Going beyond ‘vanilla’ or commoditized practices

Feature: Bank alliances

In their home markets, banks are natural competitors. In the past decade, however, forces such as globalization and deregulation have made banks shed their innate caution towards – or even suspicion of – their peers. Banks often face growing pressure usually from overseas or non-traditional competitors. Their corporate customers expect more services, better products and increased availability.

A common challenge for banks is how best to satisfy their customers in order to stay competitive. One popular response is cooperation, referred to variously and informally as an "alliance", an "arrangement" or even just an "understanding". By forging such collaborative, non-equity-arrangements, banks can strengthen core competencies. Such collaborations allow banks to defend their client bases, then profit as customers use the wider choice of products and services offered by the alliance.

Some banks form highly successful alliances. Others try, but stumble. Increasingly, successful alliances rely on the notion of a "network management" function, a mission-critical role to oversee the formation and management of the relationship.

Why banks form alliances

First and foremost, an alliance gives two banks the opportunity to strengthen their distribution channels and extend their geographic reach. Traditional correspondent banking arrangements are a clear example of this. Using correspondent banks, a bank can made and receive payments from locations where it does not have a presence, a basic yet critical cash management capability. These days, correspondent banking arrangements tend to be a "vanilla" or "commoditized" practice. Buying banks have a well-defined set of generic needs so they can offer a fuller product program. Other banks have become specialist providers of correspondent banking services, such as currency clearing.

Second, alliance arrangements allow banks to benefit from economies of scale. One bank may not have the requisite systems, people, development budgets or other capabilities to meet its growth objectives. It could enhance its own capacity, but this would entail acquisitions or investment programs. Either route is typically costly and could be risky if the bank’s strategic direction changes. The alternative is an alliance to use another bank’s infrastructure. In this way, one bank can quickly and economically build the necessary scale it needs to pursue opportunities.

Third, an alliance allows a bank to extend its existing competencies and offer customers greater range of products and services. The end customer is often indifferent to whether the offering is provided by one party or the other. Such arrangements are increasingly common. At the retail banking level, for example, a bank may offer investment funds that are ultimately owned and managed by other banks.

When properly structured, an alliance is, in essence, a long-term strategic partnership. There are substantial financial and other benefits for both sides. Both parties share and minimize long-term investment requirements and diversify the business risks they face. Many forward-thinking banks are looking into the benefits of well-though-out, well-structured alliances. However, all too frequently, alliances falter because they are neither.

Challenges facing alliance makers

Any alliance must relate to both bank’s wider strategic objectives. This is often forgotten. The value to be unlocked from a cash management alliance may take a back seat to "doing the deal". Negotiators become absorbed and sidetracked by operational, logistical and revenue sharing considerations. Even if the rational for an alliance is clear, it must complement the overall strategic direction of each bank.

At some point in the formation process, the logic of an alliance may require one party to make a tactical retreat from a particular line of business or market in which it has considerable interests and investments. For example, one bank may have to replace its in-house electronic banking platform with the other bank’s platform. The ability and willingness to accept such changes are crucial. Alliances require a hard-hitting assessment of strategic intent, mutual compatibility and the capacity to make long-term commitments.

The strategic fit may make sense, but an alliance will not prosper without the proper endorsement of a shared business plan. Both parties must set out a business plan that addressees operational specifics such as:

• "Know-your-customer" and other anti-money laundering policies: Each bank must be able to deliver services to customers other than its own. In practice, the bank providing services must be confident about the other’s undertakings and, at the same time, willing to flexibly apply its internal policies when presented with less-detailed customer data than normal. International pressure for tighter rules makes this area increasingly contentious.

• Credit risks: Banks must agree on the credit risks each will accept, particularly it asked to act as counterparties to customers with whom they are unfamiliar. Mechanisms such as stand-by letters of credit may allow one bank to service the other’s client base. Different institutional appetites for credit risks may have to be reconciled. A number of cash management alliances, for example, could entail settlement risks.

• Areas of responsibility, in case of problems: For example, what will the banks do if a payment is delayed and an attendant claim needs settling? The recommendations of the Heathrow Group, for example, provide useful guidelines in resolving such operational risks.

• The precise nature of all factors: Both banks need to be clear on all the products, services, customer groups, currencies and geographic markets covered by the alliance, plus any capacity restrictions. Such parameters can be detailed in separate service-level agreements. These agreements should also indicate contingency arrangements in case computer services, telecommunications, branch services or other facilities are interrupted.

• Real customer flows: Rules of engagement need to take into account the reality of different time zones and other exigencies that may affect the delivery of services by one bank to the other’s customers.

• Monitoring, measuring and managing progress of the alliance: Specify regular, formal performance reviews that examine financials, strategy and operational considerations, and how well the relationship between the two banks is progressing. The alliance agreement may include specific key performance indices to quantify the benefits and ensure that the reality matches the intended objectives.

There must be clarity concerning mutual benefits and alliance costs. In an alliance, each party sees the other’s business case as a broad document of expectations. In the early stages of discussions to formalize an alliance, each bank must trust that the other is transparent with information, particularly with accurate and reasonable figures about costs and benefits. The benefits of an alliance usually take time to come through, especially in a cash management alliance where annuity flows are gradual and slow to pick up, and are clearly divided based on the agreed value contribution of each party. However, costs are incurred sooner. The costs associated with establishing the alliance need to be taken into account and clear agreements reached as to who pays for what during the early stages. This does not always happen.

Alliances need adequate resources or infrastructure to deliver on the agreement, Typically, an alliance requires each bank to make adjustments to existing infrastructure, systems and processes. One party or the other may need to make additional investments to get its facilities up to scratch. If one bank either lacks the expertise and capabilities, or is not willing to invest the time and effort into developing them, the alliance may fail.

As in many formal corporate mergers and acquisitions, those pushing for and negotiating an alliance may forget that others may have an interest. An alliance - by its nature an agreement in which each bank retains its identify and voice – requires the support of people within each organization. Each party must engage the support of other stakeholders within its own organizations. Executives from operations, product management, solution delivery, informational technology, sales and customer support, and other areas need to be represented from the earliest discussions. Since they will be called on to develop, run and support the inevitable new systems and processes that will be required to implement the alliance, it makes sense to have early "buy in" from these critical units. (To be continued)