It is clear that U.S. banks need to continue reducing expenses while improving services. They are under a great deal of pressure from a variety of market forces. Operations, especially item processing, continues to be an area of opportunity.

Banks are spending billions on processing endeavors that look more and more like commodities. It makes sense to use every reasonable and economically viable option to increase efficiency in this labor-intensive area.

Although item processing is highly automated, a number of inefficiencies exist. These inefficiencies prevail primarily because of the industry fragmentation resulting from the large number of financial institutions, the number of operations centers, and the artificial barriers imposed by interstate banking.

Tight processing windows also mean that resources are underutilized during down times. Processing work uses a lot of labor, equipment, space, and technology, and it uses those resources inefficiently.

Except for a short peak period each day, these resources are often idle. It has been estimated that the check processing capacity in this country could be three times greater than it is today. High resource utilization remains the largest operational task facing most financial institutions.

Most opportunities to automate and otherwise increase productivity with traditional technology have already been realized. There are physical limits to the speed with which paper can be processed and moved. Finally, large financial institutions face an imminent retooling of item processing for imaging.

Check volume will continue to grow, and processing will continue to be an increasing operational burden for banks. Though electronic transaction volume has grown rapidly during recent years, it represents only a fraction of total transactions. Most industry experts estimate check volume to continue to grow at the current rate before peaking in the early years of the next century.

The reasons are easy to understand. Consumers like checks. They are satisfied with the reliability, accuracy, convenience, control, record keeping, and low cost. They do not perceive a compelling reason to reduce their dependence on checks. Finally, the check collection system for all of its internal inefficiencies has been well-served by such technologies as MICR and high-speed reader-sorters.

These technologies of the 1960s, 1970s, and 1980s enabled banks to cope with growing volumes of checks, but the expense of incorporating sufficient technologies and resources also cemented banks' dependence on paper. As a result, banks have had little incentive to discourage the use of paper checks.

From bank to bank, the basic operations processes do not vary substantially. The heavy industry regulation has created a high degree of service homogeneity. Industry standards in equipment, technology, and procedures further eliminate processing differences from bank to bank.

In addition, there are market forces at work that will drive the transformation of checks and payment processing as it is known today. Examples of these are same-day presentment, electronic check presentment, point of sale, bill paying through home banking, and interstate banking.

Technology within item processing is evolving rapidly, with significant improvements in image proof of deposit and image statements. In terms of locating errors, system balance, customer service, and overall efficiency, these technologies are dramatically changing check processing operations.

If banks are to reduce the cost of check processing, they must have systems that permit greater opportunities for economies of scale. Productivity increases in bank operations have leveled off after years of big gains. Most senior operations officers and consultants believe that it is only a matter of time before imaging begins to deliver processing improvements comparable only to those created when magnetic ink encoding was introduced in the 1960s.

Inevitably, image technology will help drive down industry costs significantly. Yet image proof of deposit has been slow to catch on because of the multimillion-dollar price tags.

Banks should consider three options available to leverage this steep investment: continued internal consolidations, an operations utility, and outsourcing. All are viable solutions for the appropriate situation. By further consolidations of their own operations, joint participation with other banks, or service bureau outsourcing, banks can enjoy the benefits of image processing while minimizing costs.

To realize the benefits, a true consolidation of operations must provide all functions of the bank with one processing flow.

Many banks have centralized operations under one roof but perform the individual functions multiple times. The supposed operation consolidations have in fact been little more than centralization. This also explains why so many institutions do not realize the significant benefits they anticipated. This continues to happen with financial institutions of all sizes and can adversely impact projected savings, which translate into bank earnings and stock prices.

This is the most comfortable option because it represents low risk. It can in fact be very risky because there is a lack of objectivity. Those who manage the effort have a vested interest.

These factors combine to create a business that can well be served by the "utility" environment of a joint venture between banks and an independent third party - provided the utility maintains the necessary features that permit individual institutions to differentiate their products and pricing.

The products or services of any check utility should be concentrated on core processes such as proof and encoding, item capture and balancing, statements, returns, and adjustments - not research, which is a customer service function - along with any document sorting necessary to perform these functions.

The area of cash management services was thought to be too competitive for utility processing, though images and data to build these products would often come from the utility. However, there are signs that banks, even the larger money-centers, are rethinking this position because of the slim margins and the investment in technology required to stay competitive.

For several years IBM promoted the potential benefits of merging the check processing volumes of large banks. As early as 1991, several of New York's largest banks were interested in cooperating in joint venture with IBM. Most institutions have evaluated this option over the last few years. However, there are only two well-publicized utilities: CoreState's Transys and the Global Processing Alliance of First Fidelity and Bankers Trust.

Obstacles to creating a utility are lack of trust between institutions, management control issues, valuation of the individual "franchise," agreement on termination clauses, internal transaction costing, low current cost because of the lack of spending on technology, and inadequate third- party margins. Though difficult, these obstacles can be overcome with the right advance work establishing trust and appropriate control.

Other third-party providers, Fiserv and EDS are actively building capabilities based on the latest technology and services. This may be the answer for many financial institutions wanting to modernize payment processes and their delivery systems without incurring the high cost of internal development and reengineering.

The risks are to do nothing, keeping costs high and failing to deliver new products. With current technologies, even smaller institutions can realize the scale economies and benefits of new products.

If senior management challenges operations to do these consolidations in a planned time frame with bottom-line benefits, few people are going to come forward and tell them the established plan is not workable. The risks are the benefits are not properly projected, the time line is distorted, and the current environment is not benchmarked.

There is no perfect solution. However, banks can do more to evaluate future options by including operations in the strategic planning process, understanding the true functional costs and how they relate to consolidation cost-benefit projections, benchmarking the operations prior to consolidation and standardization so the benefits can be measured, understanding today's economic costs, and allowing independent resources to accept the risk and provide objectivity.

Consolidations will continue to save money. New technology will bring about further efficiencies. The banks benefiting the most will be the ones who quickly find a cost-effective option to introducing imaging efficiencies and other technologies. It is time to position banks to expand their business.

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