This month we talk to Rajesh Mehta about the impact of the financial crisis on transaction banking and explore the wider implications for corporate treasurers.

Broadly, what impact has the financial crisis had on transaction banking?

In the past year, unprecedented turbulence in the world’s markets has seen the banking landscape shift radically as the whole financial system came under pressure. At the same time, the priorities of corporates have changed substantially − not least because credit is now more scarce and expensive.

So what implications will these two dramatic changes have on transaction banking? One possible repercussion is that banks may review their distribution and operating models and refocus on core markets. This will drive where and how they operate in transaction banking. There are already examples of some regional institutions changing their strategy in favour of their home market, exiting from non-core business lines and partnering with third-party institutions to more effectively manage their infrastructure and cost base and enhance their global capabilities.

In practical terms, the decision of a number of banks − either through choice or circumstance − to redesign or scale down their operations will accelerate the long-standing trend of consolidation in the industry. Only a handful of global banks will be able to provide a truly competitive global offering.

What makes a global offering so appealing?

Some of the banks that have retreated from a global transaction banking model now suggest that working with several different banks in each region provides clients with much-needed diversification and enhances risk management.

However, while multiple banking relationships across geographies may be an effective model for some clients, the scale and reach enabled by a globally interconnected infrastructure and network remains extremely valuable. Moreover, such a global perspective can allow a more comprehensive and effective risk management architecture.

“While multiple banking relationships across geographies may be an effective model for some clients, the scale and reach enabled by a globally interconnected infrastructure and network remains extremely valuable.”

Having a global network and interconnected platforms also allows for scale that enables the delivery of premium quality products and services. Being a global player provides banks not only with significant scale, and hence a lower cost base, but also experience and knowledge. It facilitates innovation, technology investment, infrastructure support and research and development capabilities that allow us to create solutions that are very hard to match.

Do you see transaction banking making a significant contribution to risk management?

Absolutely. The focus of innovation in transaction banking in recent years has been threefold:

• To improve working capital.
• To increase visibility and information.
• To enhance efficiency.

These three objectives remain central for all corporate treasurers, but now risk management is critical. It is not necessarily about the creation of complex off-balance sheet structures – it’s about understanding flows, smarter analytics and the enhanced use of them to mitigate risk. Technology simply makes a bank such as Citi a more effective enabler of end-to-end risk management for corporates.

And so going back to a global offering, how can risk management benefit?

A good example is the mitigation of foreign exchange volatility. Historically, the main focus of many cash management structures has been on netting or pooling funds in order to balance long and short cash positions to improve working capital. The current volatile FX environment imposes new, heightened requirements to manage multiple currencies effectively. Consequently, existing cash management and trade structures need to be enhanced to reflect new risks arising from currency volatility.

“Existing cash management and trade structures need to be enhanced to reflect new risks arising from currency volatility.”

Inevitably, global providers are better positioned to offer an interconnected infrastructure that facilitates multi-currency solutions. Moreover, the vast resources on which global providers can draw enable them – with the necessary expertise and innovation in product design – to be able to react to such challenges rapidly.

How are corporates’ priorities changing?

While the banking world has been undergoing unprecedented change, the volatility in financial markets is having similarly profound implications for corporates. Paramount among these is the reduced capacity of banks to extend credit facilities to corporates at the same time that many sources of capital markets funding have become constrained.

Given the tightening of external funding and liquidity, corporates are now placing a high priority on working capital. For a long time, abundant and cheap credit meant that the cost of working capital inefficiencies was low. Clients now are focusing on reducing working capital by streamlining the supply chain and cash management processes. The consequence of companies managing their cash much more efficiently is inevitably less idle cash.

“For a long time, abundant and cheap credit meant that the cost of working capital inefficiencies was low.”

This sounds as though it could be bad news for banks?

From the perspective of banks, balances are shrinking and risk is growing, while the cost of infrastructure remains fixed. For many institutions, it is a real challenge to move from a model that relies heavily (in some cases entirely) on revenues from balances to a pricing model that reflects true value.

Banks with a track record of successfully providing their clients with end-to-end treasury solutions and proactively assisting them to increase their efficiencies have faced the pricing paradox for a long time. As an effective solution, such institutions have already introduced a new pricing model based on variable pricing and costs, which places an increased emphasis on fees. In this new model, the ability to lower costs through scale, volume and technology will be the key to competitiveness.

What impact has the crisis had on credit exposure?

The financial crisis has redefined both the concept of credit risk and the cost of credit. A striking illustration of this is daylight (intraday) limits. The turmoil has generated a fresh perspective on exposures and risks. We are now more conscious of our intraday limits.

Recent events have not only highlighted the implications of insolvency on intraday credit facilities – the notion of cost has also evolved. The contraction in inter-bank liquidity and willingness to lend results in a knock-on effect on the velocity of cash which, in turn, creates a cost. While intraday credit operates differently for financial institutions and corporates, it is not inconceivable that some banks will identify this credit facility as a value added service that should be offered at a price. Or, alternatively, an opportunity for the clients’ infrastructures to be enhanced for increased efficiency to control these funds in the payment systems.

Meanwhile, the reduced balance sheet capacity in the banking sector is changing how credit is originated and structured. For example, where once banks were willing to back trade facilities worth hundreds of millions of dollars for a client, the emphasis for all banks is now on syndication, club deals and risk participation. Ideas from the syndicated loan market are taking hold in trade. The necessity of sharing risks is leading to the establishment of an ‘originate to distribute’ model. Some banks, including Citi, foresaw this trend and proactively adopted it in their strategic toolkit at an early stage.

“The reduced balance sheet capacity in the banking sector is changing how credit is originated and structured.”

In the current environment the failure of one company can have wider implications for others who depend on them. What can corporates do to protect themselves from counterparty risk in their supply chain?

On the supplier side, corporates need to ensure that they have an uninterrupted supply of components and materials from their key suppliers – the failure of just one critical supplier in the chain could disrupt a production momentum and the shipment of stock to its distribution network for months.

Take, for example, a major global paper products manufacturer that relies on critical supplies from Eastern and Western Europe. Citi has deep knowledge of the industry and was able to partner with both the manufacturer and its European suppliers to ensure the supply chain is robust during this difficult economic environment.

These suppliers are experiencing the same issues of credit risk and availability and, therefore, enlightened corporates are allowing their suppliers to take advantage of their creditworthiness to access cheaper finance. In some markets this may be the only source of finance available to the supplier, who, in turn, provides the corporate with the assurance of continuous supply.

“Enlightened corporates are allowing their suppliers to take advantage of their creditworthiness to access cheaper finance.”

How do you see the future beyond the turbulence?

Client relationships will no longer just revolve around the provision of processing capability and lending capacity. They will also take into account the tools and platforms that enable companies to view and forecast their cash flow and manage their working capital and risk across bank providers and geographies. In this new era, global transaction banks are well placed to provide clients with reach, expertise, innovation and scale.

Two developments are critical for the industry: the first is that improving the working capital efficiency of clients will result in new cost and revenue dynamics; the second is that the financial crisis is revealing the true cost of credit. Both of these trends are expected to result in new value added services and more transparency in pricing.

Corporates must choose a banking partner with the right experience, product capabilities, network reach and infrastructure. Citi has continued to nurture transaction banking business throughout the turmoil. Our message has remained constant: Citi remains committed to transaction banking. Transaction banking is core to Citi. Our competitive advantage is our global presence and we will continue to invest to deliver better products and services to our clients so they can minimise risks and optimise cash.