Industry
Banking
Banking Services Transformation: Unlocking Exponential Value
Highlights
- Efficient treasury operations are imperative for the financial health of individual financial institutions as well as systemic financial stability.
- Financial institutions that are still having to operate with legacy cash and liquidity platforms and data management systems often find it challenging to drive effective treasury operations and keep risks at bay.
- It is therefore imperative for financial institutions to move to a unified, next-gen cash and liquidity model to enable agile treasury operations, improving liquidity risk management.
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The prevailing treasury landscape
For banks and financial institutions, efficient treasury management is critical for day-to-day business operations.
The treasury function manages banks’ assets and liabilities, ensures optimal liquidity and cash positions, manages risk, and increases profitability through strategic utilization of funds. Consequently, it directly affects the efficiency of functions such as liquidity risk management, capital allocation, and regulatory compliance. Financial institutions use several metrics such as liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) to ensure that they have the funds to meet their business obligations. Financial institutions are also required to calculate certain ratios to manage the interest rate risk in the banking book (IRRBB), market risks by determining the expected shortfall (ES), and the tail risk arising from the Fundamental Review of the Trading Book (FRTB).
Timely access to quality data is imperative for efficient treasury operations be it cash forecasting or stress testing or intraday risk management. Existing cash and liquidity management operations, however, are largely underpinned by on-premise legacy systems and data centers that source data from a variety of federated systems such as enterprise resource planning (ERP), treasury management systems (TMS), core systems, and so on. These data feeds can be systemized or un-systemized depending on the source. Furthermore, banks operate with legacy cash and liquidity platforms, increasing dependence on decentralized and federated systems. This demands manual intervention to resolve issues such as missing data elements and attributes which increases the burden of data validation and reconciliation. Legacy systems limit banks’ ability to establish data lineage, creating difficulties in producing accurate data for cash and liquidity monitoring and reporting as well as calculating liquidity risk metrics.
Additionally, different functions such as loans, deposits, and capital markets must establish discrete and dedicated connectivity with other banks and custodians to manually retrieve their cash positions and determine their liquidity and funding needs. Such manual modes of working can be time-consuming and error-prone.
All these limitations negatively affect financial institutions’ overall treasury operations, posing risks that could have a detrimental impact on business, especially during market stress situations. Let us examine three key impact areas:
Hit on profits
When financial institutions lack complete visibility into cash positions across nostro accounts, it limits their ability to accurately determine the cash buffers that they must hold. While underestimating the buffer can potentially expose financial institutions to liquidity and reputation risks, overestimating results in cash sitting idle instead of being employed to generate revenue, which in turn negatively impacts profits.
Potential for financial instability
Legacy cash and liquidity systems lack the ability to accurately assess the intraday liquidity needs of a bank as they are not able to gather near real-time or real-time cash positions. Consequently, banks have a very short window of time to respond to evolving stress situations. Delayed response to liquidity stress situations can potentially result in bank runs, directly affecting financial stability and reputation.
Higher cost of capital
Financial institutions regularly assess their funding sources to optimize their capital structure and reduce the overall weighted average cost of capital (WACC). An incomplete or insufficient view of available funding sources can result in banks resorting to wholesale markets and credit lines to meet secondary and contingency liquidity and funding requirements. Funds from these sources come at a higher cost compared with traditional channels, increasing the overall cost of capital and reducing profit margins.
Drawbacks in existing treasury platforms
Financial institutions worldwide have embarked on programs to transform legacy cash and liquidity systems.
However, problems persist due to the implementation of point solutions without a holistic modernization strategy in place. Financial institutions have managed to address their operational challenges related to payroll management, account payables, account receivables, and other business operations by adopting ERP and payment solutions (see Figure 1).
Figure 1: Existing cash and liquidity platform
However, despite undertaking change programs, difficulties remain—system bottlenecks, disparate connections between federated systems and third parties for accounts receivable (AR) and accounts payable (AP), and manual processes—resulting in the following pitfalls.
Inefficiencies in payments
Lack of visibility into delays in payment settlements can result in banks not making the necessary arrangements to ensure the required cash and liquidity positions. Longer settlement cycles cause inaccurate regulatory reporting of cash and liquidity positions in turn inviting stringent scrutiny.
Incomplete visibility into assets and liabilities
Federated and legacy cash and liquidity systems have limited ability to update accounting records which constrains banks in obtaining a holistic view of their assets and liabilities portfolio and payments data. Consequently, business users manually consolidate the cash positions held in different primary or nostro accounts. This manual, error-prone process delays reconciliation leading to inaccurate liquidity reporting, attracting regulatory action. It can also negatively affect profits—for example, if a bank erroneously believes that it is short of liquidity, it may borrow from the market at higher costs to tide over the situation in the short-term.
Clearly, while point modernization solutions may address the immediate challenge, they are seldom effective in the long run. Financial institutions will need to undertake holistic transformation of cash and liquidity management to achieve long-term strategic goals.
What banks must do
In our view, financial institutions must transition to a unified cash and liquidity model equipped with next gen capabilities.
The target model (see Figure 2) must:
- Include an application programming interface (API) framework for near real-time or real-time visibility of cash and liquidity positions.
- Incorporate generative artificial intelligence (GenAI) tools to predict cash flow and liquidity, identify patterns such as seasonal spikes and stress situations, derive insights on what action should be taken to control market stress situations, and ensure efficient utilization of funds.
- Include a framework to determine contractual and non-contractual cash flows for predictive cash and liquidity modeling.
- Offer a holistic view of cash and liquidity positions to the treasury function, in turn enabling intelligent channeling of funds to high-yielding opportunities and reducing settlement delays and costs.
- Integrate all the source systems and establish a holistic data strategy underpinned by cloud infrastructure while ensuring robust governance, which will help banks demonstrate the stringency of their control mechanisms to regulators.
- Automate payment functionalities to enable more accurate cash forecasting; implement straight-through processing (STP) in payments to improve tracking, enhance collection and cash flow efficiency, and reduce errors.
- Include a throttling framework to configure the payment classification system so that high priority payment requests are processed immediately while low priority ones are held back during liquidity stress situations, which will help maintain stability by ensuring adequate cash and liquidity positions.
- Leverage cost-efficient, third-party products with pre-built connectors and automated payment modules, which integrate effectively with existing infrastructure, to gain a real-time view of cash positions.
Figure 2: Target state integrated cash and liquidity platform
To move to the target model shown in Figure 2, financial institutions must define an implementation roadmap, including the following key steps:
- Assess and document the existing treasury landscape.
- Adopt a business architecture driven approach to identify business and technology problems (such as inability to view cash positions on time, un-systemized data feeds among others).
- Evaluate whether to opt for in-house solution development or choose a third-party solution based on the complexity of the cash and liquidity module.
- Identify the industry best practices that will work best given specific requirements.
- Define a target state business and solution architecture that addresses the existing gaps and meets target state requirements as well as future business and regulatory requirements.
- Define implementation timeliness along with key milestones for the target model based on business needs.
- Integrate ERP, TMS, trading systems, and core line of business platforms through an API framework.
By adopting the proposed model, financial institutions can realize several benefits such as faster cash and liquidity analysis and more efficient fund utilization with optimal buffers. Higher accuracy in cash and liquidity forecasting driven by real-time data will ensure flawless cash positions, reducing liquidity management and funding costs while enabling holistic monitoring of cash and liquidity in real-time or near real-time. The proposed target model needs limited manual interventions, which can help enable faster processing, reduce errors and payment failures, and save costs related with payment failure penalties and surcharges. Most importantly, this ensures human-in-the-loop decisions for selected processes that are critical.
Looking ahead
The treasury function is the heart of financial institutions.
Inefficient treasury management can spell disaster for financial institutions, resulting in consequences such as inability to meet financial obligations, maintain financial stability, and retain the confidence of customers, which in turn can lead to bank failures. Despite this, most banks are lagging behind in the modernization of treasury operations—they largely operate with legacy cash and liquidity platforms, compromising their ability to respond nimbly in stress situations. Furthermore, legacy platforms hinder day-to-day treasury operations, adversely affecting fund utilization, risk management, and profitability. For banks, moving to an integrated cash and liquidity platform is the need of the hour. And sooner the better, for quick action is key to ensuring the long-term health of individual banks as well as the stability of the wider financial system.
