptions offered by traditional correspondentbanking arrangements. Ripple Labs, havingdeveloped a real-time, cross-border openpayment protocol based on recent crypto-


Gradual yet steady improvements inindustry standards and platforms

strengthen the impact of digitization,enabling banks to automate processes

and integrate systems.


Trade finance Supply chain finance Cash management

New industry standards

Multi-bank account management(e.g., EBAM)

Trade messages for corporations(e.g., SWIFT MT 798)

Multi-bank industry utilities for KYC operations (e.g., Accelus, SWIFT KYC, Markit ISDA)

Global clearing providers (e.g., Earthport, GlobalCollect)

Paperless trade instrument with third-party clearing(e.g., BPO/TSU)

Cloud-based multi-bank trade platform(e.g., Bolero)

Cloud-based multi-bank SCF platforms(e.g., OpenSCI, Orbian, Ariba)

Real-time cross-border open payments protocols (e.g., Ripple)

Potential “game-changer” for TB business

Emerging third-party platforms

Multi-bank authentication and profiling (e.g., 3SKey)

Source: McKinsey Global Payments Practice

Exhibit 2

New standards and platforms improve connectivity and interoperability

Offensive moves Defensive moves

Acquire new clients from geographies not covered on a stand-alone basis

Avoid churn in portfolio by filling critical gaps in current product offering and geographic coverage

Deepen client relationships

Expand own offeringDifferentiate through shared investments in new products and services

Optimize profitability by sourcing low-margin products and providing high-margin products as respondent

Optimize product and service offering

Reduce the number of partners to a close circle of trusted and complementary banks, thus minimizing complexity and risk

Mitigate country and corporate risks through partnerships with institutions that have deep knowledge of the targeted region or sector

Reduce complexity and risk exposure

Build a solid market position in countries that are relevant to the bank with minimal set-up and operating costs

Increase overall scale/volume on platforms, benefiting from economies of scale and efficiency

Broaden network and gain scale


Exhibit 3

Partnership and cooperation models must serve clear strategic objectives

currency technologies, is an example ofthese new types of third-party platforms.Such innovators allow financial institutionsto streamline and improve the service levelsand costs of critical steps in the correspon-dent banking infrastructure, such as mes-sage routing and settlement. The speed atwhich new entrants are evolving, as shownby Ripple’s recent partnership announce-ment with Earthport, increases the potentialfor a significant disruption within the indus-try. (See page 19 for an interview with Rip-ple Labs CEO Chris Larsen.)

As a consequence of these structural trends,banks are rethinking which markets theywant to compete in and how to serve tar-geted segments and geographies with dis-tinctive products and service levels. Incrafting their strategy for market coverage,they focus on four main objectives: deepen-ing relationships, optimizing products andservices for competitive distinction, reduc-ing complexity and risk exposure, and iden-tifying markets that are important to theirclients and where they can grow at scale(Exhibit 3).

Four models of bankingpartnerships

In order to maintain stronger control overrisks and costs while also extending geo-

graphical reach, transaction bankingproviders are devising new approaches to co-operation. Whether the objective is prima-rily aggressive (that is, to expand marketshare) or defensive (to protect existing rela-tionships), four distinct partnership modelsare emerging: regional-to-local agreements,inter-regional agreements, global-to-re-gional agreements and white-labeling (Ex-hibit 4, page 16).

Regional-to-local agreements

Regional institutions enjoy the broadestrange of options for partnering, whether themain objective is offensive or defensive. Aregional leader may partner with a localchampion where the local institution hasdeep penetration and relevance in replacingmultiple existing correspondent bankingagreements.

On the local champion’s side, these agree-ments aim to streamline the number of cor-respondent relationships, reducingcomplexity and risk exposure, mainly forthe purposes of traditional trade financerather than supporting international treas-ury operations. On the regional leader’sside, these agreements allow access to newmarkets (in particular to serve SMEs) withlimited upfront investments and capital al-location. It is important to note that servicelevels in this model typically will not exceedthose offered in correspondent banking,and the primary objective of this model isto defend relationships that may be tar-geted by aggressive competitors. Further-more, these relationships may becomevulnerable if the regional player does notkeep up with clients’ evolving needs forboth broader geographic scope and digitalcapabilities at competitive pricing.


To maintain stronger control over risksand costs while also extendinggeographical reach, transaction

banking providers are devising newapproaches to cooperation.


Local players have a natural advantage inknow-your-customer and access to liquidityand should exercise this advantage thought-fully, weighing not only evolving client needsbut the long-term strategic benefits of part-nering with either a global champion or re-gional leader.

Inter-regional agreements

Inter-regional agreements are peer-to-peerpartnerships between regional institutionsthat do not compete with one another, andtherefore can complement one another’sstrengths in two separate regions (e.g., CentralEurope and the Nordics or China and Africa).

Pursuing a strategy for aggressive growth,two regional institutions may reap largeeconomies of scale by linking their networks

or building shared technology platforms. Ascase studies in the airline and automotive in-dustries show, this type of deep strategic al-liance can be extremely successful. If theobjective is primarily defensive, inter-regionalarrangements typically involve light integra-tion of IT systems to leverage common stan-dards and raise service levels, enabling eachbank to strengthen relationships that mightotherwise be lost to global players. However,these lighter, defensive partnerships usuallydo not bring substantial new revenue andmay falter if either partner does not stayabreast of market expectations and techno-logical advances. A more aggressive playhowever, including deeper integration andpotentially exchange of human capital, typi-cally allows for further cross-fertilization ofeach bank’s customer base.

Regional-to-local agreements

Local Italian large corporate

Italian local champion

Regional leader with broad APAC

presence

Global-to-regional agreements

Multinational with HQ in North America and operations in Africa

Global powerhouse

without presence in Africa

Multiple local champions in

different African countries2

Inter-regional agreements

Multinational with HQ in North America and operations in Western Europe

MNC with HQ in Western Europe and operations in North America

Regional Leader in North America

Regional Leader in Western Europe

White-labeling

Local Turkish mid corporate

Turkish local champion

without eFX capabilities

Global powerhouse

with presence in Turkey

Partnership1 Primary relationship Secondary relationship

1 Direction of arrow indicates flow of services; each slash indicates a space where a technology partner can add value (as partner or challenger).

2 Or better, the global powerhouse might partner with a single regional leader with presence in multiple African countries.


Exhibit 4

Four models of bank partnerships for global, regional and local institutions, with varying breadth and depth (illustrative)

Global-to-regional agreements

Global institutions with networks spanningmultiple regions have a proven value proposi-tion for serving multinational corporations(MNCs). This is no reason for complacency,however. Indeed, a global bank’s objectives informing a partnership with a regional institu-tion or a number of local champions may beto defend relationships from a new and far-reaching global alliance between two regionalleaders. Alternatively, an aggressive partner-ship strategy might aim to undercut a globalor regional competitor. Seamless service(based on deep systems integration) andtransparency are competitive advantages.

However, these arrangements are costly, re-quiring ongoing investment in systems inte-gration and platform connectivity, and thebusiness case can be difficult to justify. In-deed, cost grows almost proportionally tothe number of countries covered; exponen-tially if the bank partners with a differentlocal player in each country rather than asingle regional player.

Whether for aggressive or defensive reasons,partnerships will likely account for a grow-ing share of business for each global power-house, and it is vitally important to selectpartners with care according to a globalcompetitive strategy to extend reach andmaintain distinctiveness.

White-labeling

Global and regional players with a techno-logical edge continue to provide specificproduct capabilities to local champions,which is a way to leverage scale on their ex-isting platforms. In practice, however, thesearrangements involve a high degree of tech-nical complexity. In addition, they will likelyrequire significant upgrades (transparency,analytics and digital access) in order to re-main attractive and competitive. The risk ofcannibalization by the in-sourcing partner isrelatively high.

Technology specialists have an importantrole to play both in building internal plat-forms and establishing seamless interfacesbetween institutions and clearing and set-tling networks. Technology firms such asRipple Labs, Earthport and third-partysupply-chain finance platforms may act ascompetitors as well as partners, particularlywherever there is an interface between cor-respondent banks. Furthermore, the non-bank provider of cross-border clearingservices may appear to be highly attractive tothe smaller partner, as there is no risk ofcannibalization.

Five critical success factors

New partnership models in transactionbanking will have a deep impact on a bank’sinternational operating model, and shouldthus be part of the CEO’s strategic agenda.Partnerships must be carefully aligned withthe competitive strategy of each partner andwith an overall plan for partnerships withbank and non-bank entities. Indeed, de-pending on the institution, technology part-nerships may play a more significant role inachieving competitive distinction than cor-respondent banking arrangements. Five


New partnership models in transactionbanking will have a deep impact on abank’s international operating model,and should thus be part of the CEO’s

strategic agenda.

major factors for success for evaluating po-tential bank and non-bank partners are aclear strategy, a strategic fit, a harmonizedclient experience, integrated platforms andprocesses, and aligned incentives (Exhibit 5).

* * *Market and regulatory pressures dictate thatbanks take a new look at the role that part-nerships play in overall business strategy.The traditional examples of correspondentbanking have become too complex and risky,and they inhibit banks from providing thecapabilities their transaction banking

clients demand. Proactive banks will take asystematic and iterative approach to restruc-turing their correspondent banking relation-ships and non-bank partnerships, startingwith a review of current partnerships, thesetting of strategic priorities, and a robustpartnership strategy governing each party inthe alliance.

Alessio Botta is a principal in the Milan office,

Steve Krieger is an associate principal in the

Luxembourg office, and Raffaela Ritter is a

principal in the Vienna office.


Clear perspective on needs to be fulfilled by the partnership, in particular:

- Which customers will we serve?

- What do we need to serve them?

- What are the expectations of those customers?

Complementary footprint and client base

Cultural compatibil-ity, shared legal background and trust between partners, often established through successful historic business relationship

Harmonized customer experience regardless of which institution is actually providing the service, typically defined through SLAs

Right-sizing the services provided to satisfy the needs of customers within a predefined scope (geographies, products)

Common/compatible legal jurisdictions

Integrated platforms and processes, enabling a harmonized customer experience

Clear reporting and governance structure to resolve issues and track benefits

Financial incentives, (e.g., exchange of equity stakes, smart/ transparent transfer pricing, co-investments)

Where high level of integration is needed: operational incentives (e.g., exchange of staff), transfer pricing

1Clear partnership strategy

2Strategic fit of partners

3Harmonized customer experience

4Integrated platforms and processes

5Aligned incentives


Exhibit 5

Successful partnerships meet five criteria

volume 8, number 21 may 2015 mckinsey on payments/media/mckinsey... · mitigate country and...

Documents