In this time of record net interest margins, a potential Achilles' heel to many banks' strategies and potential performance is beginning to emerge -- what to do about payment systems costs.
These overhead expenses keep rising, slowing the drive to lower noninterest costs and enhance operating efficiency ratios. As net interest margins begin to erode, the levels and concerns related to noninterest expenses will become much more apparent.
Finally, after many false starts and promises of change, senior bankers are facing the reality that core deposit-taking functions are no longer the stepchildren of commercial and retail banking.
A Cohesive Strategy
Banks need to develop integrated line-of-business strategies that set them up for both lower costs of delivery and more efficient delivery processes that carl be modified as alternative delivery forms emerge.
Inherent in these changes is the premise that many banks lack a truly integrated payment systems strategy, relating to both short- and long-term positioning.
Rather, payments utilities are a vestige of the old "islands of influence," separating delivery from many of the line users of the utilities that have formed. As a result, unique line-of-business requirements can be compromised to the needs of the utility.
Today, banks cannot afford to miss the mark. The marketplace has changed radically. Interest rates no longer hover around 15%, the Federal Reserve is pushing hard against payments risks, and new technologies like imaging stand ready to overtake traditional paper-based processes.
Bank managements must begin the transition from the old "if it ain't broke, don't fix it" paradigm to cohesive payments strategies.
As bankers take advantage of lower interest rates in their net interest margins and their securities portfolios, they must also challenge the operations that have been built on the promise of continued high interest rates.
Delivery strategies that were put in place to maximize timing differences, or float, are no longer appropriate. According to the latest Bank Administration Institute Check Processing Survey, the average bank allocates over 20% of its direct costs to float-related expenses.
In some cases, the indirect costs associated with peak-load processing pushes the total tab for accelerating payments flows to 35% to 40%.
Optimizing Production Costs
Banks are being forced to look at a future where they can join other industries in leveraging new production management techniques to permanently lower operating costs and begin the migration from paper to electronic delivery and introduce quality as a means of product differentiation.
Some may question the validity of the notion that the float-oriented world of payments has been displaced by a new order of production management. But bankers need to begin making substantial cost reductions, optimizing production costs and delivery requirements rather than deemphasizing production costs in favor of float-derived revenue.
From an economic standpoint, the deposit-taking function of banking continues to be labor-intensive and resistant to the need to permanently lower costs.
Some banks have made marginal strides in cost reduction, but the real changes needed to push new production management techniques have been frustrated by a general sense of confusion in the payments system planning process.
Continually pressed to reduce costs, bankers have generally treated new payments initiatives individually rather than as integrated options driven by cogent business strategies.
Changing the focus of a utility processor to a line-of-business integrator opens the risk of change to the old paradigms of processing.
Actions by the Federal Reserve also have contributed to the confusion. With the new world of same-day check settlement due to commence Jan. 4, many banks will be compelled to break old correspondent ties and present checks directly to one another to eliminate presentment costs and to get use of a higher percentage of funds during the day.
Beyond reducing presentment costs, the move to simultaneous settlement of debits and credits will limit business practices that have been dependent on deferred check settlements.
Meanwhile, efforts such as electronic check presentment, the Electronic Check Clearing House Organization, interclearing house exchanges, and the National Clearing House Association will eliminate float premiums from check operations and move the world of check clearing toward more cost efficient delivery methods.
In the new order of banking, influenced by mergers and consolidations, payments processing is not as simple as adding one to one and coming up with two. The banks that are adding significant payments volumes through acquisitions are discovering new complexities and new demands on old check processing conventions.
Clearly, a need exists for newer production management techniques and technologies. Customers, meanwhile, care about quality.
What will prove most troublesome for bankers, however, is the challenge of managing for today and investing for the future. Results of the 1992 BAI Check Survey bear this out. Most large banks spend about $1.5 million on check processing for every $1 billion of deposits.
Yet, prior studies indicated that it can take investments of $1 million per $1 billion of assets to fully integrate imaging technology into existing operations.
Commitments to Change
So, the fight for capital intensifies. Yet, paradoxically, a streamlined and reengineered delivery platform will greatly accelerate the ability to complete consolidations yielding the very payoff that bankers seek.
Meanwhile, the new potential for outsourcing will challenge each bank to determine the importance of payments strategies to its overall business and market plans. If banks are moving toward the provision of commodity services where little value can be created producing payments products to support broader business strategies, then outsourcing arrangements will proliferate.
Alternatively, those banks that consider payments systems delivery strategies integral to overall business and market strategies will make greater commitments to change and to new levels of productivity.
Many bankers will have to challenge the old paradigms in order to succeed with their payment systems strategies and reduce costs. As in other areas of banking, the payments arena will begin to dissolve into nontraditional supplier and user alliances and joint ventures.
Only those bankers who strive to keep ahead of the change curve will be able to reap the benefits of an integrated strategy that the future demands.