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Page 1: UBS Newsletter - What makes a bank a bank?

UBS got to the bottom of this questionwhile analyzing an important client bank.What came out of the study is the Ref-erence Bank Model described on page 6.This model provides a general overviewof the functions, products and servicesthat a bank must have and offer to clientsin order to be perceived as competentand to be legally classified as a bank.

The Reference Bank Model might alsohelp any bank gain a clearer picture of its business model and strategy. AsHenner Schierenbeck, Professor for BankManagement & Controlling at the Uni-versity of Basel points out in his articleon page 2, banks worldwide sometimesfeel pressure to consolidate. To succeed,banks have to concentrate on strengthsand core competencies and keep costsunder strict control. Consequently, theyhave to consider which areas of theiroperations they need and want to coverand which areas they can outsource orsell. The model serves to help banksstructure and document their functionsand processes as well.

Lastly, the Reference Bank Model demon-strates where and how activities can be outsourced. It also ensures that botha bank, and potential outsourcing part-

News for BanksUBS Newsletter for Banks and Financial Institutions I/2005

6 Focus BusinessThe Reference BankModel

2 ResearchThe transformation ofthe banking landscape

9 Focus BusinessClear, informed decision-making

10 Round TableMulti-dimensional decision-making

ners are speaking the same language byclearly defining every term. The modelcannot, of course, judge whether itmakes sense to sell a specific businessarea, or whether doing so will be a hugesuccess. The four participants in theround table (page 10) addressed thisquestion in their final thesis for their Ex-ecutive Master of Business Engineeringprogramme. They developed a modelthat highlights the critical points andrenders the decision-making processesinvolved in a potential outsourcing proj-ect more transparent.

From a shareholder value point of view,a bank has two critical long-term assetswhich drive profits: client relationshipsand a brand which can help generatenew client relationships. These two as-sets cannot be outsourced. Dependingon a bank’s strategy, most other func-tions can be partially or completely out-sourced.

The Reference Bank Model to outsourc-ing is usually not one of strategy orfunction. It is usually internal debate. Webelieve that the Reference Bank Modelis an outstanding tool to help any bank’smanagement team tackle these issues.We hope you, too, find it valuable.

What makes a bank a “bank” ?

Marten Sybren HoekstraMember of the Group Managing BoardHead Market Strategy & DevelopmentUBS Wealth Management & Business Banking

��

Point of view

14 In BriefSWIFTNet: a criticalassessment

Page 2: UBS Newsletter - What makes a bank a bank?

A wave of consolidationsis sweeping across thebanking industry, leaving a verydifferentlandscape in its wake.Cross-border mergersare a likely prospect inEurope. In asset andwealth management andin retail banking, too, the pressure looks set to continue.

For some years now, the banking sectorworldwide has been undergoing con-solidation on a major scale, leading tomassive structural change. Consolidationis generally understood to mean a pro-cess of increasing market concentrationas a result of mergers and takeovers,whereby the historical fragmentation inmany sectors of the banking market isreduced or eliminated altogether. As aresult of this process, the number ofbanks in the six leading industrializednations – the USA, Japan, Germany, theUK, France and Italy – nearly halved, on average, between 1990 and 2002.And in terms of their total assets the 50biggest banks worldwide also saw theirshare increase from 45% in 1995 to 55%in 2002 (see Figure 1).

Likewise, the group of small andmedium-sized banks in Europe has alsoundergone consolidation. This segmentis dominated by public-sector (savings)banks and co-operative banking organi-zations. Given the nature of the public-sector and co-operative structures inquestion, takeovers or mergers betweenthis segment and the private sector area virtual impossibility. As such, cross-sector mergers can only take place ifboth legislators and the associationsconcerned are ready to abandon these

legal structures. How far advanced thisprocess is, differs from one part of Europe to another. Where things haveyet to open up, mergers have takenplace within sectors. As such, the num-ber of independent financial institutionsfell significantly between 1998 and June2004 and the process is still ongoing(see Figure 2).

The driving forces behind consolidationWhen searching for the causes of con-solidation, one factor that stands out isthe growing trend towards industriali-zation in the banking industry. There arevarious reasons for this: the impact ofmodern information technology, with-out which many activities would simplynot be possible, the growing pressureon margins in almost every segment ofthe banking business, the deluge ofbanking regulations with their negativeimplications, the relentless pressure forinnovation and the ever-higher levels ofexpertise required to stay competitive in today’s banking industry, to name buta few.

Then there is the sharper focus by mod-ern bank managements on value andthe capital markets, which is undoubt-edly one of the key elements driving theconsolidation process. As a result of this,a bank’s rating becomes a more impor-tant measure of success as reflected inits funding costs as well as market stand-ing and customer business in general.Another reason is the increasing pres-sure for banks to live up to investorexpectations. In particular, this meansthat market capitalization and the struc-tural return on shareholders’ equity

Research

The transformation of the bankinglandscape

2 UBS News for Banks I /2005

Figure 1: The global concentration process

The top 50 banks have increased their total market share by ten percent over the past seven years through mergers.

Given the limited num-ber of potential mergercandidates and activeplayers in Europe, thefirst movers with thebest strategy will be at a distinct advantage.

Top 1000 banks’ assets in USD billion

45

40

35

30

25

20

15

10

5

01995 2002

Top 10

Next 10

Next 30

Remaining 950

Source: The Banker

55%

21%

10%

14%

45%

25%

12%

18%

Page 3: UBS Newsletter - What makes a bank a bank?

ing industry is Germany. Here, the fivebiggest banks have a combined marketshare (in terms of total assets) of just20%. Top of the table are the Scandina-vian countries, with G5 values in excessof 77%. The main reason for this highlevel of consolidation is the seriousbanking crisis of the early 1990s.

The bank density ratio also varies fromcountry to country. Front-runner here isthe clearly “overbanked” Austrian mar-

become vital criteria for success, thatbanks must earn the cost of their capitaland that they must consistently applythe principles of return-based capital allocation when deciding which busi-nesses to operate in. These two trendsare the primary forces determining thedirection and momentum of the restruc-turing process in the banking sector (see Figure 3).

An overview of the European banking landscapeIn order to ascertain the strength of thepressure to consolidate within a givenbanking system, we can study bothmarket structure data and profitabilityindicators based on data for the period1992 to 2001. In this instance, thestructural data include bank concentra-tion figures, the G5 coefficient (i.e. theaggregate market share of the fivebiggest institutions), the bank densityratio per million inhabitants, the densityof the branch network (number ofbranches for every 10,000 inhabitants)and the average number of branches perbank. It is important to note that – forsystemic reasons – the G5 coefficient willbe higher for smaller countries althoughthe absolute figures for the banks inquestion will tend to be lower. Therewill also be country-specific anomalies.

At the bottom of the league table whenit comes to concentration in the bank-

ket, with 103 banks per million inhabi-tants. At the other end of the spectrumis the UK (8), which has managed toslash the number of banks drastically.

As far as the density of the branch network is concerned, the mid-rangevalues are much closer together. Ex-tremes are shown with the UK, Swedenand Finland with between 2.1 and 2.4branches per 10,000 inhabitants andSpain with 9.5. These major disparitiescan be attributed to strategic differencesin the distribution systems of the variouscountries, but – in this case – have noreal impact on efficiency.

Finally, the average number of branchesper bank is a further key structural in-dicator. Here, Finland (3) and Austria (5)

Research

UBS News for Banks I /2005 3

Figure 2: Consolidation among small and medium-sized banks

Due to current legal strictures, mergers among small and medium-sized banks have tended tooccur within the same sector.

Figure 3: Consolidation pressure on two fronts

Industrialization, together with the banks’ sharper strategic focus on value and capital markets, is driving consolidation.

Number

11010090807060

2,500

2,100

1,700

1,300

600

550

500

450

Credit co-operative in GermanySavings banks in GermanyRegional banks and savings banks in Switzerland

1998 1999 200 2001 2002 2003 June 2004Source: zeb/rolfes.schierenbeck.associates

● ●

◆◆

◆◆

��

��

◆●

–39%

–18%

–36%

1,3781,3931,4891,619

1,7922,035

2,256

594 578 562537

108 106 10394

520

88

491 486

83

69

Growing pressure on margins

Deluge of banking regulations

Ever-greater exper-tise required/pres-sure for innovation

Decline in state guarantees and subsidies

Banks’ increasing dependence on capital markets

Growing pressure to rationalize

High investmentrequirement

Increasing importance of bank ratings

Banks increasinglyfocused on inves-tor expectations

Bank strategiesgeared to valueand capital markets ...

...as the drivingforce for consolidation

Industrialization of the banking industry...

and

Industrialization and thesharper focus by modernbank managements onvalue and the capitalmarkets are the primaryforces determining thedirection and momen-tum of the restructuringprocess in the bankingindustry.

Page 4: UBS Newsletter - What makes a bank a bank?

structures actually encourage competi-tion and, at the same time, have a posi-tive impact on banks’ performance.

With this proviso, the following rule applies: successful banking systems tendto exhibit a relatively low bank density, ahigh number of branches per bank anda relatively high degree of concentration(G5). And vice versa.

On the other hand, the density of thebranch network per se is apparentlyonly of minor importance. In otherwords, it gives more of an indication ofhow well the population is providedwith financial services than the degreeof consolidation of the banking market(see Figure 4).

Cross-border mergersOutside of the “bulge bracket” seg-ment, too, the consolidation of the bigbanks looks set to continue apace. Inother words, in the European big banksector – now that the opportunities forconsolidation at the national level havebeen exhausted in many places – we arelikely to see a growing trend towardscross-border mergers and thus theemergence of pan-European banks.

Such a development looks probable fora number of reasons. Firstly, this is theonly way to achieve any kind of a coun-terbalance to the might of the bigAmerican banks such as Citigroup inparticular. The EU – with its regulatoryframework geared to integration, partic-ularly in relation to the financial servicesmarket, its common currency in the formof the euro and its standardized bankingregulations (Basel II Accord) – looks setto dismantle the barriers to cross-bordermergers. Running counter to this is thestrong desire in certain European coun-tries – such as Germany or France – tobuild up or preserve their own “nationalchampions” in the banking sector, butthis can be neutralized through Euro-pean holding structures. Last but notleast, there is no doubt that the Euro-pean banking industry still lags a longway behind other sectors in terms of thedegree of market concentration.

Given the limited number of potentialtakeover/merger candidates and activeplayers in Europe – no more than about30 institutions in total – the first moverswill be at a distinct strategic advantage.

Research

have extremely low values indeed. Thisis due to the prevalence of savings banksand co-operative banks in particular. Atthe other end of the spectrum is Spain,with almost ten times more branches perbank than Germany (15), for instance.If one compares the country-specificstructural data, certain clusters emerge.With the exception of certain ambigui-ties, we can identify three distinct groups.In the first group we find Switzerland,Denmark and Sweden. The secondgroup is made up of the UK, Belgiumand the Netherlands, Finland andFrance. The third and final group com-prises Spain, Italy, Germany and Austria.

In addition to structural data, banks’ per-formance indicators are also analyzedon a country-by-country basis. The crite-ria used for comparison purposes areprofitability, measured by return on

assets and the cost/income ratio, andmarket capitalization, as expressed bythe price-to-book ratio. As in the case of the structural data, distinct clusterscan be identified, which can again bedivided into three groups. In group 1 we find Switzerland, Spain and the UK.Group 2 is made up of Denmark, Sweden, Belgium, the Netherlands, Germany and Italy. Group 3 comprisesFrance, Finland and Austria.

On this basis, we can state that success-ful banking systems are characterized byabove-average profitability, as measuredin terms of return on assets, a highcost/income ratio and high market capi-talization in terms of price-to-book ratio.When it comes to attempting to link theperformance indicators with the marketstructure data, it is important to beaware that there can be no simple,monocausal explanations. There is sim-ply too much divergence in the strate-gies pursued by the various Europeanbanks in their respective business seg-ments and the “perceived psychologicalstress” in the event of poor perfor-mance. There are examples of extremelysuccessful specialist and full-servicebanks in Europe, as well as highly prof-itable bancassurance companies. Spain,in particular, is convincing proof that arelatively high market concentration andintense competition need not be mutu-ally incompatible. Here, oligopolistic

4 UBS News for Banks I /2005

Figure 4: Regional differences in consolidation pressure

Linking the performance indicators for banks in individual countries with the corresponding structural indicators reveals which regions will be exposed to the greatest cost pressure.

Performance indicators:

• Ø Return on assets

• Ø Cost / income ratio

• Ø Price-to-book ratio

Structural indicators:

• G5 coefficient• Bank density• No. of branches

per institution• Density of the

branch network

ESCHUK

DKSEBE/NLDEIT

UKBE/NLFIFR

CHDKSE

FRFIAT

ESDEITATG

roup

3G

roup

2G

roup

1

Gro

up 3

Gro

up 2

Gro

up 1

hig

hC

on

solid

atio

n p

ress

ure

low

Successful banking systems tend to exhibit a relatively low bank density, a high numberof branches per bankand a relatively high degree of concentration(G5). And vice versa.

Page 5: UBS Newsletter - What makes a bank a bank?

UBS News for Banks I /2005 5

Research

At the same time, those first movers willincrease the consolidation pressure onother banks (see Figure 5).

Strong pressure to consolidateThere may be immense pressure to con-solidate, but not all banks or businessareas will be affected in the same way.Looking at the various banks and the re-spective core businesses individually, onecan say that the pressure to consolidate

will be greatest in the two key strategicareas of retail & commercial banking andwealth & asset management (privatebanking). Of late, there has been agrowing consensus of opinion that retailbanking is in a position to generate re-spectable, stable margins provided thatthe business is run properly and with asizeable customer base. Combining pri-vate clients and (medium-sized) corpo-rate clients in an integrated businessmodel can also be an additional contrib-utor to success. But above all, if a retailbank is to succeed, it must have an out-standing sales culture, a strong distribu-tion model, rigorous cost control – withintense exploitation of economies ofscale in processing and transaction-based operations, in particular – andhighly sophisticated risk managementprocedures. Moreover, the greater itsmarket clout and the larger its customerbase, the better placed a bank is toboost its earning potential still further.Thus, to the extent that mergers serve

to increase a company’s market shareand the number of potential customersin its particular businesses, they can alsooptimize the earning potential of thesebusinesses.

In asset management – which is oftenan integral part of wealth management– many banks and insurance companiesmassively increased their capacity duringthe boom period in order to benefit fromthe expected growth in the industry. Inthe meantime, they have had to lowertheir expectations considerably. Accord-ing to a study by Oliver, Wyman & Co.the volume of assets under manage-ment in Europe will only grow by 7.4%per annum up to 2006 compared with20% in the 1990s. At the same time,annual earnings growth is set to halveto just 7%.

Much like traditional on-balance-sheetbusiness, the asset management andprivate banking markets are highly frag-mented. With more than a thousand ri-val players in the field, the five biggestasset managers in the European bank-ing scene have a total market share ofjust 16.5%. In private banking, the topfive global players account for a mere6.5% of the assets of high net worthindividuals. As such, we can also expectto see a massive process of consolidationin both these businesses in the future.

Henner Schierenbeck

Professor at the Department of Bank Management

& Controlling, Institute of Economics,

University of Basel

[email protected]

Figure 5: Prospective merger candidates

There are 28 banks which are candidates for a pan-European merger.

Bibliography

KPMG: “Hungry for more? Acquisition appetiteand strategy in the global private banking andwealth management industry”, Zurich, 2004.

Krabichler, T. / Krauss, I.: Konsolidierung im europäischen Bankenmarkt, Regensburg, 2003.

Lahusen, R.: “Bankenerfolg in Europa: Grosse Fortschritte durch Konsolidierung – mitAusnahme Deutschlands”, in: EU-Monitor,Frankfurt am Main, 2004.

Oliver, Wyman & Co./UBS: “The Future of AssetManagement in Europe”, September 2002.

The 2004 Global 500 annual ranking of theworld’s largest corporations, in: Fortune, Vol.150, pp. F16–F22.

Paul, S.: “Zwingt das Internet-Zeitalter Bankenzu internationalen Fusionen?”, in: Internationalisierungsstrategien von Kredit-instituten, Stuttgart, 2002.

Source: Datastream

Commerzbank 8.490

Hypo-Vereinsbank 9.842

Svenska Handelsbank 10.059

Banco Popular Español 10.173

Abbey National 12.632

Danske Bank 12.681

San Paolo IMI 13.764

KBC Group 14.575

Dexia 15.768

Standard Chartered 15.888

Nordea 16.491

Gruppo Intesa 18.220

Fortis 23.264

Unicredito Italiano 25.053

ABN Amro 28.638

Crédit Agricole 28.881

Société Générale 30.257

Deutsche Bank 31.282

Credit Suisse 31.864

Lloyds TSB 34.842

BBVA 37.503

Grupo Santander 37.670

HBOS 41.839

BNP Paribas 42.802

Barclays 44.751

UBS 65.785

Royal Bank of Scotland 73.261

HSBC 135.107

Market capitalization in EUR billion, as of July 31, 2004

If a retail bank is to succeed, it must have anoutstanding sales cul-ture, a strong distribu-tion model, rigorous costcontrol and highly so-phisticated risk manage-ment procedures.

Page 6: UBS Newsletter - What makes a bank a bank?

6 UBS News for Banks I /2005

Focus Business

solutions are absorbing more and moreresources, competition and falling mar-gins demand efficiency and cost control.

Rather than succumbing to the pressureto consolidate and going down themerger route, many banks are opting tooutsource parts of their value chain toprofessional, experienced partner organi-zations – the rationale behind this beingthat another bank can carry out theprocesses in question more cost-effec-tively than would be possible in-house.But before deciding which activities andprocesses to entrust to a partner organi-zation, a bank must first identify its owncore competencies.

Speaking the same languageWith that in mind, the UBS ReferenceBank Model can be a very useful tool in-deed. The model replicates every singlevalue creation, management and sup-port process. The accompanying ques-tionnaire is designed to help the man-agement team identify the applicablecore competencies and determine thebank’s future strategic orientation. Onlythen can the issue of outsourcing non-strategic sub-processes be addressed.By depicting all the different areas ofthe business, the generic bank model

also helps to facilitate understandingbetween a bank considering out-sourcing and its prospective solutionproviders. A corresponding glossary ensures that both parties to any out-sourcing arrangement are speaking thesame language when it comes to thefunctions and processes concerned. TheReference Bank Model is the result of acollaborative venture with a Swiss private bank that contacted UBS to dis-cuss the possibility of outsourcing ele-ments of its value chain.

Focusing on the clientFor a private bank, the ever more so-phisticated nature of financial products,for example, raises the issue of whetherit can – or indeed should – continue todevelop and put together the full rangeof products in-house, or whether itmight not, perhaps, be better to buy inthe requisite know-how from an exter-nal source, given the increasingly com-plex regulatory and fiscal environment.By teaming up with a professional part-ner organization that will develop the financial products and deal with all thelegal issues, a bank can concentrate itsefforts on front-line activities such as theacquisition of new clients and the careof existing clients, or devising tailor-

As an aid in the optimi-zation process, UBS has developed a genericmodel that replicates the value chains of arange of different banks. The Reference BankModel is a useful tool for the managements ofpartner banks whenfaced with decisions on the outsourcing ofsub-processes.

The intense competitive and consolida-tion pressure in the banking industry isforcing non-global banks in particular toconsider their future strategy. The mainquestion facing management is whetherthe bank can continue to cover all areasof the business to optimum effect andhow best to utilize the available re-sources. Whilst the ever-changing regu-latory environment and the increasingcomplexity of customer products and

The Reference Bank Model

Industry trends in private banking

The private banking industry has undergone fundamental changes over the last few years. Both strategic and structural changes have been accelerated by the recent bear market.

Major industry trends

• Changing client needs

• A more demanding regulatory environment

• Continued in-market and cross-border consolidation

• Ongoing cost control paramount as margins are continually squeezed

• Outsourcing of back-office functions as a means to address the cost issue

Business implications

• Advice required on all financial needs: assets, liabilities, insurance, tax, pensions, real estate

• Risk systems need to be enhanced (or outsourced)

• Size increasingly important as a means to extract cost (synergies) and remain competitive

• Weak performers will come under further pressure and will have to either rationalize or exit

• Intense competition for outsourcing mandates could help to further reduce cost

Page 7: UBS Newsletter - What makes a bank a bank?

UBS News for Banks I /2005 7

Last but not least, by clearly illustratingthe processes involved, the generic bankmodel allows the costs of carrying outspecific sub-processes within the bankto be identified. Only when these pre-cise costs are known is it possible tomake any meaningful comparison withwhat a prospective outsourcer is offer-ing. In some cases, the outsourcer willnot only be more cost-effective, but alsomore flexible and more responsive.

Markus Bühler

UBS Investment Bank,

Regional Distribution Channel Management

[email protected]

party products or using external tradingplatforms, for instance, would involveany risk to a bank’s reputation and, ifso, how that risk can be limited.

Once the areas to be outsourced havebeen decided, the next step is to clearlydefine the interfaces with the partnerorganization. Here, the challenge lies inthe detail. Take the decision to out-source the processing of securities trans-actions, for example. It might soundstraightforward. But in practice the entire process – from submission of the order through to confirmation of execu-tion – has to be broken down into itsconstituent parts so that the relevant activities can be outsourced withoutcausing disruptions in the process as awhole (see diagram on page 8). As arule, this will also involve seamlessly integrating different IT platforms at thevarious interfaces.

made investment solutions. In this way,the bank will be able to devote far moretime to its clients and dramatically im-prove the quality of the contact it haswith them.

Identifying risks and defining the interfacesThe potential risks of outsourcing particular activities can be identified atan early stage with the aid of the Refer-ence Bank Model. Thus it is possible toascertain early on whether selling third-

Focus Business

The Reference BankModel replicates everysingle value creating,management and support process.

Client

Corporate Functions Products and Services Client Advisory

Financial

Planning

Investment

Solutions

Banking

Products

Transaction

Products

Research

Investment

Banking

Business Strategy

Central Logistics

IT

HR & Education

Communication

Legal

Risk & Compliance

ALM & Finance

Outsourcing to be ruled out Outsourcing to be considered

Financial Planning

Estate Planning

Tax Planning

Foundations and Trusts

Insurance

Fund Advisory

Portfolio Advisory

Portfolio Management

Alternative Investments

Fund Administration

Accounts

Cards

Payments

Mortgages

Other Loans

Trade and Export Finance

Equities

FX

FI

Proprietary Funds

Third-Party Funds

Macro-Economic

Investment Strategy

Asset Allocation

Capital Structure Advisory

Restructuring/Privatization/IPO

M&A and Divestitures

Corporate Finance Advisory

+

The Reference Bank Model for a private bank

The Reference Bank Model shows all the products, functions and processes of a bank at the generic level. With the aid of this model, a bank can identify its core competencies and business strategy. At the same time, the model also illustrates which activities a bank could theoretically outsource.

Page 8: UBS Newsletter - What makes a bank a bank?

Focus Business

Breaking down processes to the last detail

The Reference Bank Model can be used to break down a process into its component parts. The flowchart for a sub-process of securities trading shows which aspects are suitable for outsourcing and which should definitely remain in-house. It shows all supporting elements, as there are systems, human skills and tools required for each individual activity. In addition the model enables the calculation of production/service creation costs. The entire model can also be seen as a glossary explaining and defining terminology being used in the financial industry. It there-fore makes communication across different companies much easier.

Offer BasicProduct Service

Process SecurityDelivery

Enter EquityOrder

Market

Execute EquityTrade

Allocate Execution to Equity Order

Generate EquityOrder TradeConfirmation

Allocate Equity Order Executionto Client

Custodian Network

ArchiveDocuments

Client

Execute EquityTrade

Enrich EquityTrade

Equity Trade Order (requested)

BVC Flow Diagram:Equity trade is requested

Equity Trade Order (captured)

Equity Trade Order (validated)

Equity Trade Order (captured)

Equity Trade (filled)

Equity Trade (executed)

Equity Trade Order (executed)

Equity Trade Order (executed)

Equity Trade Order (confirmed)

Equity Trade Order (executed)

Equity Trade Order (confirmed)

Equity Trader Order (executed)

8 UBS News for Banks I /2005

Outsourcing to be ruled out

Outsourcing potential identified

Outsourcing possible

Sub-process /activity

Infrastructure

External agent /party

Page 9: UBS Newsletter - What makes a bank a bank?

1. Business strategyQuestionnaire: corporate strategy,core competencies, management’soutsourcing capabilities, possibility ofpartnerships and cultural change

2. Complexity of the process, function or subjectQuestionnaire: documentation, inter-faces, proximity to core business andtype of activities to be outsourced

3. CostsQuestionnaire: economies of scale,reduction of fixed costs as a result ofoutsourcing

4. StaffQuestionnaire: communication withstaff, future employer, staff training

5. Outsourcing partnerQuestionnaire: core competencies,track record and experience, financialstrength; as well as “soft” factorssuch as negotiating language, vision,etc. of the prospective outsourcingservice provider

6. Legal aspectsQuestionnaire: length of negotiations,transparency, termination options, liability for damages

With the help of the outsourcing decision-making model, manage-ment can make more informed decisionsabout outsourcing basedon a clear understandingof the inherent risks and benefits.

The Reference Bank Model can helpbanks to define their processes andfunctions and identify those areas whereit might make sense to outsource prod-ucts or services to a third-party provider.But what the model does not indicate iswhere problems might arise in the eventof outsourcing or what prospective out-sourcing partners need to considerwhen evaluating a particular solution ordiscussing plans with potential partnerorganizations.

With this in mind, four members of theExecutive Master of Business Engineeringprogram at the University of St. Gallen’sInstitute of Information Managementhave developed an extensively generic,non-industry specific procedure for eval-uating different outsourcing projectsand making the corresponding decisionsclear, comprehensible and transparent.For, as their thesis on the OutsourcingDecision-Making Model points out, out-sourcing decisions are often based on alimited number of factors – mostly cost-related – and, as such, tend to be emo-tional rather than objective.

Although the Outsourcing Decision-Making Model is universally applicable,it nevertheless takes account of the specific circumstances of a given out-sourcing project.

Drawing on the relevant specialist litera-ture, the architects came up with eightdimensions that they believe have a ma-jor impact on outsourcing decisions andthe evaluation of outsourcing options. A detailed questionnaire has been drawnup for each of the eight dimensions,and touches on the following topics:

UBS News for Banks I /2005 9

7. RisksQuestionnaire: dependencies, ar-rangements for dealing with tempo-rary quality-related problems, prepa-ration of management for changeson the personnel front

8. Management of the outsourcingQuestionnaire: experience with out-sourcing decisions, project culture,control mechanisms

In a second phase, the answers to thequestions on each of the eight dimen-sions are weighted again by the respon-dent. Finally, the computed and weightedvalues are displayed visually in a net-work diagram (see below). This showsat a glance whether outsourcing is anoption in a particular case and pinpointspossible trouble spots. As such, any potential problems in connection withoutsourcing can be addressed at anearly stage.

The Outsourcing Decision-MakingModel is the subject of the round tablediscussion that follows. Further informa-tion is also available from the architectsof the model.

Monika Baumgartner

UBS Wealth Management & Business Banking

[email protected]

Focus Business

Clear, informed decision-making

The eight dimensions of the Outsourcing Decision-Making Model

The network diagram shows the subjectively weighted values from the eight questionnaires.The result indicates that, due to the complexity of the system, outsourcing could present difficulties. Being aware of these problems can be tackled at an early stage.

Management of the outsourcing

Costs

Complexity

Business strategy

Personnel

Outsourcing partner

Legal aspects

Risks

Outsourcing Strike Point OSPResults of the evaluation

109876543210

Page 10: UBS Newsletter - What makes a bank a bank?

Participants

Claudius SutterChief Operating Officer, UBS Investment Bank, Opfikon (Switzerland)[email protected]

Marcel MüllerChief Risk Officer, Member of the Executive Board, Baloise Bank SoBa, Solothurn (Switzerland)[email protected]

Herbert PortmannHead of Controlling,UBS Card Center AG, Glattbrugg (Switzerland)[email protected]

Andreas UrwylerHead of Consulting, Partner, Stepwise AG, Jegenstorf (Switzerland)[email protected]

Outsourcing a process,system or function is often exclusively a matterof costs. In the opinion of the participants inthis discussion such an approach is too short-sighted. They have de-veloped a model in whichdecisions on outsourcingcan be taken more con-sciously and with greatertransparency.

When does a bank make the decision tooutsource ?

Claudius Sutter: When you realize thatthe bank has no core competence in aparticular area and does not want tobuild up such a capability; when you re-alize that the services to be provided re-quire critical mass and there is no possi-bility of achieving economies of scale. Inreality, companies often try to improve aproblem situation by outsourcing. I havealso observed that management oftendoes not have enough time to effectivelydeal with the sector that is a potentialcandidate for outsourcing.

10 UBS News for Banks I /2005

Marcel Müller: It’s certainly a balancingact. If you are not talking about a corecompetency, then a company wants tobenefit from the capability of a partnerin this sector so as not to have to dealwith this problem.

Herbert Portmann: In my experiencecosts usually dictate the outsourcing decision. The idea is to try and achieveeconomies of scale by outsourcing,which in fact is often the case. What isoften underestimated are the coordina-tion and control costs of outsourcing aswell as all other aspects.

Andreas Urwyler: For the small andmedium-sized enterprises for which I actas an advisor the point of outsourcing isnot to save money. These companies arelooking to boost their quality, for exam-ple in the Human Resources area. Com-panies notice that their systems andprocesses are no longer up to the lateststandards. Their core competence is notin this area, so not much time and effortis invested. Nevertheless, the companieswant to benefit from the most efficienttechnologies and methods.

Round Table

Multi-dimensional decision-making

Andreas Urwyler

The coordination andcontrol of costs as well asother aspects are oftenunderestimated in out-sourcing.Herbert Portmann

Page 11: UBS Newsletter - What makes a bank a bank?

You developed an Outsourcing Decision-Making Model for your final thesis at the University of St. Gallen. Why ?

Sutter: In the period following themerger, we at UBS were confrontedwith the topic of outsourcing for certainsectors. I noticed that the discussionswith management concentrated onthose aspects that were at that timeperceived as costs. But there was notenough clarity about how new costscould arise during the outsourcing. Atthe same time I was also scouring therelevant literature for a model that dealtwith the various aspects of outsourcing.There was no model out there, however.So I took the initiative and found somecapable and competent colleagues tohelp me develop it.

Portmann: I had a similar experience inmy job as controller. Attention is com-pletely focused on costs. There was nopragmatic model that one could use tofind out whether the outsourcing of anactivity was even practicable. The thesisgave me the opportunity to work to-gether on developing such a model. Themodel not only takes into account themany aspects of outsourcing, it alsoshows where potential trouble spots andopportunities could arise if the decisionto outsource is made.

Urwyler: The model makes it possibleto find out where you stand. But it canalso show a company what it can andmust do to ensure the outsourcing goes

Sutter: For small and medium-sizedcompanies outsourcing means primarilyIT outsourcing. In this respect they arenot that different from large banks. Ifthe infrastructure is not state-of-the-art,then you have to go outside the firm toget it. But the picture is different forbusiness processes. I would draw a linebetween client-facing and back-officeprocesses. Basically, a bank should out-source those processes that do not giveit differentiation in the market. Thereare of course services that a bank mustprovide due to regulatory requirements.

Müller: Small and medium-sized busi-nesses, compared with banks, haveclearly defined core competencies. Thusfor these companies it often makessense to outsource their non-core areas.The core competencies for banks areless clearly defined. Regional banks arenot best in class in any area. They maybe able to stand out in the market byadvertising that they provide more per-sonal service; but as long as the globalplayers put pressure on prices, this ad-vantage does not bring much. Clientswant more than personal service; theywant low prices above all.

UBS News for Banks I /2005 11

smoothly. It should help in recognizingand managing the potential risks; thusthe model can also be used as a control-ling instrument. It is also a good tool for an outsourcing service provider toassess potential clients. Outsourcingmeans making a contractual commit-ment over a long period. The model canhelp the outsourcing service providersestimate whether they are dealing witha short-term opportunity or a long-termrelationship and thus manage risks accordingly.

The model covers eight dimensions. Thepurpose is to make the outsourcing de-cision-making process more transparent.How important is that ?

Müller: A big problem in making deci-sions – and not only with outsourcing –is the one-dimensional focus on num-bers. It’s as though the numbers prima-rily serve later as the (only) justificationfor the decision taken. Marketability, implications for processes and the envi-ronment – in other words soft factors –

Round Table

Claudius Sutter Herbert Portmann

The model brings a cer-tain level of objectivityinto the assessment ofoutsourcing projects.Claudius Sutter

It is crucial that everyoneinvolved agrees to the decision-making processitself, before the resultsof that process are on thetable.Andreas Urwyler

Page 12: UBS Newsletter - What makes a bank a bank?

are sometimes also considered, but of-ten not analyzed and documented in astructured way.

Sutter: In the evaluation phase the po-tential success of outsourcing an activityis measured using net present value. Atthis point in time it does not matterwhether the project will be successful ornot. Often there is one lead person promoting outsourcing for specific andsometimes very personal reasons. Thusthe model can help bring some objectiv-ity to the assessment of outsourcingprojects, despite all the subjectivity thatthe model also allows for. The modelcan help management make a con-scious decision about how subjectivethe final decision should be.

Costs are just one of eight dimensions inyour model. Is it not expecting a bit toomuch for something other than costs tocome up in discussions with the man-agement ?

Portmann: The model makes it possibleto weigh individual aspects subjectively.If management sees costs as the mostimportant element, the model can givea stronger weighting to costs over otheraspects. The weighting of the factorsmakes the model dynamic and takesinto consideration the various points ofdeparture a company may find itself in.

Sutter: It is possible to argue versusmanagement that all dimensions are ex-pressed in terms of costs sooner or later.

The model could help me determine, forexample, that the resources that I couldsave with outsourcing cannot even bereduced, whether due to regulatory fac-tors or possible damage to the com-pany’s reputation. This would be a po-tential cost factor. The management isopen to these types of arguments, as itunderstands that there are risk factorsthat only later start to impact the num-bers.

Urwyler: It is crucial that everyone in-volved agrees to the decision-makingprocess itself, before the results of thatprocess are on the table. This meansthat the persons responsible for the pro-cess that leads to the decision must ap-prove the process, regardless of the re-sulting final decision. Otherwise, the re-sult could be questioned by stating thatthe process leading up to it was deficient.

Müller: There is no doubt that costsdrive outsourcing. But when discussingoutsourcing with company managementpersonnel issues are also a key element.

12 UBS News for Banks I /2005

It is relevant both for the outsourcer andfor the provider to know how many em-ployees and which employees will betaken over. This is not only a question ofpeople’s lives and livelihood, but alsoone of ensuring know-how and qualityin the company after the outsourcingtakes place.

Have you been able to use the model ?

Sutter: We have used it several times.We have learned that the model helpsyou to focus on details that you may nothave paid much attention to otherwise.With the model you can also demandproof, as sometime in the marketing effort solutions are proffered that lookrosier on paper than they are in reality.We have not entered into certain part-nerships because either we have discov-ered details that we were not happyabout or because after applying themodel we discovered that the risks asso-ciated with the outsourcing were greaterthan the benefits.

Portmann: I have used the model tolook into the sale of a business unit. I had to leave out certain aspects suchas the outsourcing partner or substitutesome aspects such as the size of thebuyer. Using the model helped me to include all the key points in the decision-making process and not focus merely oncosts.

Interview

Monika Baumgartner

Round Table

Marcel Müller

A frequent problem in the decision-making process is the one-dimensional focus on numbers.Marcel Müller

Page 13: UBS Newsletter - What makes a bank a bank?

UBS News for Banks I /2005 13

In Brief

clients, and would also be notified of anyrelevant information updates regardingthose clients. The estimated economicbenefits of such a system are expectedto be significant.

The Wolfsberg Group had already iden-tified the information that its memberswished to see in the registry, which wouldalso ensure a standardization of due dili-gence information globally, in itself pro-viding a potential cost-saving in that lesstime would be spent collating requiredinformation from a diverse set of sources.

The Group began collaborating withBanker’s Almanac in early summer, andwe are delighted to inform you that theDue Diligence Model, which the Wolfs-berg Group has contributed to develop-ing, is now available for “inspection” onthe internet.

While we are still assisting Banker’s Almanac in the finalization of various elements of the module, the comingmonths will clearly be spent encourag-ing our correspondents to populate theregistry, so that it is as useful, completeand cost-effective as possible for every-one. We therefore wholeheartedly rec-ommend that you visit the site, inspectthe module and suggested requirementsand submit your documents as soon aspossible, so that the benefits of a fullyfunctioning registry can be achievedsooner rather than later. In the currentregulatory environment, such a facilitycan only be seen as a boon to the ap-propriate and risk-based conduct of cor-respondent banking business, if not apanacea for all ills.

Contact/further information

[email protected]

www.bankersalmanac.com

The avid reader of News for Banks willrecall the publication, in the January 2004issue,of an article entitled “Due diligencemade easier” which described in somedetail the concept of an internationalregistry for financial institutions, emanat-ing initially from the Wolfsberg Anti-Money Laundering Principles for Corre-spondent Banking of November 2002.

The yet more assiduous reader may evenrecall that the purpose of such a registrywas to centralize useful and necessaryinformation which would assist financialinstitutions in carrying out appropriatedue diligence investigations on their cor-respondent banking clients, while gen-erating cost-savings, though not dis-charging financial institutions from theirresponsibility to conduct their own riskassessments based on the informationheld in the registry.

It was argued that, in the context ofever increasing regulatory requirements,the registry as recommended by theWolfsberg Group, and fully supportedby UBS, provided an indispensable toolfor banks to ease the financial burdenof conducting proper due diligence ontheir correspondent banking clients. Re-cent enforcement actions by US Regula-tors prove that insufficient due diligenceon these clients will not in any way passmuster on inspection. Indeed, the finesrecently levied for failings in due dili-gence exercises in respect of correspon-dent clients have been on the high side,and the historical tendency for fines toincrease rather than decrease shouldgive us some pause for thought.

The basic premise of the registry remainssimple: rather than requesting the rele-vant information from each individualinstitution, and, similarly, rather thanprovide this information to each corre-spondent, the necessary due diligenceinformation would be centralized in aglobal registry. Financial institutionswould be responsible for providing andmaintaining accurate, complete and up-to-date information in the registry; theywould be able to retrieve informationabout their correspondent banking

Due diligence made easier…Take 2

Growing UBS

UBS has grown significantly in all three divisionsInvestment Bank, Wealth Management andGlobal Asset Management over the past fewmonths. The first in a series of acquisitions,mergers and joint ventures was the purchase ofthe Capital Markets division of Charles Schwabin New York. The transaction was completed atthe end of October 2004. Already a top-threefirm in the trading of NYSE-listed securities, theintegration of SCM results in a significant expan-sion of UBS’s US capabilities. By increasing itsequity sales and trading offering, including theaddition of a state-of-the-art technology plat-form and NASDAQ trading system, UBS also becomes one of the top volume traders in NASDAQ securities in the US.

In Wealth Management UBS is supplementingits organic growth with a series of acquisitions inEurope and the Americas. In Germany, UBS andSauerborn Trust will merge their advisory ser-vices for ultra-high net worth clients. Managingmore than 6 billion euros in client assets forsome 100 families and family-owned compa-nies, Sauerborn Trust is Germany’s biggestprovider in this market. In Italy, UBS is to acquireEtra SIM S.p.A. of Milan which manages 500million euros in assets for wealthy private andinstitutional clients. UBS will acquire the privatebanking activities of American Express Bank inLuxembourg with assets of around 385 millionUS dollars, and also take over the wealth man-agement business of Dresdner Bank Latein-amerika. DBLA, with a head office in Hamburg,is active in all Latin American markets, managingassets for affluent and high net worth clients ofaround 4.8 billion euros. In Canada and the USUBS will acquire the North American wealthmanagement operations of Julius Baer with amain location in New York and offices in Los Angeles, Palm Beach and Montreal. Theymanage more than 4 billion US dollars in clientassets. The new acquisitions are all subject to receiving the necessary regulatory approvals.

In January 2005, UBS Global Asset Managementannounced the formation of a joint venturefund management company in partnership withthe Chinese State Development Investment Corporation (SDIC). The joint venture will comeabout through UBS’s purchase of a 49% stake in the Shenzhen-based China Dragon FundManagement Co Ltd (China Dragon). This jointventure will be one of the first to allow the newmaximum 49% foreign partner holding in a Chi-nese fund management company, and continuesthe growing interest UBS has in the Chinese financial services industry. In the same month,Global Asset Management signed an agreementwith Siemens in which UBS will acquire a majoritystake (51%) in the real estate funds business ofSiemens Kapitalanlagegesellschaft mbH (SKAG),currently a 100% subsidiary of Siemens AG and part of the Siemens Financial Services Group.Both transactions are subject to regulatory approvals.

Page 14: UBS Newsletter - What makes a bank a bank?

In Brief

Approximately five years ago, SWIFT an-nounced the concept of a new messag-ing platform, based on the well-knownand established Internet Protocol (IP)technology. It was intended to replacethe outdated and somewhat inflexibleX.25-based messaging environment1.The official deadline communicated forthis migration was 31 December 2004.

Today the financial messaging world hasalmost achieved this ambitious migra-tion goal. Based on current statistics(December 2004), approximately 99%of all financial institutions, accountingfor some 96% of the entire SWIFT-basedtraffic, have migrated to the new tech-nology. As it stands today, the migrationwill be globally complete by the time ofpublication. SWIFT expects that it canbegin dismantling the old X.25 infra-structure commencing the second quar-ter of 2005.

Within the financial world, the SWIFT-Net migration is the second largest initiative since Y2K. Due to the signifi-cance of both its size and success, thismigration is a milestone for the entire financial industry.

Goals of SWIFTNetIt is not always enough to replace (evenoutdated) technology with newer tech-nology, just for the sake of updating it.This raises the question of what strate-gic or particular objectives the SWIFTcommunity had on its agenda when theSWIFTNet initiative was agreed uponand eventually launched.

It is important to note that the technicalSWIFTNet migration was a mandatoryundertaking for all SWIFT participantsbecause SWIFT is a co-operative ownedby banks. Consequently, whateverSWIFT does must be agreed upon andapproved by the member banks or,

more generally, the financial industry.Hence, when considering the migrationof the underpinning technology, thequestion for UBS and all other financialinstitutions working with SWIFT was notwhether to adopt, but rather when.Inthe past,financial messaging infrastruc-ture technology was perceived merely asan enabler, not as a potential product inits own right. Thus, the driver for thischange was more than simply to utilizeincreasingly modern technology. The keypoint was that the financial industry wasdemanding more services from SWIFTthan “just” the old FIN service. SWIFTwas compliant and introduced addi-tional new SWIFTNet services which areonly available and possible with themuch more flexible IP technology.

The new services offered by SWIFT include:

❑ SWIFTNet FINSWIFTNet FIN essentially remains thesame. The difference between X.25 andIP-based FIN is in the technology, notthe service as such. SWIFTNet FIN is stillthe most common and frequently-usedof all SWIFT services. In 2004 (Jan–Sept)for example, FIN carried roughly 1.7 bil-lion messages. Peak days will currentlysee above 10 million messages.

❑ SWIFTNet InterActSWIFTNet InterAct is an interactive mes-saging service supporting the pre-agreedexchange of messages between twoparties. With InterAct, banks can ex-change interactive messages. Contraryto the FIN Store & Forward service, Inter-Act can be used for mission- and time-critical applications such as ContinuousLinked Settlement (CLS) or real-timegross settlement systems (RTGS).

❑ SWIFTNet FileActSWIFTNet FileAct allows the secure trans-fer of files and can be used to exchangebatches of structured or unstructured fi-nancial messages. With FileAct it is nowpossible to send files as large as 250megabytes. FileAct is closely linked withInterAct.

❑ SWIFTNet BrowseSWIFTNet Browse allows users to oper-ate in a secure and reliable environment.

The browse service is based on the“https” internet standard protocol. It is designed to complement SWIFTNetFileAct and SWIFTNet InterAct.

New services pose challenges Banks which have made the technicalmigration to SWIFTNet have the optionof using the new services described. Although these services are available forall financial institutions, there is a priceto be paid if banks want to fully utilizethem for high-volume processing, automation or even straight-throughprocessing (STP). This price involves factors such as investments in infrastruc-ture components or more complex andtherefore more costly processes. Not allbanks are willing to invest this muchwithout seeing a clear business opportu-

New services: where does UBS stand today?

UBS was the first financial institution amongstthe top 10 SWIFT users to complete the entireSWIFTNet migration. After successfully finalizingthis, UBS went on to use FIN over IP as its firstSWIFTNet service by the third quarter of 2003(FIN is the traditional and broadly used Store &Forward Service of SWIFT).

Technically, UBS has been SWIFTNet compliantsince the third quarter of 2003. This, however,does not mean that the firm wishes to immedi-ately take the final steps towards a full-scale roll-out of the new non-FIN services including theMA-CUG concept without considering the op-tions available. Instead, UBS is looking for a clearbusiness opportunity, to justify investments inthis area.

This opportunity might come from the marketbut it is also highly probable that product devel-opments will make it necessary to bundle prod-ucts with one or another of the new SWIFTNetservices.

SWIFTNet is very important to UBS. The bankclearly sees the benefits of using the new services if it can justify capital expenditures and operating costs. And since SWIFTNet is – to acertain extent – a fixed-cost-driven infrastructure, it makes sense to go for the highest transactionvolume possible in order to reduce unit costs.For instance, using the new SWIFTNet servicessuch as InterAct and FileAct could enable UBS to remove volumes from other proprietary mes-saging infrastructures and consolidate thesetransactions in SWIFTNet.

With the bulk of migrations having beenachieved, the financial industry is now enteringa fresh phase of opportunity where the next fewyears promise to be challenging yet rewardingfor UBS as well as the entire SWIFTNet commu-nity.

1 X.25 still is a popular international standard for

packet-switching networks. It provides a connec-

tion-oriented technology for transmission through

highly error-prone facilities, which were more

common at the time it was first introduced. Error-

checking is performed at each node, which can

slow overall throughput and renders X.25 inca-

pable of handling real-time voice and video.

SWIFTNet: a critical assessment

14 UBS News for Banks I /2005

Page 15: UBS Newsletter - What makes a bank a bank?

nity, including a business case with areasonable ROI.

Unfortunately, the situation can becomeconvoluted and intractable. On the onehand, we have financial institutionswhich want to see clear demand fromthe market. On the other hand, themarket seems to be waiting for avisibleoffer from potential service providers.Somehow, the Gordian knot will have to be cut.

In addition to the market situation andthe question of who should take thelead to drive this further, there is an issue involving standards. Whilst the FINservice is very strict on standards, thenew services, in principle, allow for sig-nificant flexibility. Hence, in an extremecase, two partners could negotiate indi-vidual agreements outside any pre-de-fined defaults. This gain in flexibility im-plies a loss of standardization, and thusone of SWIFT’s original core values. As a result, the issue of standards con-vergence must be discussed on a muchbroader basis. If not, each financial insti-tution could be required to spend largeamounts dealing with the implicationsof any bilateral agreements it mighthave with potential partners.

Additional SWIFTNet featuresThere is a further issue which requiresaddressing. Based on SWIFT’s 2006strategy, the intention was – and still is –to significantly increase its customer base.The only way this could be achieved wasto allow corporates access to SWIFTNet.However, it was decided to prohibit di-rect access for corporates as members,and instead allow them access as partic-ipants or via a so-called Member Admin-istered Closed User Group (MA-CUG).

Every point mentioned in connectionwith the new services must also be ap-plied to corporate users. In an extremesituation, this can lead to an environ-ment where banks have to monitor bilateral standards agreements not justwith other financial institutions, butwith corporates as well.

Contact

[email protected]

UBS News for Banks I /2005 15

In Brief

UBS AG Production: UBS AG, Marketing & Sales Development /Publications; Financial Institutions CC PublishingP.O. BoxCH-8098 Zurich Photos: Andy Müller, ESA+41-1-239 80 [email protected] Date of publication: February 2005www.ubs.com/newsforbanks

Disclaimer:While the facts in this publication have been carefully researched,UBS cannot be held responsible for their accuracy. The opinionsexpressed may differ from official UBS views.

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