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The changing face of retail banking in Ireland Back  
In the first of a two part series, Derek Moriarty examines the changing landscape of Irish retail banking and says that faced with increasing competition from new entrants such as Northern Rock, banks will have to demonstrate radical new capabilities to profitably capture the growth opportunities likely to exist in the market.
Irish retail banks have certainly had much to shout about. In recent years, they have capitalised on strong economic growth and a relatively benign competitive environment to significantly outperform European peers in terms of profitability and returns to shareholders. Increases in domestic consumer and corporate demand for financial services products have been driven by underlying Irish economic growth which has exceeded that of European counterparts by 5 per cent per annum over the last ten years. At the same time, the relative lack of price-based competition in most product markets has allowed Irish banks to maintain some of the highest deposit and lending margins in Europe - delivering in turn cost/income ratios which are among the lowest in Europe, and returns on capital which are the envy of European peers.
Recent evidence, however, would suggest that the tide is changing fast. While projections for growth in domestic demand in most product markets remain ahead of other European economies, it is likely to run at levels significantly below those observed through the ‘Celtic Tiger’ years. Of much more concern to providers, however, is the potential step-change decline in profitability resulting from increased price-based competition in almost all retail banking product markets. This has come about from the entry of new, mostly foreign-based competitors offering headline prices below existing market levels. Examples include Northern Rock in demand deposit accounts, MBNA in credit cards and Bank of Scotland in residential mortgages. While these entrants have had varying degrees of success in building profitable footholds in Irish markets, the knock-on impact of their arrival has been to reduce market price levels significantly (e.g. by c. 125 basis points in the case of residential mortgages), to educate consumers on the impact of product pricing on their own personal economics and as a result to increase the importance of price as a key buying criterion in purchase decisions.
So can Irish banks maintain their track record of superior performance under these new circumstances? The market does not yet appear to be convinced. Despite the extensive speculative ‘noise’, which has resulted in particular from this year’s change of leadership at Bank of Ireland and subsequent events at Allfirst, the Irish financials as a group continue to trade at a p/e discount to their European peers.
In our view, extending the performance track record of Irish financial services institutions will require them to demonstrate radical new capabilities to profitably capture the growth opportunities likely to exist in the market. This implies on the one hand delivering new cost models that allow them to profitably compete below rebased price ‘ceilings’, and on the other hand identifying and exploiting those segments of retail product markets that have the highest structural profitability. The remainder of this article will discuss our approach to achieving the former of these objectives, while the concluding article in the next edition will present some thoughts on how to deliver the latter.

First attempts made but need to dig deeper
Irish financial services institutions are already down the road in thinking about cost reduction. We have observed a range of initiatives being undertaken by leading players including centralisation of activities, automation of transactions, branch rationalisation and so on down to reducing the number of newspaper subscriptions for staff!
In addition we are seeing signs of more radical approaches being adopted.

• Shared services: Over the past five years Ireland has been a favoured location for the establishment of shared services centres, which allow business units to share the processing of common functions, such as accounts payable, G/L and reporting, expense reporting, payroll, HR administration, etc. Companies such as Oracle, Microsoft, Siebel, Dell and Whirlpool have established centres here. Over the recent past the shared services concept is being adopted by Irish financial institutions. Successful implementation of standardised processing is a critical first step for outsourcing.

• Outsourcing/co-sourcing: Clearly this is not a new concept, and institutions like Bank of Ireland have had long-standing outsourcing arrangements that cover basic administration processes (indeed they act as an outsourcer themselves in the area of securities transactions processing). However it is our contention that the economics of profitable participation in the future Irish market environment will result in renewed focus in this area. We have observed the emergence of innovative outsourcing models in other markets such as ‘pay-as-you-go’, however of particular interest to us in an Irish context is the joint venture or co-sourcing model, in which banks share and sometimes co-invest in an outsourced platform. Viewpointe Archive Services LLC - a cheque image storage utility jointly owned by Bank of America, JP Morgan Chase, and IBM - is a prime example of this model. We view initiatives of this type as potential vehicles to provide Irish institutions with sufficient operational scale (with associated economies) to enable them to profitably compete over time with foreign-based institutions leveraging large operational and administration capacity located outside Ireland. The recent announcement by AIB and Bank of Ireland to establish a joint venture to share IT infrastructure is a good example of this trend.

• Property portfolio restructuring: Our view here is that Irish retail banks have large amounts of capital tied up in their extensive property portfolios, the productivity of which could be significantly improved through the adoption of new approaches to real estate management. These involve on the one hand adoption of a more needs-based approach to property which reflects the emerging location, channel and service preferences of customers, and on the other hand consideration of innovative financing arrangements which bring benefits in the form of reduced capital, improved tax efficiency better flexibility. We have observed such approaches being used by institutions such as Merrill Lynch and RBS outside Ireland to deliver real and substantial bottom-line benefits.

• e-sourcing: Once again, the area of procurement is one which has been transformed in recent years - facilitated in particular by developments in technology which have on the one hand facilitated streamlining of procurement transaction processes and on the other improved transparency resulting in lower prices from preferred suppliers.
Foreign-based financial services institutions like RBS have achieved cost savings of the order of 10 per cent per annum through the implementation of e-procurement solutions and our view is that this area remains one of untapped potential in this country.

Maintaining a cost focus
Now that our indigenous banks have arguably captured most of the low-hanging cost reduction ‘fruit’, how should they think about this issue going forward?
Cost reduction needs to be a standing item on the CEO’s agenda. Costs need to be kept under constant review. The focus should be on both operational and strategic cost reduction.
Operational Cost Reduction is achieved by targeting well-defined areas of expenditure for straightforward cost reviews. Short opportunity assessments are conducted to identify ‘quick wins’, which are researched, validated and implemented. A strategic cost review encompasses but goes considerably further than an operational review, challenging the ways in which the business is structured, deals with suppliers and/or services its customers.
The result is a programme of cost reduction initiatives, which are progressed in parallel and which deliver results according to a planned timetable, creating a momentum and a culture of cost efficiency within the organisation.
The notion of an ongoing cost programme is important here, as historically banks (like companies in other industries) have in practice taken more of a ‘big-bang’ approach to cost, concentrating resources on implementing sweeping changes over short periods and then losing the impact of the work as the attention of management and resources diverts to more exciting, less painful projects.
In conclusion, we expect the structural profitability of retail financial services markets in Ireland to be eroded going forward driven by price-based competition sparked by new entrants. We consider that one half of the equation for Irish financial services institutions to deliver sustainable profitable growth in this new market environment involves raising their games on cost.
This includes the adoption of an ongoing culture of cost management and cost efficiency and increased receptiveness to ideas that challenge some long-held sacred cows with regard to cost and operating models.
The other half of the equation involves identifying and exploiting new, more profitable revenue models and this will be the subject of our concluding article next month.

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