Security, fraud, and risk Model Bank profiles: Alfa Bank and USAA

Banks have worked hard to manage the different risks across their institutions. It has been and will remain costly, time consuming and a top priority. Celent profiles two award-winning banks who have modelled excellence in their use of risk management technologies across their banks.

They demonstrated:

  1. Degree of innovation
  2. Degree of difficulty
  3. Measurable, quantitative business results achieved
(Left to right, Martin Pilecky, CIO Alfa-Bank; Gary McAlum, SVP Enterprise Security Group USAA; Joan McGowan, Senior Analyst Celent)

(Left to right, Martin Pilecky, CIO Alfa-Bank; Gary McAlum, SVP Enterprise Security Group USAA; Joan McGowan, Senior Analyst Celent)

ALFA-BANK: SETS THE STANDARDS FOR BASEL COMPLIANCE IN RUSSIA

Alfa-Bank built a centralized and robust credit risk platform to implement Basel II and III standards, simultaneously, under very tight local regulatory deadlines. The bank decided to centralize all corporate credit-risk information onto a single platform that connected to front office systems and processes. Using Misys FusionRisk, Alfa-Bank was able to implement a central default system with a risk rating and risk-weighted asset calculations engine. The initiative is seen as one of the most important initiatives in the bank’s history. The successful completion of the project has placed Alfa-Bank at the forefront for setting standards and best practice methodologies for capital management regulations for the Russian banking industry and Central Bank.

USAA: SECURITY SELFIE, NATIVE FINGERPRINT, AND VOICE SIGNATURE

The game-changer for USAA is to deliver flawless, contextual customer application services that are secured through less intrusive authentication options. The use of biometrics (fingerprint, facial and vocal) to access its mobile banking application positions USAA to be able to compete with Fintechs across the digital banking ecosystem and offer exceptional service to its military and family members.

USAA worked with Daon Inc. to provide biometric solutions paired with its “Quick Logon” dynamic security token technology, which is embedded in the USAA Mobile App for trusted mobile devices. Biometric and token validation focus on who the user is and who the verifiers are and it addresses increasing concerns around the high level of compromise of static user names, passwords, and predictable security questions from sophisticated phishing attacks, external data breaches, and off-the-shelf credential-stealing malware.

For more information on these initiatives, please see the case study abstract on our website.     

The new 4 C’s of commercial lending

Last week, I participated in a Finextra webinar on the topic of “Connected Credit and Compliance for Lending Growth” with panelists from ING, Vertus Partners, Misys and Credits Vision.  As I prepared for the webinar, I thought back to my first exposure to commercial lending when I worked for a large regional bank and I recalled the 4C’s of commercial lending from credit training:  character, capacity, capital and collateral.  All of those original 4C’s are still relevant in today’s environment when evaluating borrowers, but when considering the state of the commercial lending business in 2016, we need to think about an entirely new set of 4C’s:
  • Constraints on capital and liquidity
  • Cost of compliance
  • Changing client expectations
  • Competition from new entrants
On a global basis, banks are being forced to restructure their business models, technology platforms, and organizational processes in order to grow their portfolios, remain profitable, and stay in the good graces of their regulators.  All the while, meeting the evolving demands of clients who can view and manage their personal finances on demand, at their convenience, using the device of their choice. Despite these challenges, the panel remains optimistic that banks can and will evolve to grow this critical line of business. finance590x290_0 Where does this optimism comes from? Alternative lenders provide both a threat and an opportunity for banks as they make the difficult decisions on whether and how to serve a particular segment of the commercial lending market. Fintech partners offer more modern solutions than the decades-old clunkers that many banks still use; providing for more efficient and accurate decisioning, enhanced visibility and processing within the bank, and where appropriate, self-service capabilities.  Connectivity with clients and partners will increasingly be the hallmark of a successful commercial lender. For more insights from the panel, please register for the on-demand version of the webinar here: Finextra: Connected Credit and Compliance for Lending Growth.  

Increasing headwinds in corporate banking?

This week I’m in Singapore, which provides a beautiful backdrop for Sibos 2015, the annual conference that brings together thousands of business leaders, decision makers and topic experts from a range of financial institutions, market infrastructures, multinational corporations and technology partners.

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This year’s conference theme is connect, debate and collaborate and takes place at a time of increasing headwinds from a slowing global economy, higher compliance costs, increasingly global corporates, and competition from both banks and nonbanks alike. I spent the past few months taking a deep dive into corporate banking performance over the past 10 years–a period of both tremendous growth and unprecedented upheaval. As expected, corporate banking operating income and customer deposit balances have experienced healthy growth rates over the past 10 years. But surprisingly, despite increases in customer deposits, corporate banking income was largely stagnant over the past few years.

Corporate Banking Income and Deposits

Corporate banking plays a dominant role for the largest global banks. In 2014, corporate banking was responsible for 33% of overall operating income and 38% of customer deposits across the 20 banks included in this analysis.

As outlined in the new Celent report, Corporate Banking: Driving Growth in the Face of Increasing Headwinds, this critical banking sector is shaped by four external forces: economic conditions, the regulatory environment, business demographics, and financial technology. These same factors are slowing corporate banking growth and creating an environment in which banks are overhauling client offerings in the face of regulatory pressure, re-evaluating geographic footprints in response to shifting trade flows, and investing in technologies to ensure a consistent, integrated customer experience.

Much of the discussion at Sibos is on exploring transformation in the face of disruption. As they look to an unsettled future, corporate banks that are flexible, adaptable, and creative will be the ones that succeed. Changing time-tested ways of doing business is painful, but critical for future success.

Paying banks to take your money — huh?

Corporations have historically parked excess cash in their demand deposit accounts to take advantage of earnings credit allowances. Each month, the bank calculates the earnings allowance for a client’s accounts by applying an earnings credit rate to available balances. The earnings allowance is then used to offset the cost of cash management services. In the United States, corporates got the option of earning interest in money market accounts with the repeal of Req Q by Dodd Frank. The Liquidity Coverage Ratio (LCR) provisions of Basel III and the advent of negative interest rates in some European countries are upending traditional cash flow management for banks and their corporate and institutional clients. The LCR requires large and internationally active banks to meet standard liquidity requirements. It makes assumptions for deposit runoff in times of financial stress, resulting in a liquidity squeeze. Banks must hold enough high quality, liquid assets (HQLA) to fund their operations during a 30-day stress period. Examples of high quality assets include central bank reserves and government and corporate bond debt. The phase-in of the LCR started on January 1, 2015. It requires banks to distinguish between two types of short-term (30 days or less) deposits. Operational deposits include working capital and cash held for transactional purposes. Non-operational balances are other cash balances not immediately required and assumed to be investments; such as short-term time deposits with a maturity of 30 days or less and accounts with transaction limitations, such as money market deposit accounts. Non-operating/excess balances are assigned a 40% runoff rate for corporations and government entities and 100% for financial institutions, making them the least valuable to banks. As a result, corporates with non-operational cash investments may find it difficult to place in overnight investment vehicles. Many banks are reducing their non-operating deposits either by encouraging corporates to place their funds elsewhere, or by creating new investment products such as 31+ day CDs, money market funds and repurchase agreements to avoid the LCR charge on excess balances. Similarly, corporates also face a risk of higher costs for committed lines of credit which also require more Basel III capital to be held by banks. Bank demand for HQLA in the form of central bank reserves along with European fiscal policy has pushed central bank interest rates into negative territory for the safest monetary havens (Sweden and Switzerland). In other countries with central bank rates hovering near zero, once you take the inflation rate into consideration, those rates are negative as well (ECB and Denmark). Central Bank Interest Rates Central banks had hoped that negative interest rates would encourage commercial banks to increase lending, but there’s only been a slight increase in outstanding loan balances. Financial institution clients are hardest hit by central bank negative interest rates, particularly deposits in Euros, Swiss francs, Danish crowns and Swedish crowns. Many global banks are charging “balance sheet utilization fees” or other deposit fees. For corporate clients, savvy banks are taking a collaborative approach—working with corporate treasurers to educate them on the impact of regulatory and economic forces on their cash management and investment decisions and advising them on the available options.

The next step in European ACH competition?

Yesterday saw very interesting news coming out of Europe regarding a joint venture between 6 European ACHs.  To understand why many of us have sat up and taken VERY close interest in the announcement, we need to review some recent history first. Much of this will be covered in more detail in a forthcoming report on ACHs. In the very early days of SEPA, the European Commission made many public comments. As SEPA was as much a political goal as anything, many of these were observations on how the Commission thought the market ought to develop. Given the size of the task and the perceived reluctance to the banks to do anything about SEPA, the Commission narrowed down the observations to a set of specific requirements, eventually culminating in the regulations that made migration mandatory in Euro countries. The downside is that some of the initial elements triggered some activity, but they were never fully pushed through. One such item was the Commissions perceiving their to be an over-supply in payments processors. In the Commissions view, a single market would reduce the 50+ processors to between 5 and 7. That would be enough for a competitive market, but not so many for an inefficient market. The latter stance is based on the fact that processing is broadly a fixed cost business and so the larger the volumes processed, the cheaper the cost per transaction is to process. As a result of this statement was a flurry of activity amongst the ACHs to be one of the “survivors”. It triggered a wave of mergers (Equens is a German/Dutch/Italian merger for example), near mergers (everyone courted everyone else!) and direct approaches to banks and markets to acquire them as customers and boost volumes. But whilst there were mergers, the market broadly remained unchanged. Indeed, some markets chose to build their own SEPA compliant ACH, rather than use the services of a SEPA-ready ACH. There are many reasons for this, not least ownership and control. The announcement yesterday therefore was very significant. At face value, 6 ACHs are going to collaboratively process cross-border SEPA payments. Given the tiny volumes, this isn’t exciting. However, dig deeper, and it becomes clear that Equens – arguably the largest ACH in Europe – is providing all the infrastructure and services to the new company, and the new joint entity company is registered at… Equens HQ. Those other 5 ACHs are considerably smaller – their volumes combined are still dwarfed by Equens. Secondly – it’s for cross-border SEPA payments today but mentions possibly delivering the real-time payments interoperability that’ll be required going forward. That means more ad more services that will be offered by Equens to these other ACHs. It’s particularly noteworthy as many believe that EBA Clearing has been positioning itself to provide exactly that service, and has been leading the discussions. The third point is a broader one. There has been considerably more talk in the last few months about processing, given various elements of PSD2. It’s not yet clear whether the scheme/processor split will apply to “just” card companies, particularly when some of the ACHs process cards. A number of organisations have also mooted whether the XS2A provision potentially provides a way to bypass ACHs – that is break the connection between bank and ACH. Given the range of potential impacts, it seems likely that there will at least some impact. Finally, we are aware of more than one discussion in Europe about the future of that countries ACH, particularly as they ponder on how to deliver a real-time payments solution for that country. All bets are off. The net result suggests to me that we’re entering new phase for payments processors, particulalrly ACH, which has been a relatively stable market for many years. The industry – and technology – is in a very different place than when the discussions happened in c. 2005. What made sense then may not make sense now. We believe that the announcement yesterday will be just the first of a number over the next 2 years. The phrases exciting times and ACHs can be at last mentioned in the same sentence!

On the cusp: regional integration in Asia

It’s 2015, the mid-point of the decade and a good time to start looking at major trends in Asian financial services over the next five to ten years. One of the major themes will be regional integration, which is another way of saying the development of cross-border markets. There are at least two important threads here: the ongoing internationalization of China’s currency, and the development of the ASEAN Economic Community (AEC) in Southeast Asia. RMB internalization is really about the loosening of China’s capital controls and its full-fledged integration into the world economy. And everyone seems to want a piece of this action, including near neighbors such as Singapore who are vying with Hong Kong to be the world’s financial gateway to China. The AEC is well on its way to becoming a reality in 2015, with far-reaching trade agreements designed to facilitate cross-border expansion of dozens of services industries, including financial sectors. While AEC is not grabbing global headlines the way China does, we see increasing interest in Southeast Asia among our FSI and technology vendor clients. From Celent’s point of view, both trends will open significant opportunities across financial services. In banking, common payments platforms and cross-border clearing. In capital markets, cross-border trading platforms for listed and even OTC products. In insurance, the continued development of regional markets. Financial institutions will be challenged to create new business models and technology strategies to extract the opportunities offered by regional integration. It’s the mid-point of the decade, and the beginning of something very big.

IPS 2014 Roundup

So you’ll have gathered from recent blog posts that it’s conference season. This is the first of a few posts rounding up some of my recent events. This post is about International Payments Summit (IPS) which took place last month. Jacob mentioned in his Finovate post that he ensures that he attends as many sessions as possible – IPS is very much turning into my equivalent. I wrote last year about my return to the event after a long absence. This year didn’t disappoint either. For me, there is a great mixture of depth but also variety, with many speakers I’d not seen before. It’s not a cheap show, but content wise, worthwhile. If I had to make some suggestions, I’d suggest perhaps fewer 20min presentations. Whilst I can think of one speaker where that was probably 18m too long, there were some others who deserved longer. Lots of notes and things to follow-up on, but two themes really stood out. 1)      Innovation. Some great presentations, some challenging ideas. For me, the most provocative was from Mark Stevenson, of Flow Associates. The famous baseball player Yogi Berra once famously said “The future ain’t what it used to be”. Mark left me feeling somewhat like that! I can’t do his presentation justice here, but from the advent of cheap solar power to impact of 3D printers, the picture of the world that Mark painted was necessarily, radically different than the world of today. But effectively the punch line to the presentation was that this future was not 50 years away, but only 5. Scary, scary thoughts ensued as we thought this through! 2)      Regulation. The second day of the conference fell the night after the second draft of the PSD2 was voted upon in Brussels. The speaker had attended the session, and then hot-footed it to London – content can’t get much fresher! But across the conference, there were some very deep, technical discussions, which even I struggled with at times. Regulation seems to be getting ever more complex and specialised. The conference closed with the panel that I sat on, where we summarised the key points of the conference. My take away was labelled “Mind the gap”. I was particularly struck about how little overlap there was between the innovation and regulation discussions, and noticeably, how they were moving further apart. It would seem, considering the sheer volume of regulation that banks face, an obvious place for innovation to take place.

The Most Important Three Little Words in Payments?

No, not “I Love You” or “Buy Celent Research”. But That, Which and May. The long running saga around Durbin interchange fees took another twist last week. To recap, a group of merchants (knowns as NACS) sued the Federal Reserve, arguing that the Durbin rule it had imposed exceeded the authority granted by Congress to the Federal Reserve. To many peoples surprise, in July 2013, U.S. District Judge Richard Leon upheld that opinion and ruled that the Federal Reserve did not comply with the Durbin. The opinion was generally harsh on the Fed, with the judge writing: “The court concludes that the [Federal Reserve] Board has clearly disregarded Congress’ statutory intent by inappropriately inflating all debit-card transaction fees by billions of dollars.” The judge also ruled that the Federal Reserve failed to ensure that merchants enjoy access to “multiple unaffiliated networks” to process each debit-card transaction, as also required by the Durbin Amendment. In short, the judge ruled that the Fed needed to re-write the Durbin amendment. In January 2014 the case went to the US Court of Appeals, with literally billions of dollars at stake. Last Friday, March 21, saw the panel overturn the initial ruling, and the Durbin Amendment stands. This is a significant victory for the Fed and the banking industry, and major blow for the retailers. So why the title of this blog? In their decision, the judges severely criticised the quality of the drafting of the report. In particular, the use of the word “which” instead of “that” became central to the decision. That’s two of our three words. It reminds me of the issues in implementing the Payment Services Directive in Europe. The PSD was published in French, German and English. Understandably, the numbers of words varied between documents. But oddly, so did the numbers of paragraphs. That was the first issue – a belief that not everybody was working to the same document. With English the business language of many of the international banks, and English being spoken more widely than the other two languages, more countries used the English version as their starting point. And that’s where the trouble began. The word “may” was used widely throughout the document – over 200 times. The nuances of English language education meant that some read the word as permissible; some read it as optional; whilst other again assumed it meant they had to. A simple word, but very important differences in understanding. The consequence is that the next draft of the PSD is trying to address issues that it never assumed would be issues! Three simple words which (that?!) most of us probably never think about yet had billions of dollars in implications!

Much Ado About Nothing

Today the European Commission released its long awaited study into the cost of merchants accepting cash and card payments. A copy of the preliminary presentation can be found here. It’s long awaited for a number of reasons. Firstly, it is supposed to finally address the issue of comparing actual costs. Whilst there have been many studies in the past that looked at this, nearly all had a flaw. Those commissioned by one of the interested parties had such inherent biases that it rendered them almost unusable. For example, the anti-cards lobby conveniently chose to inhabit a magic kingdom where labour was free and cash magically appeared and disappeared from stores, free of charge!  Academic studies have typically been too academic – lots of interesting formulae, but not grounded in reality. The Commission set out, once and for all, to get a definitive answer. That’s the second reason why it is important. The Commission has taken what many believe as an “anti-card” stance, with a view that cards are unnecessarily expensive. At the same time, they are actively promoting electronic payments as paper/cash is costly and inefficient, but not taking into account some fundamental differences, such as cards are a commercial business, whilst cash is supplied in essence by the State (I know, I know – that sentence is a whole debate in itself!). The study then was supposed to create an unambiguous fact-base. The more cynical of us has wondered what happens if the study presents data that is contrary to the stance of the Commission, and that could contradict the last decade of activity from the Commission in this area! The programme has not been without it’s problems. A previous study commissioned a few years ago has never been released, and has been perceived as not reaching the answer the Commission wanted. This is primarily because the consultancy selected is highly regarded for their integrity and knowledge – by not sharing anything about the study, the market has reached it’s own conclusions. In the introduction to the document today though was a comment that it had “Unsatisfactory methodological recommendations.” Secondly, the request for a subsequent study was woefully underfunded. Unsurprisingly, the target number of merchants to study was not met by a considerable margin. This isn’t to criticize the firm that won the tender, more that the opportunity to do this right was never there. Alot of preamble – what did we learn? Not much. I wasn’t able to attend the presentation, so there is – literally – only the afore mentioned deck to study. For me the initial take-aways are:
  • The fact that no clear conclusions could be reached yet, and that the sample size achieved was only 50% of the initial target highlights, either just how hard this is to do and/or, actually it’s much closer than they thought. For example, if one payment type had substantially more costly than another it’d surely have been highlighted
  • The low response rate and the bias to large merchants is likely to leave the survey open to criticism
  • More detail is required to give comfort – for example, the cost seems to suggest some significant missing costs (such as CIT fees, bank cash handling fees, etc)
The net result is that we’ve not really any clearer, and we’re left wondering why they didn’t wait until they had reached some conclusions. Whilst we don’t have the commentary given during the presentation, the fact that the event and presentation didn’t even warrant its own press release suggests that not much was said. And so we’re left still in the dark, and probably, on balance, even less optimistic that we’ll get the answer that we all seek. Much ado about nothing!

Saddling up the hobby horse again

Wednesday saw the Government announce  ) its plans to overhaul UK payments. Regular readers of the Celent blog will know I’ve commented on this several times – here, here, and here. In short, the Government asked the industry, in a poorly formulated consultation, whether it wanted to be regulated or not; unsurprisingly, the industry said no. The Government then launched a second consultation, and asked the industry whether a) it wanted to be regulated or b) whether it wanted to be regulated. As one response said “….we believe the aims of Government in the current consultation are weakly defined, naive and rather generic.” And that from a non-bank and who would potentially benefit from the changes! It came as no surprise then that the Wednesday that the Government has chosen to regulate the industry. Coverage in the press has been less than helpful. One small bank was quoted in The Times as saying that they had to pay 40p for a Faster Payments whilst the big banks got them for free, and that was symptomatic of the issue. Indeed, that comment is symptomatic, being incorrect, illogical and unhelpful. The big banks do pay for every transaction, also paid large amounts of money (>£200m) collectively to create the system, and the small bank would be most welcome to join the scheme, and pay lower transaction fees (albeit accompanied by large running costs for the system!) Previously, I challenged the Treasury to come up with some clear objectives, with transparent ways of measuring success in achieving those objectives. These still don’t exist – indeed, in the release they use a bizarre example from Sweden which isn’t even successful in Sweden as justification. I think therefore we need to start from even further back. Firstly, let’s get our facts right. Get an independent auditor to level set the assumptions and data they’ll be building from. Secondly, let’s be clear of the purpose. Much of what the regulator is proposing will have no positive effect for the consumer, and likely a negative one, as ultimately someone has to pay for these changes, and it’ll be customers. Thirdly, use the correct analogy. A utilities regulator assumes it’s a utility, but payments isn’t and never has been. The payment system is a private enterprise, run by a group of banks, for a group of banks. Could we imagine the local corner shop trying to force Tesco to let use its online shopping site to sell its goods? No, but that’s essentially what the regulator is trying to do here. The regulator will never succeed unless it’s sets off on the right foot, and in the right direction. There is little evidence of that so far.