Offshoring of Business Processes by Banks from Switzerland

Diplomarbeit von Alexander Beutler

Introduction:

The global banking sector is currently undergoing fundamental changes. Banks face new challenges created by socio-economic and political developments and the potential of new information and communication technologies. Competition has risen to formerly unknown levels and active management of costs has become an ongoing tasks.

Unlike the manufacturing industries most banks still cover large parts of their value chain by themselves. Lead by Anglo-Saxon institutes global banks have started in recent years to use the advantages of globalization by splitting up their value chains and by offshoring selected functions to countries offering wage differentials. According to experts banks have just started to create their global sourcing model, so that the offshoring volume is projected to increase further.

While most banks have started their offshoring initiatives with IT functions, business process offshoring and even knowledge process offshoring have now become the main drivers of the move to the key offshoring locations like India, China and Eastern Europe.

Banks from Switzerland have been spectators to the global move towards a global delivery model for many years. Only its two large global banks - UBS and Credit Suisse - have started offshoring initiatives yet trying to catch up with their global competitors. They face challenges especially from the legal and regulatory side, which are specific to offshoring from Switzerland, and have to balance cost discipline with keeping the high standards in quality, security and confidentiality, which are the base for the high reputation of the Swiss banking market.

Table of Contents:

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Chapter 3, Offshoring by banks: This chapter focuses on offshoring of business processes by banks and commences with describing the drivers that have led to the high growth rates in offshoring in recent years. The paper then identifies benefits and risks entailed in offshoring and continues with defining criteria for selecting banking processes, which are suitable for offshoring, and by presenting the status quo, which banking processes have been offshored most so far. Offshoring may not be the right strategy for all banks as the final section of this chapter on potential strategies explains.

Chapter 3.1, Drivers for market growth in business process offshoring: The global market in business process offshoring is booming with 49 percent annual growth between 2001 and 2006. For 2005 the addressable market for business process offshoring was estimated to amount to 122 to 154 billion USD, of which only eight percent or ten to twelve billion USD had been captured so far. It is likely to overtake the market in offshoring of IT processes soon, which grew by just 21 percent from 2005 to 2006. In IT offshoring eleven percent or 16 to 20 billion USD of the addressable market, which amounts to 147 to 178 billion USD, is believed to have been captures so far.

What were the factors that lead to this large potential and high real growth rates of a mostly new industry? In the 1980s following the customer was the main motive for offshoring, while in the 1990s costs and new options created by modern IT and communication became the dominant drivers. In the new millennium the development in information and communication technology created completely new opportunities and trends for banks, which are relevant for offshoring:

Banks have further specialized and streamlined their processes using IT, which are now stable and standardized enough for offshoring. 91 percent of financial services companies have simplified processes and 74 percent have centralized operations.

Information and communication technology makes it possible to source non-material services from outside in a timely and cost-efficient manner. Services have become marketable.

The production of these services is no longer bound to geographic barriers. For banks the production site of mobile services without physical customer contact has become secondary, so that the opportunities of the global labor market can now be used.

These developments have led to the large increase in the offshoring potential; cost pressure caused by global competition was then the trigger for real growth of demand. These cost reduction measures were the driver for outsourcing of IT processes, which were then sent to even cheaper offshore locations in a second step. Business processes followed afterwards.

Next to increasing demand the market is also driven from the supply side. Learning from India’s success in offshoring, regions, countries and cities around the world are now being actively promoted as global or regional service hubs. They offer an array of incentives from tax breaks and regulatory reforms, direct training and hiring subsidies, to special certification and language-training programs, broad-based infrastructure improvements and education to attract and retain offshore service centers.

Chapter 3.2, Benefits: Chapter 3.2.1, Cost savings: The primary, yet not only impetus for offshoring in the banking sector is margin pressure. 74 percent of financial services executives with offshoring experience see cost savings as one of the three main benefits that their company has actually realized. Financial institutions saved over 40 percent on average against their onshore costs, on a process-by-process basis in 2006. Source: own illustration based on data from Operations Council, p. 10.

As figure 4 shows for knowledge-based offshoring, wage arbitrage (60 to 65 percent) is the main factor for cost savings. Efficiency gains (5 to 10 percent), e.g. from merging processes in one location that were formerly scattered around the globe, constitute five to ten percent of savings.

Another five to ten percent of the savings are from having access to new capabilities or business opportunities. One leading US bank saved $100 million by using offshore staff to detect fraud in low-value transactions that could not be monitored profitably onshore. Lower processing costs have even allowed banks to create new products, such as subprime lending to previously unprofitable customer segments.

Access to new talent and expertise adds another 10 to 15 percent, as banks often have access to higher qualifications for the same jobs abroad. While higher qualification may decrease the cost savings from wage arbitrage, it has a positive impact on the quality of services. Benefits are partly outweighed by additional costs for transition as e.g. for training (5 to 10 percent), governance as e.g. managing interfaces to the offshore location (10 to 15 percent), hidden or unexpected costs like productivity gaps (10 to 15 percent).

From the author’s experience the transition costs can easily exceed the average value stated above in offshoring from Switzerland, as especially the clarification of legal restrictions and the subsequent potential IT adjustment or process reengineering can be significant cost drivers requiring large project staff for the setup of an offshoring initiative.

Overall, companies can save 40 to 50 percent of their current cost base in knowledge-process offshoring. In low-skill offshoring, where complexity is lower and wage differences are even higher, total cost differences can even sum up to 70 to 75 percent.

The effect of labor cost arbitrage is highest in labor intensive processes. Highly automated processes may therefore not offer sufficient savings potential, especially if specific and rare know-how is required at the operation site for maintaining the automization.

Chapter 3.2.2, Access to new talent pools: While cost reduction remains a prime justification for many offshoring implementations, labor arbitrage is no longer the only impetus. Increasingly, banks offshore to gain critical access to highly skilled scientific and engineering talent in emerging locations. In other words, offshoring is evolving from a cost-saving tactic into a workforce management strategy. In the long term access to a global labor pool can even become more crucial regarding the effect of the demographic gap between aging developed and rather young developing countries.

Chapter 3.2.3, Market access: Offshore operations may give banks a foothold in new and emerging markets where revenue opportunities may be significantly more lucrative than in mature markets back home. Many of the leading offshoring destinations are in emerging markets, that are attractive e.g. for private banking and investment banking from Switzerland. The setup of offshoring operations can be a first step to develop a bank’s brand in a new market and to gain insight into market conditions.

Chapter 3.2.4, Process optimization: The creation of shared services can be facilitated by offshoring and aggregating processes that may not have been consolidated previously. ABN Amro and Credit Suisse, for instance, deploy similar processes from multiple sending units into one offshore center, where best practice processes get identified and new globally harmonized processes are created. The offshore vendors are experienced in streamlining processes and keen to create economies of scale, as parts of their profits are based on these productivity increases.

Chapter 3.2.5, Further benefits: Next to short-term tactical benefits, companies experienced in offshoring have also realized long-term strategic advantages as e.g. improved business continuity by reducing geographic concentration risk. By creating a global footprint the offshoring bank increases its strategic flexibility, especially if combined with outsourcing. The hybrid and offshore outsourcing models offer further strategic benefits, as e.g. concentration on core competences, change management in formerly unchangeable processes and improved scalability.