1
ICBI Operational Excellence
What do Banks Really Need to do to Address the Issues
of Business and Operational Excellence?
How will the Long Arm of Regulation Continue to
Impact Banking Operations?
September 2010
BOB LYDDON – IBOS ASSOCIATION
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The Payments business is not on a convergence trend
● Harmonisation within the EU / EEA has hit the buffers
Politicians’ stated aim
 Cut 2% GDP off cost of payments
 Direct Payments
Status
 Only 4% migration to SEPA instead
of the critical mass that should, by
end of 2010, have made migration
irreversible (SEPA Roadmap 2004)
 Fewer Interbank events
 Layered Market
 XML no longer integral to
ISO20022 or SEPA
 More room for national flavours
● Maxi-SEPA, universal usage of XML are not “just
around the corner”….
3
Impact of latest regulations
Reg 924/2009
- partial abolition of CBR
- reachability for SEPA Core Direct Debit
- no MBPs after 2012
PSD
- float income reduction
- increased responsibilities and risk
- new entrants with passports
SMED
- mandatory adoption of SEPA schemes
- but with many safety valves
- national variations/”niche” schemes
 More complexity
 Lower price
Latest “Industry” developments
SWIFT
- standards co-existence
- no retirements dates for MT
- E&I and n92, 95, 96 co-exist beyond 2012
SEPA
- SEPA does not mean XML any longer
- “essential requirements” discussion
- permits national variations/data formats
- Credeuro (XCT) is SEPA-compliant
- “niche” schemes formally excluded (RIBA)
 Standards convergence no longer on the agenda
 Proliferation and complexity
 Very low migration to SEPA instruments so far (see Appendix with
STEP2 statistics including for Credeuro)
4
EU Vision for future market structure: away
from Vertical to Horizontal Integration
VERTICAL = BANK
Acquisition
Customer Access Systems
Processing
Operations and data centres
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HORIZONTAL
Direct SWIFT
Access
Bank-owned
Channels
Mobile
Social Networks
Activities requiring Banking Licence or Payment Institution Licence
Processors of non-licensed activities
Communications
Own backbone
Clearing &
Shareholdings
Direct memberships
Sub-memberships
Settlement
Correspondents
SWIFT
PEACHes
ISPs
ACHs
BT Radianz
Net Settlement Systems
Banks
Final Settlement activities:
● Direct RTGS membership
● Banks
Only two areas of activity are the unalterable preserve of Banks:
 Activities requiring a full Banking License (as opposed to a PI or eMI)
 RTGS clearing membership
EPC Design Model for Card Schemes (Source EPC)
 Cards market model is already layered
 EPC design encapsulates this
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7
EPC Design Model for Payments (Source EPC)
 Layered – big change from status quo
 More layers and more complex than for Cards
 In principle a lot of space for non-bank “horizontal” players
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Cards vs Payments
Cards
Payments
Schemes
Concentration of volume
on Visa and Mastercard
Distribution over many CSMs to
avoid duopoly
Standards
Rigid definitions from the
centre
Space for community-defined
variations in the form of
Additional Optional Services and
Value-Added Services
Performance
High speed, high volume,
interoperable
Bigger message size (XML) and
usage of SWIFT (which runs on
the lines of Equant etc) could
compete with public internet usage
Message size x line
capacity x routing facilities
>> quick response time
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SWIFT Standards Co-Existence IR 535
IR 535 approved at SWIFT’s June Board Meeting is a major
change of position:
 Migration to XML is non-mandatory: no end dates for MT
 ISO20022 does not automatically imply XML as the physical
layer
 The UML level (actors, data, process) is the fulcrum
 By extension any Scheme that fulfils the EPC Rulebooks and
the UML models can be SEPA-compliant – it does not have to
use XML
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Industry Utilities
 Layered market should create many opportunities for industry
utilities
 For activities not needing a banking licence
 Should banks lead this? What is the track record in collaborative,
self-regulatory ventures?
 What activities and tasks could be delegated to industry utilities?
 What would be the hand-offs to them as Inputs to their Processes,
and how would their Process Outputs be re-integrated into the banks’
processing flow?
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Simple Outsourcing Model (Source PW)
Critical
Non-critical
Core
Do-It-Yourself
Volume processer:
Cheaper if output is
commoditised
Non-Core
Professional service
expert: more expensive
Don’t do it at all

So which actions in the payment processing flow can be
outsourced and who to?

Complicated in banking by the banking licence issue + VAT +
no proof that the service itself is becoming harmonised.
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Linear & Sequential Process - Amazon
Enquiry
Acquirer
Logistics
Company
Fedex
Warehouse
Carrier
Stock
Check
Payment
Order
Fulfilment

Payment and Logistics are Non-Core but Critical.

What about Fedex?

Is there room here for a cheap volume processor?
End of core
activities
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Payment Process
Banking
Controls
PSP
activities
Cash / Collateral
position
information
Choice of
routing
Queue
Outsource
Activities
Communications &
Security
Data &
Content
Validation
Prepare
accounting
entries
Release

Sporadic “Core and Critical” actions all the way along

PSP must retain decisions on credit, routing and liquidity.

Outsource does the legwork that does not require a banking licence.

Multiple hand-offs during the flow

Outsourced work is VAT-able towards the PSP: can the PSP reclaim it?
Correspondent /
Clearing
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ACH models – direct + indirect submission

Vocalink acts as an effective outsource for UK banks

It prepares files of accounting entries

There is no “choice of routing” for UK Credit Transfers and
Direct Debits as Vocalink is the sole system

Banking controls are done upfront by the posting of credit limits
by system members for corporates + other FIs (who are not
direct members)

Those other FIs in turn post limits for their customers

Three rings: not equal access for all, as required by PSD Title 2
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ACH Payments – Credits and Debits: Submission direct to clearing
DR/CR
ACCOUNT
Client
Accounting
system
File upload
into EB
Accountholding
bank
Clearing
System
OTHER
BANKS
OTHER
BANKS
OTHER
BANKS
BENEFICIARIES/DEBIT PARTIES’
ACCOUNTS
ACH Payments – Credits and Debits: Submission model through the bank
Client
Accounting
system
DR/CR
ACCOUNT
File upload
into EB
OTHER
BANKS
Account
holding
bank
OTHER
BANKS
Clearing
System
OTHER
BANKS
BENEFICIARIES/DEBIT PARTIES’
ACCOUNTS
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Is Cloud Computing the answer?

Cloud computing is internetbased computing, whereby
shared resources, software
and information are provided
to computers and other
devices

Is this the way the hand-off to Outsourcers is effected?

What is the certainty that the computing resources at the Outsource remain
superior to in-house ones?

How nimble is this set-up when requirements change and what are the costs
of change?
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What about Blade Computing?

A blade server: houses multiple
server modules ("blades") in a
single chassis (rectangular, usually
steel frame).

Used in datacenters to save space
and improve system management.

Massive increase in power and flexibility.

Enables datacentre consolidation and shrinkage.

Game-changer – allows processes to be run in much smaller scale without normal
penalty of poor scale economics.
What’s the environment we are going into?
Proliferation of processes defying achievement of scale economics
Variations in data and service level
Learning from other industries:
o Banking processes are not linear and can be hard to fully automate
o Activity has to be strictly standardised with rigorous data and banking
checks applied upfront
o The Cards business and a utility model like Vocalink for UK BACS follow
this line
o That is not the SEPA environment as it appears to be unfolding
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SEPA environment unlikely to be 6σ compliant





Bank
A
SEPA
Compliant
ACH
R-message
STEP
2
Too many players
Too many routing choices
Expandable data requirements (VAS, AOS..)
May work in small volumes to begin with
As more players come on and more volumes,
standard deviation moves away from the mean
over time
 Many instances then fall outside Upper/Lower
Specification Limits which are only 2σ away
from the mean
 Not 3.4 Defects Per Million Opportunities (6σ)
but 000s of DPMO
 non-STP rate in 15-20% range
SEPA
Compliant
ACH
R-message
PEACH
Bank
B
Account
Blocked
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What happens when more volume is brought onto SCT and the normal assumed
movement of 1.5 occurs in or over time?
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LSL
μ
USL
 Curve is7 same shape
but μ moves by 1.5σ
 Hardly 6any instances
below LSL
5
4
3
2
1
0
-3σ -2σ -1σ μ +1σ +2σ +3σ
μ moves by 1.5σ because
 μ itself moves or
 σ widens
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 But huge numbers –
45% - fall outside USL
 Non-compliance / not
STP
 Proliferation of official
Schemes (Core, B2B..)
 Annual Scheme
upgrades
 AOS
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Conclusions
The emerging environment is one of divergence, not convergence
Detailed management of inputs and outputs becomes a Core and
Critical function of a Transaction Bank
That means “do it in-house”
Whether the IT configuration can include Cloud will depend on line
capacity and contention with public internet usage
Blade seems to be a better bet: higher power in one place and more
flexibility >> lower costs and a change of scale economies
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Appendix
EBA STEP2 Volumes as a proxy for SEPA migration:
 STEP2 frequently used a bridge between other CSMs
 Credeuro (XCT) statistics are steady
 SEPA Credit Transfer (SCT) statistics show steady increase:
o Higher average value than XCT
o Higher average value than national payments
 Volumes are therefore:
o Cross-border payments
o Corporate payments
 Virtually no Direct Debit volumes migrated to the SDD yet – key date
is 30th November when all Euro-in banks must be reachable
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APPENDIX: STEP2 SCT
Average daily volume
Average daily value
July 2010
663,259
3.84 bio. euro
June 2010
653,925
3.77 bio. euro
May 2010
604,561
3.55 bio. euro
April 2010
594,092
3.53 bio. euro
March 2010
553,841
3.13 bio. euro
February 2010
466,026
2.76 bio. euro
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APPENDIX: STEP2 XCT
Average daily volume
Average daily value
July 2010
189,292
841 mio. euro
June 2010
192,439
822 mio. euro
May 2010
189,131
805 mio. euro
April 2010
202,067
852 mio. euro
March 2010
193,253
789 mio. euro
February 2010
195,586
778 mio. euro
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APPENDIX: COMBINED STEP2 SCT & XCT
Average daily volume: Average daily value:
XCT + SCT
XCT + SCT
July 2010
852,551
4.681 bio. euro
June 2010
846,364
4.592 bio. euro
May 2010
793,692
4.355 bio. euro
April 2010
796,159
4.382 bio. euro
March 2010
747,094
3.919 bio. euro
February 2010
661,612
3.538 bio. euro