Banks should embrace utilities model to help with regulatory compliance, new report says

Banks currently engage in many "fragmented and costly ways of operating non-differentiating processes", consultancy business Capco and financial services news provider Finextra said in their report (24-page / 2.23MB PDF). There is an opportunity for them to reduce their costs, free up resources and focus on core and differentiating aspects of their business by adopting the utilities model, they said.

The utilities model in banking is an advancement of the shared services model, which involves two or more organisations pooling resources to carry out functions common to them all. A utilities model builds on that concept as it involves banks engaging third party providers to carry out certain non-differentiating functions, such as payment processing or anti-money laundering due diligence checks, using resources and IT infrastructure that are commonly paid for.

According to Capco and Finextra, the utilities model "directly addresses areas of complexity where banks have systemically limited capabilities" as it "reduces risk, deals highly cost-effectively with large transaction volumes and drives up Capability Maturity Model Integration (CMMI) levels, among many other benefits".

Capco and Finextra surveyed 102 financial services professionals from 69 financial institutions operating in 26 different countries and found that some banks are already operating a utilities model in some areas of their business, or are planning to do so.

Nearly half of the respondents (47%) said that a utility model could deliver minimum savings of between 16 and 25% on current operational costs, whilst other benefits like "the operational flexibility that comes from the ability to cope with variable volumes", along with the opportunity to obtain "predictable service and quality levels and improved productivity" and "reduced labour costs" were also identified in the survey.

"We can reasonably infer that the majority of financial institutions see utilities as a route to lower-cost, high-volume and flexible processing, delivering predictable quality at a substantially lower price," the report said.

Many respondents specifically identified the potential for a utilities model to improve the way they address regulatory compliance. However, Capco and Finextra highlighted reasons why many banks have yet to move to a utilities model for regulatory compliance tasks.

"It is striking that just under 80% of the surveyed market sees regulatory change as a major driver of utilities adoption, and yet 64% of the same sample have not considered or taken any action to pursue the application of utilities to their own regulatory change capabilities," the Capco and Finextra report said. "Only 12% have fully embraced the utility model in this context."

"One potential explanation of the disparity is that financial institutions are too busy just doing the work of compliance. It is challenging to make the time available to examine regulatory response approaches strategically. However, with the unrelenting volume of regulatory changes and burdens, more institutions will realise that reactive and tactical regulatory response initiatives alone are inadequate and too expensive. Over time, the desire to take more effective action will translate into more radical approaches," the report said.

Financial services and technology law expert Yvonne Dunn of Pinsent Masons, the law firm behind Out-Law.com, said: "While utilities models will be attractive from a cost-saving point of view, banks will need to weigh this up against the risks. Handing over regulatory compliance responsibility at a time when banks are under so much scrutiny is a challenge to get senior buy-in for."

"However, the regulatory regime does place financial pressure on banks and so it is likely that more will embrace these models in future, and there are many aspects of the compliance process that could be done on a utilities basis without impacting customers. Getting comfortable with the security issues is going to be key – the same considerations around segregation as arose when banks started to consider shared services and cloud are going to be relevant here as well," she said.

Capco and Finextra said that "fully independent" utility platforms, harnessing "specialist external fintech expertise", could emerge in future. It said dedicated "regulatory utilities" could also align with "the regulators’ drive toward standardisation and consistency".

"These utilities will provide cost-effective processing capabilities on an agnostic basis to all users," Capco and Finextra said. "They will reduce the risk of fines for noncompliance. Potentially, they can even provide an automated, instant and credible platform for regulators to validate compliance, on a machine-checks-machine basis. Contrast this with the awkward and hugely expensive inspection regimes at work today. Without radical changes in approach, both the regulators and the banks will need to continue to pump resources into compliance for the foreseeable future."

However, barriers to the adoption of utilities models in banking were also outlined in the report.

Cultural issues and IT and process silos, a lack of standardisation and data segregation and security concerns are among the main barriers to adoption of a utilities model, according to the survey report.

"There can be no doubt that the security and effective segregation of data in a pooled utility model remains a live issue," the report said. "Yet, more than three-quarters of the surveyed market, paradoxically, see improved data quality and risk management as a driver toward utilities uptake."

Capco and Finextra also said that "concerns that commoditisation of processes and service will make it easier for their customers to switch banks" was another issue that came to light from its study. In addition, the fact that banks cannot outsource their regulatory responsibilities means they often "insist on a large element of control", Capco and Finextra said. This limits "the full potential and scope of a utility-based solution", they said.