Friday, January 22, 2010

Good bank, bad bank

While financial stocks are reeling in the wake of U.S. president Barack Obama's announcement that he wants to limit the scope and size of banks and their trading activities, their must be mixed feelings amongst banks about this announcement and what it means for certain parts of the bank.

Trading, hedge funds, private equiy and  investment banking look as if they could be the hardest hit particularly as much of the U.S. government's rhetoric is around those banks that have become more than just deposit takers and are indulging in risky trading activity on their own books (and still expecting to be bailed out by the government). According to a article, one White House spokesman said that banks that received a "backstop" from the taxpayer shouldn't be able to make a profit off their own investing."

It goes back to the co-mingling of clients' funds with the banks' money, but as early newspaper reports suggest trying to disentangle one from the other could be tricky unless you clearly separate good old fashioned banking (lending and deposit taking) from proprietary trading. That smacks of Glass-Steagall.

Most banks will be reluctant to separate investment banking or proprietary trading from the rest of the bank and will argue that one feeds into the other in terms of cross-selling opportunities. After all investment banking or proprietary trading, although  high risk, made a substantial contribution to  banks' balance sheets prior to the recent crisis and in its wake.

But what does this mean for the less riskier parts of a bank's business, for example, transaction banking? Does Obama's clampdown on banks mean that transaction banking - which is less volatile and a relatively stable business in good times or bad - will become the most prized of all the banks' businesses?

We are certainly seeing that with the likes of Citi, which has divided itself into "good bank", "bad bank", putting its more core, stable and profitable businesses such as GTB into a separate unit called Citicorp and riskier non-core assets into Citi Holdings. Are other banks going to have to follow this example in order to comply with Obama's requirements? And if they don't is transaction banking in danger of being polluted or fouled by the mistakes or errors of judgement of its riskier investment banking counterparts?

Transaction banks vye for a slice of the remittances market

One aspect of the cross-border payments business that global transaction banks have failed to monopolise is remittances. Estimates from the World Bank suggest that the global remittance market increased 63% in the five years leading up to 2009 with more than $550 billion worth of funds remitted by immigrants living abroad in 2008.

Any bank can see the huge revenue potential if they are able to capture a substantial share of the global remittances market. However, the global remittances business is still dominated by non-bank money transfer providers such as Western Union and MoneyGram. One of the reasons for that is that remittances tend to touch the "unbanked" in emerging markets - people that don't have a bank account or ready access to one.

Banks, also being risk averse, have hesitated to enter this space particularly given the onerous regulatory requirements it entails for them in terms of compliance with Know Your Customer (KYC) and Anti-Money Laundering legislation. That perhaps explains why figures suggest that, in the US market at least, there are only about 100 banks that offer consumer remittance services with any meaninful volumes.

Yet, some banks like Citi and Bank of America have made forays into the remittances space, either alone or in conjunction with partner banks to offer consumer remittances at a lower cost than the traditional money transfer agencies.

Deutsche Bank is the latest entrant to this space. While it has no interest in selling remittance services to consumers directly, as part of its growth strategy for its Global Transaction Banking business, this week the German bank announced a strengthening of ties with payments network Eurogiro, which connects postal organisations globally.

Deutsche has taken an 8% equity stake in Eurogiro and plans to expand its offering to Eurogiro's network of postal organisations, post banks and othe financial institutions beyond US settlement services to encompass multicurency services. In return Deutsche gains access to Eurogiro's enviable global footprint across emerging markets without having to build a bricks and mortar presence itself.

Paul Camp, head, cash management, financial institutions at Deutsche Bank says the strategic investment in Eurogiro is part of Deutsche's Global Remittance initiative which combines Eurogiro's reach with the bank's existing capabilities as well as its plans to leverage mobile and SMS.

Camp was coy about Deutsche and banks' overall share of the global remittances space, but said its overall share was quite small  (Deutsche's share of total cross-border payments globally is 5% based on SWIFT traffic volumes) but that it was looking to grow its presence. "However it is not a risk free market," he says, "given the AML and KYC issues."

Deutsche will be relying on the partner banks and postal organisations within Eurogiro to have the right risk controls in place while it will provide them with multicurrency settlement capabilities. It is also working with mobile technology provider Luup to expand its mobile payments capabilities particularly in the B2B space. Mobile is deemed to be a useful technology in the remittances space because it allows people without bank accounts to receive money.

On the whole whoever, both banks and the money transfer agencies have been slow to leverage mobile technologies in the remittances space. They have been pipped to the post by telecom companies like Vodafone which partnered with in Kenya to launch M-PESA, a mobile money transfer system which has more than 7 million subscribers.

The banks have yet to clearly demonstrate what additional value they can bring to the remittances space, however, the gloves are off, and Western Union and MoneyGram can expect increased competition from banks, telcos and pre-paid card providers.