The Future of Outsourcing in the Investment Banking Industry | Article

businessman thinking on a stack of coinsForward progress by the European banking industry in information technology (IT) has been severely reduced over the last two years as efforts have been focused on two major concerns. This year the banks’ concentration is to finalize work in making sure that their systems are Y2K compliant. And much of the previous year was centered on the addition of the Euro into the European banking system, says Jeremy Smith, a managing director at Deutsche Bank, who was previously at Bankers Trust before the takeover on June 4.

“Huge amounts of effort have been put in to banks’ systems and operations, but it hasn’t really got them any further forward,” Smith says. “You can make your computers Euro-compliant and Y2K-compliant but that doesn’t really increase their functionality towards straight-through processing.”

Smith believes that there is a huge backlog of development waiting for post-Y2K. And many banks in Europe are contemplating a move into business process outsourcing because they may not want to spend any more of their own money on implementing and managing a computer system and hiring a staff that knows how to use it.

“You are going to see companies getting together with a couple of their competitors and developing joint projects or they will outsource,” he says. “Outsourcing seems the most likely approach of the two.”

From One Bank to Another

Smith works in London and provides investment banking processing services to other banks. His tight-knit staff of fifteen employees has developed a blue print for how they will approach future vendors that are seeking their services. The group is one of few organizations that offer the services they do, services that Smith foresees as an eventual booming industry. The business within Deutsche Bank provides a full soup to nuts service for OTC derivatives that includes trade capture, valuations, daily profit and loss, risk reporting, confirmation processing, settlements, and accounting services like books and records reporting and regulatory reporting.

Right now they are working with one client, Abbey National. Abbey National is the United Kingdom’s fourth largest bank. Abbey National converted from a “building society,” which have some similarities to “savings and loans” in the United States, into a full service bank ten years ago. The bank’s second largest business is Abbey National Treasury Services, which is basically the wholesale and investment-banking arm of Abbey National. This business includes Abbey National Financial Products, which is an active participant in the interest rate and currency swaps market as well as a wide range of more exotic products.

The contract with Abbey National started in October 1995, and began as a three-year contract, but has recently been extended to October 2000.

Smith says that the market for the types of business processing services that Deutsche Bank offers will grow rapidly once the world enters into the new millenium. He makes his conclusions based on similar growth in the retail financial industry. In that industry a lot of white label processing is being practiced, whereby one bank is providing another bank’s service in the same way that the Deutsche Bank does for Abbey National, but under the client bank’s name. This process has become fairly widespread in retail banking, but has yet to reach the inner corridors of investment banking

“I think the concept will spread to investment banking and you will see businesses such as ours taking off very soon,” he says. “What we have enabled Abbey National to do is almost act as a virtual bank; they have been able to set up a trading business without having to build the delivery mechanism.”

Virtual banks will continue to grow as have the companies that offer securities trading over the Internet for $8 to $10 a deal, he says. A lot of new names have come into the market and a lot of money is being made. Smith believes that E-commerce will grow quickly in wholesale and investment banking.

“Companies will not want to implement and manage their own infrastructure, so what that will lead to is the growth in virtual banks, which can trade quite happily without owning their own infrastructure,” he says. “There will be a growth of operating service companies, which are basically processing outfits that will provide the back-office services for a number of major banks and new entrants.”

Wasting Time and Money

The way that banks get better at offering financial services is through technology, he says. And banks are currently spending millions on their current systems to beef up their investment-banking prowess.

“Each bank is spending a lot of money on their computer systems and they are all dealing the same products. This is a very wasteful amount of money that is being spent in our industry,” he says. “What outsourcing can do is spread the cost of computer systems development amongst a number of clients. So the first benefit is that a company can potentially run much cheaper because the client is not spending a large amount of money on computer systems, but is instead buying a shared service.”

Another benefit of using this type of service is an increase in expertise. A large bank like Deutsche Bank has a lot of experience in the market and can leverage their abilities across a number of clients. Also, a company can focus management time on the business side rather than the management of the operations.

Lessons From The Outsourcing Primer:

  • European banks have fallen behind in technology because of their efforts over the last two years to make their systems Y2K- and Euro-compliant.
  • Many banks are contemplating a move into business process outsourcing beginning next year in order to gain immediate technological advances without the high costs.
  • Virtual banks will continue to grow as have the companies that offer security trading over the Internet.
  • Banks are spending millions of dollars on computer systems when they could use a shared service center and split the cost of implementing and operating a system.

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