Three of the biggest Canadian banks have taken back-office outsourcing to a new level with a cooperation agreement that could foreshadow similar technological alignments among U.S. banks.
The Canadian institutions - Royal Bank of Canada, Bank of Montreal, and Toronto Dominion Bank - announced their intention last week to form a joint check processing venture.
The still unnamed company, being hailed north of the border as a breakthrough in cooperation on a so-called core banking function, would handle the three partners' combined annual volume of two billion checks, or 40% of the national total.
While it would take many more than three U.S. banks to account for so much of the national check volume, industry sources said it would not be out of the question for two or more of this country's giants to pool their resources in any of a number of data or paper processing operations.
That is, in effect, what Chase Manhattan Corp. and Chemical Banking Corp. accomplished in their recent merger. Back-office cooperation short of such a merger - it might be called mega-outsourcing, though the Canadians prefer "co-sourcing" - could work the same way.
It has already happened on a more modest scale: In 1993, Bankers Trust New York Corp. formed a check processing unit with First Fidelity Bancorp. of New Jersey, later acquired by First Union Corp., which allowed the banks to reduce their costs by 20%.
"The economics make a very strong case," said Lawrence Willis, managing director at First Manhattan Consulting Group in New York, which worked with First Fidelity on its outsourcing strategies. "I would expect more of these deals as banks continue to merge and find themselves in areas where they have check processing requirements but don't have scale."
John Kennedy, a Canadian banking consultant, called the latest, tripartite deal "quite significant."
"It could be an example for U.S. banks to do the same thing," said Mr. Kennedy, president of ISG Inc. in Burlington, Ontario.
Mergers may slow the trend in the U.S. because "there is always the question of who takes over whom," said Mr. Kennedy. "Mergers upset the apple cart."
The Canadian arrangement may indicate that banks there are feeling many of the same pressures faced by their U.S. counterparts in the item, or document, processing areas.
"It's driven by cost savings," said Thomas Jarmai, analyst at First Marathon Securities in Toronto. "We expect to see many more deals like this in the future."
The considerable costs of high-technology imaging are leading even the biggest banks to look for outside expertise, say analysts.
One of the big six Canadian banks not in the check venture, Canadian Imperial Bank of Commerce, is reportedly about to close an item processing contract with Fiserv Inc., the Milwaukee-based bank services company.
Executives at the three "co-sourcing" banks said they were motivated by other technological successes, as in debit cards and home banking, that have led to a 4% decline over the last five years in annual check volumes.
"The driving force has been the reduction of paper-based transactions," said Duncan Gibson, executive vice president of operations at $81 billion- asset Toronto Dominion. "You need to have substantial volumes to justify the expense of investing in new technologies."
Each of the three banks will own a third of their Toronto-based joint venture. They will contribute a total of $110.2 million to equip the new company with the latest imaging systems. The three banks expect $400 million in annual cost savings - about 15% for each - once the new company is up and running in 1997.
The deal affects 4,300 employees who are in the banks' separate processing areas. Bank officials said the new company will have only 2,700 employees, the difference accounted for by attrition or transfers to other departments.
Some stock analysts described the Canadian consortium as an antidote to restrictive bank merger laws.
"While only a merger of the back office, so to speak, it is the first major step towards voluntary consolidation of the Canadian financial services industry," wrote Donna Toth, analyst at Scotia McLeod Inc. in Toronto.
Robert Tetley, senior vice president of operations at $109 billion-asset Bank of Montreal, said Canadian ownership was seen as more desirable than turning to a U.S. outsourcer. "We all had similar views that we wanted to protect our employees and keep the business in Canada."
"It's hard for an outsourcer to come into a market where they don't already have significant volume," said Mr. Willis . "Without that volume in place, it's hard to put together an attractive deal."
Nevertheless, $126 billion-asset Canadian Imperial appears prepared to turn the processing of checks, credit cards, and corporate remittances over to Fiserv.
Stock analysts have been expecting the deal for weeks, and it has been the subject of articles in the Canadian press, but formal announcements are not anticipated until later this month.