As banks outsource ever more services to third parties, they must contend with the associated headache of strict governance and spiralling costs. Tamar Schechter, EMEA head of third-party management at Citi, explains how economies of scale and new outsourcing locations can help.
In many respects, the outsourcing arena might be seen as a microcosm for the financial services industry at large. Subject to heightened regulations and intense cost-cutting measures, the banking sector is expected to do more with less, and as outsourcing becomes more prevalent, third-party relationships are bearing the brunt of these demands.
"How tomorrow's bank looks, I can't really predict, but I do foresee that we will see much more outsourcing," says Tamar Schechter, EMEA head of third-party management at Citi. "We will see fewer branches, and we will see a lot more social media and electronic banking being promoted simply because the banks have no ability to sustain their current level of expenses."
Schechter, whose role includes strategy and risk management, does not wish to discuss outsourcing as a single topic, pointing out the wide variance that exists across different aspects of the industry. While the broader trend has been towards a greater reliance on third parties, the sector has been far quicker to embrace some forms of outsourcing than others.
"I think where the banks are outsourcing is on one hand the traditional areas such as producing consumer cards, for example - that's always been outsourced," she says. "Call centres and back offices would be outsourced, but the digital arena will take longer - I don't see the banks rushing in until there's proven security in those areas."
However, she feels the current slew of regulation is testament to an industry-wide phenomenon that can no longer easily be ignored. During the financial crisis, the full extent of banks' outsourcing activities was revealed to regulators for the first time. After Lehman Brothers collapsed, it wasn't simply a matter of turning on the lights and resuming work - with so many operations taking place elsewhere, sorting through the mess became intensely challenging.
Since then, regulation has been tightened, largely as a means of protecting the end customer. Regulators want to ensure that, should history repeat itself, they will be able to deal with any problems at warp speed.
While the logic is unimpeachable, these regulations put a huge burden on the banks from a cost and staffing point of view. As more and more people are employed to deal with risk and oversight, this is steadily draining resources from already overstretched departments.
"The regulators will probably reach a point of status quo where they will say, 'okay, let's see where we are today and what's really required for tomorrow'," says Schechter. "I don't think the regulators aimed at increasing the financial burden on the banks, but their actions have meant it's becoming very tough for all the financial institutions to cope. So they will have to find a golden mean in between the requirements, the costs to obey those requirements and the end results."
Until that point arises, however, Schechter believes we will continue to see different levels of oversight in different banking institutions. As not all of them are currently meeting the regulators' expectations, the industry isn't likely to ease the pressure just yet.
"I don't see any appetite with the regulators to listen to any lighter version of their current regulation," she says. "If you look at the Office of the Comptroller of the Currency (OCC), for example, it published a very detailed, prescriptive bulletin in October last year, which explains exactly what its expectations are through the life cycle of outsourcing. In order to follow that, the whole industry has to change. I don't see anyone really stepping aside now to say we can reduce our requirements."
She also feels that, when it comes to a bank's relationship with a third-party service provider, it's important to differentiate between oversight and governance. Oversight is something a bank executes on a daily basis - where it has outsourced its payment processing, for instance, the employee tasked with oversight will ensure that all payments have indeed been processed. Governance, on the other hand, entails looking at key performance indicators and identifying risks, verifying that the relationship is performing as agreed in the contract.
"For this, you need different people who have a different mindset - who have the knowledge and the risk-management approach," says Schechter. "You tend to invest in those people nowadays, and I think that, going into the future, we will have to combine certain groups and enjoy the economies of scale even for outsourcing governance."
Out with the old
Outsourcing is not just facing tight regulation - it is also forced to contend with higher costs. As certain outsourcing locations become more expensive, banks are being forced to re-evaluate exactly where they allocate their resources.
The classic example here is Indian call centres. With an English-speaking workforce and low overall costs, India was once the go-to location for UK organisations looking to move their operations overseas. More recently, however, the subcontinent has become prohibitively costly and the industry is chasing opportunities elsewhere.
The UK market, for instance, has invested in a surge of shared-services centres elsewhere in Asia, with a particular push towards call centres in the Philippines. Here, they can find a strong talent base at low cost, without sacrificing any of the advantages they initially found in India.
When it comes to technological services, Eastern Europe has attracted a reputation as a suitable outsourcing hub. Because these are specialised graduate professions, some banks are establishing cooperative relationships with certain Eastern European universities. Students are encouraged to take particular courses, which will set them up for a job.
However, as mentioned earlier, digital services are generally still being retained in house. Due to the associated security risks, few banks are taking the gamble of sharing their sensitive data with a third-party provider.
"The problem with outsourcing these services is you run the risk of exposing personal data to a third or fourth party," explains Schechter. "Even placing customer information in the cloud has to be secured. There's a lot of regulation around protecting personal information, so banks are not rushing into outsourcing digital media."
Over the next few years, Schechter believes there will be more internet companies assuming some of the functions of traditional banks. Once cybersecurity has improved to the requisite degree, the likes of eBay, Amazon and PayPal are likely to expand their range of services significantly.
"This is where "There is a school of thought that you can just throw data to big-data lakes and still benefit from trends and valuable insights."the competition is coming from," she says. "The more we are digital - the more we are able to answer everything without speaking to a human being - the more this will change our world. For this, we will probably need much better technology than we have today, and we will have to protect our service much better since we are currently under attack every day, but it's already showing. The number of bank branches are being cut, and banks are looking to reinvent themselves in a certain way when they're dealing with consumers."
In the meantime, she feels the banking industry will fare best when it takes ownership over its own outsourcing decisions, rather than being led by factors beyond its control. In her experience, where decisions are driven by regulatory requirements, those requirements feel like a painful impingement as opposed to a seamless part of the process.
"It's important not to let the regulators spoon-feed you," Schechter says. "You have an opportunity to design your outsourcing in a way that complements but does not disturb the business, and then when the regulators come in with their requirements, you've already created a receptive environment.
"Business has its own priorities and timelines, and we must always support the business and make sure it reaches its targets. The outsourcing levels are part of that. I think a bit of ingenuity and forward-thinking has always helped."