OPERATIONS IN FINANCIAL INSTITUTIONS - WHY IT

1
OPERATIONS IN FINANCIAL INSTITUTIONS - WHY ITS
MORE THAN JUST PROCESSES

• B60.2315.20 OPERATIONS IN FINANCIAL SERVICES

Spring 2002
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discussion.
2
THREE OPERATIONS-RELATED THEMES FOR FINANCIAL
INSTITUTIONS

1. How to apply manufacturing techniques to
   reengineer and rethink the operations processes
2. How to use offshoring to redefine the traditional
   operations location and operating model
3. How to respond to industry planned next-day trade
   settlement (T1) initiative

3
THREE OPERATIONS-RELATED THEMES FOR FINANCIAL
INSTITUTIONS

1. How to apply manufacturing techniques to
   reengineer and rethink the operations processes
2. How to use offshoring to redefine the traditional
   operations location and operating model
3. How to respond to industry planned next-day trade
   settlement (T1) initiative

4
LEAN MANUFACTURING GENESIS AND KEY PRINCIPLES
Key principles of lean manufacturing

1. A workforce that is waste aware and skilled in
   reducing/eliminating waste
2. Level production load from matching demand to
   capacity/supply
3. A just-in-time production process that produces
   only when needed and in quantities required
4. A process designed to deliver quality the first
   time using robust, in-process mechanisms
5. An energized organization with the processes and
   capabilities to achieve continuous improvement
   year after year

5
LEAN MANUFACTURING LEVERS TO ACHIEVING OPERATIONS
EXCELLENCE
Main lever
Specific improvement
Example
Migrate to lower cost channels

• Reduced channel cost in credit card company by
  50 due to migrating inquiries from call center
  to Web

Optimize/manage complexity

• Segmented volume based on customer profitability
  to maximize contribution margin

Manage demand at the source
Level load incoming demand to match supply

• Created measures encouraging branch loan
  applications to arrive on an ongoing basis during
  the workday

Capture information and correct errors one time,
accurately, at the source

• Reduced labor costs 40 in check processing due
  to one-time, quick capture of information

Understand customer preferences/tradeoffs

• Conducted customer interviews to optimize
  required decision time of loan application

Standardize and stabilize work processes

• Reduced variability on incomplete application
  handling to a no tolerance approach which
  improved completion rate by 50

Streamline critical path

• Ordered appraisals on homes for equity loans
  earlier in the decision process

Optimize process, layout, and flow
Operations excellence
Build in quality

• Created data entry forms that have restricted
  fields to reduce incoming errors

Create one-piece synchronized flow

• Redesigned the underwriting process to a single
  piece, first-in/first-out flow which reduced
  turnaround time from hours to minutes

Organize around processes, not tasks

• Created end-to-end accountability for
  performance not department/task-based
  accountability

Set clear process metrics

• Created a performance scorecard including
  timeliness, service quality, and
  cost/productivity measures

Manage perfor-mance
Determine stretch targets

• Designed stretch targets based on theoretical
  limits, not incremental performance

Tailor incentives and consequences to results

• Tied process metrics to team-level performance
  and to team compensation

6
MANAGE DEMAND CHANGE SCHEDULES TO MATCH DEMAND
Number of applications
Fax demand
Current schedule capacity
New schedule capacity
140
120
100
80
60
40
20
0
7 AM
8
9
10
11
12 PM
1
2
3
4
5
6
7
8
9
10
11
7
OPTIMIZE PROCESSES, LAYOUT AMD FLOW LISTED
EQUITIES TRADE FLOW
Automated
A
Automated
Eliminated
Manual
Sales/trading
Exchange floor
Middle
Order
Cash-
Daily
PS
Office
Room
iers
PL
Messengers/data
Sales/traders
Block traders
Booth
Brokers
entry operators
1. Enter order into A
4. Acknowledge order
8. Write down order (or print order from B)
A
A
A
5. Write down order on pad
2. Select block trader from pull-down menu
9. Beep 2 or house broker
10. Pick up order at booth
A
Rejected by D
11. Execute order in crowd
3. Send order to trader through A
6. Decide exe-cution strategy
Call order into
D
sales/trader
Executed by D
7. Call order to floor/enter order into D
12. Call verbal to booth
Client
A
A
15. Write down execution check against pad
13. Deliver written to booth
14. Call back execution (or type into B)
A
A
16. Enter execution into A
20. Write floor execution report
21. Pick up floor reports and deliver for punching
17. Send/allocate execution to sales/trader
22. Type floor report into
18. Call execution to client
A
19. Print house execution report
A
Systems
B
A
C
Rolesinvolved

Sales/ traders

Assistant

Booth

House brokers

Key punch

traders
clerks
2 brokers
operators

Block traders

Runners
Support block desk and other products
8
IMPACT FROM REDESIGNING LISTED EQUITIES TRADE FLOW
Steps in trade flow process

• Description of opportunity
• Trade flow involves over 70 steps, 40 of which
  are manual
• Manual steps and the resulting errors requires
  hiring costly FTE and limits capacity
• Large numbers of systems increasing the level of
  complexity and steps
• Numerous reconciliations based on multiple
  sources of data entry

• Financial impact
• 10 reduction in FTEs

Total steps
Manual steps
-13

• Key success factors
• Walking the process to see each activity
  first-hand
• Willingness to redesign the process from scratch
  rather than generating changes to current system
• Make sure the trade flow is right before
  introducing technology

-33

• Assumptions
• Service levels to customers would not decline
• The majority of manual steps do not require
  complex decisions that cannot be automated

Before
After
Before
After

• Implementation time
• 12-18 months

New design also reduced flow through 18 of
remaining steps
9
OPTIMIZE PROCESSES, LAYOUT AMD FLOW UNDERWRITING
ACTIVITY
From convoluted physical flow
PC
Order
x
x
Denial
PC
Printer
Printer
x U/Ws x
x 6 x
PC
PC
Printer
PC
Printer
PC
x
x
x
PC
x
3 regional underwriting queues
PC
x



PC
Fax
Fax
Fax
10
OPTIMIZE PROCESSES, LAYOUT AMD FLOW NEW
UNDERWRITING PROCESS
Production flow
Phone U/W
X
X
Single queue
X
X
X
X
PC
PC
10 paces
Printer
Printer
Processors
Fax
11
IMPACT OF REORGANIZING UNDERWRITING ACTIVITIES

• Eliminated transportation time, increasing
  underwriting capacity by 6
• Moved all clerical work to processors, increasing
  underwriting capacity by 11
• Transitioned all first and second decisions to 4
  underwriters (and reprioritize tasks), decreasing
  through-put time
• Created phone underwriters positions (for 2
  staff members) to handle all communication and
  non-time-sensitive underwriting, allowing other
  underwriters to focus exclusively on first and
  second decisions

12
OPTIMIZE PROCESSES, LAYOUT AMD FLOW CURRENT
CHECK PROCESSING
Checks are transported from branches to
centralized processing site
Each check is read by a proof operator who enters
the amount which is MICR encoded onto the check
The checks are then run through a sorter equipped
with a MICR reader and microfilm camera data
from each check is sent from the sorter to the
banks IP servers
Checks are then prepped and put into trays
13
OPTIMIZE PROCESSES, LAYOUT AMD FLOW IMAGE
TECHNOLOGY
Checks are transported from branches to
centralized processing site
Checks are prepped and put into trays
Each check is run through a sorter equipped with
a MICR reader and a digital camera which captures
an image of the front and back of the check
Jane Doe 123 Main Street Anywhere, PA 11111
123
Date
The images are then run through OCR software to
determine the amount the amount and other
infor-mation on the check are sent to the banks
server
For checks where the image cannot be read, a
person at a terminal reviews the image and enters
the amount
14
IMPACT OF NEW TECHNOLOGY ON CHECK PROCESSING
Operational lever
Time to get 1 entry through process
Selected changes
FTEs
Optimize/ manage complexity
Improve labor utilization by introducing
cross-training and workcells
Build in quality
Reducing the number of touches will provide fewer
opportunities or errors
Before new process
Since new process
Before new process
Since new process
Organize around processes, not tasks
Team-based accountability improves total system
quality
15
THREE OPERATIONS-RELATED THEMES FOR FINANCIAL
INSTITUTIONS

1. How to apply manufacturing techniques to
   reengineer and rethink the operations processes
2. How to use offshoring to redefine the traditional
   operations location and operating model
3. How to respond to industry planned next-day trade
   settlement (T1) initiative

16
RECENT SIGNIFICANT REDUCTION IN INTERACTION COSTS
Advancing technology
Easing regulation
Maturing markets
Supplier base India Billions, revenue
Reduction in bandwidth costs

• Strong financial incentives (Malaysia example)
• 100 tax exemption for 10 years
• No VAT
• Aggressive operating incentives (India example)
• State-sponsored training in soft and domain
  specific skills
• Privacy protection act to protect offshored
  customer data
• SLAs between state and telecom providers to
  ensure dedicated, high quality supply

Thousands PA for 2 Mbps fiber leased line,
half circuit
CAGR 69
Mar 2000
85 drop in India as state monopoly faces
competition from private satellite providers
Mar 2001
Mar 2002E
Employment in offshoring industry India
Thousands
Philippines
CAGR 53
Mar 2000
India
Ireland
Mar 2001
U.S.
Mar 2002E
Cost of international leased line for India
cost of long distance domestic leased line in the
U.S. costs are for January each year for India,
based on Mumbai or Cochin U.S. half
circuit data is derived by dividing full circuit
data by half Source VSNL press releases
literature search Lynx, Goldman Sachs estimates
McKinsey analysis
17
REMOTE SERVICING HAS BECOME A LEVER FOR DRIVING
PERFORMANCE
From physically co-located end-to-end operations
. . .
18
THREE DIMENSIONS OF BENEFITS FROM REMOTE SERVICING
Cost

• Dramatic reduction in cost (10-30)
• Increased flexibility permitting greater
  capacity/demand balancing
• Improved transparency and predictability

Operational improvement
Quality
Time

• 24 x 7 service
• Faster turnaround times from learning curve
  benefits
• Continuous production possible with effective
  synchronization

• More established processes and metrics for
  meeting higher performance standards
• Access to basic and specialized skills
• Minimized baggage of outdated infrastructure,
  e.g., software

19
LOCATIONS USED TO REMOTE SERVICE DIFFERENT
SERVICES

• Ireland
• Software development
• Call centers
• Shared services

• India
• Call centers
• Data entry
• Software development
• Engineering design
• Back-office operations

• Caribbean
• Data entry

• Philippines
• Software development
• Call centers
• Data entry

• Ukraine
• Software

• Singapore
• E-commerce hub
• Shared/financial services

• South Africa
• Financial services

Source McKinsey analysis
20
LARGE OPPORTUNITIES IN BANKING AND INSURANCE
Areas of greatest opportunity
High (300)
U.S. cost base industry US Billions
Medium (100-300)
Low (0-100)
Low (0-1)
Medium (1-5)
High (5)
Remote serviceable processes share of cost base
Source U.S. Census Bureau team analysis
21
INITIAL FOCUS ON LOWER END PROCESSING/DATA ENTRY
ACTIVITIES
Current activities Future activities
Support activities (IT, HR)
Asset management
New business processing
In-force transactions
Customer acquisition
( )
Source Press searches GE Remote services case
study
22
EARLY MOVERS ARE ALREADY SEEING BOTTOM-LINE
IMPACT
2001 Forecasted savings (public statements)
Cost savings Millions PA
Current employees
Main activities
340
9,500
Call center, mortgage and insurance, accounting,
bill payment
14
6
20
300
Back-office processing, e.g., payments, account
services, support
2,050
Trade finance, check processing, data entry,
customer services, loans, bills, credit cards,
cash management
70
35
105
6
54
60
Transaction processing, e.g., accounts opening,
mortgage clearing
300
18
17
35
730
Data processing, accounts, check clearing
16
70
54
800
Accounting services, operating services, and call
centers
14
55
41
400
Insurance claim processing, call center
Total pretax operating cost savings based on
labor cost savings for main activities adjusted
for higher other costs (e.g., telecommunication)
not adjusted for startup inefficiencies Source L
iterature search industry interviews team
analysis
23
CITIGROUP EXAMPLE
Corporate philosophy/thinking

• Plan to become biggest outsourcing centre within
  Citigroup.
• Works for over 22 overseas units - current
  geographies covered are CEMIA (Eastern Europe,
  Africa, South Asia). US and UK operations
  recently announced plans to use India as source
  base
• Ensure at least 10 of total business comes from
  third party sources
• Operate as a cost centre. Billing is on a cost
  plus basis for services offered. Billing per
  employee currently is 25,000-30,000/year

Start of year Source Press searches,
Interviews, McKinsey analysis
24
AMERICAN EXPRESS EXAMPLE
Background/corporate philosophy

• One of the three global financial resource
  centres (FRCs)of AMEX
• 100 owned by AMEX. Caters only to AMEX internal
  requirements
• Key geographies covered are Australia, New
  Zealand, Singapore, Japan, Hong Kong, Philippines
• Future plans are to
• Expand into higher value added work such as
  planning and forecasting, account consolidations,
  risk modeling
• Increase service lines especially in TRS for
  activities such as voice based customer support
  etc.

Start of year _at_30000/FTE/year Source
Press searches, Interviews, McKinsey analysis
25
HSBC EXAMPLE
Corporate philosophy/thinking

• Created a separate 100 owned subsidiary (HDPI)
  of HSBC, UK to provide services
• Provides support for select back office
  operations of UK and US bank operations
• Caters to more than 17 business areas
• Plans to
• Expand into high-end retail banking processes and
  expand to wholesale banking processes, and other
  branches in Europe, and Australia
• Reach 3000 FTEs by 2002
• Add another global processing center in Hyderabad
• Invest additional 10 million

_at_40000/FTE/year Source Interviews, press
searches, McKinsey analysis
26
EXAMPLE PROCESS END-TO-END LENDING
Fully remote serviceable Partially remote
serviceable
Origination
Servicing
Payout
Application to closing
Fund disburse-ment to coupon delivery
Description Cost Percent of
total Savings Percent of cost

• Initial customer contact
• Data entry of applications
• Underwriting/ credit decision- ing
• Communication and upsell to applicant
• Document preparation
• Disbursements/ closing
• 45-50
• 15-20

• Review of closing document for compliance
• Booking of document to system
• Funding
• General ledger reconciliation
• 25-30
• 6-10

• Scan and index of file
• File management
• Assist in internal and customer inquiries
• Research of issues
• 10-15
• 15-25

• Processing final payments
• Releasing collateral
• 5-15
• 20-25

Source Team analysis
27
FIRMS ADOPTING A UTILITY VIEW TO IDENTIFY
OPPORTUNITIES
28
POTENTIAL BARRIERS AND CONCERNS

• Perceived issue/risk
• Reliability of telecom
• Lower quality
• Lower productivity
• Cultural differences
• High bandwidth costs
• Unsustainable labor cost advantage
• High government/ regional risk/ instability

• Current status/method for management
• Reliability has improved over the last 5 years
  satellite now at about 99 percent fiber at 95
  percent
• Significant further improvements are likely
  addition of 14 TBps of international capacity
  addition of 270,000 miles of domestic fiber
• Players experiencing increases in quality due to
  lower turnover and higher skill level
• Higher productivity and quality can be achieved
  through investment in training, compensation and
  labor pool rotations between on-shore and
  off-shore locations
• Bandwidth costs have significantly declined due
  to deregulation and investment in capacity
• Supply of talent in some locations ensures cost
  advantage will exist for 20-30 years
• Unlikely given not harmful to domestic
  constituencies
• Government supports action e.g., U.S. and
  Indian government agreed to decouple information
  technology trade from politics
• Can manage through multiple location operations
  (e.g., India and Philippines)
• Early development of public relations strategy

General concerns
Infrastructure
Service levels/ responsiveness
Cost advantage
Political/country
Operations and community
29
COMMON QUESTION WHERE TO LOCATE?

• Skills
• Availability of frontline skills
• basic/language
• specialized (as appropriate)
• Availability of senior management skill
• Cost

• Telecom/other infrastructure
• Telecom bandwidth and reliability
• Availability of IT service providers
• Reliability of power sources

• Regulatory environment
• Mode of entry
• Fiscal incentives
• Operating area compliances

Attractiveness of a location for remote services

• Political risk
• Stable government
• No domestic conflict
• Legal enforcement
• Bureaucratic transparency and limited corruption

Source Team analysis
30
COMMON QUESTION WHAT IS THE APPROPRIATE BUSINESS
MODEL?
At scale
Size of operation
Significant sub-scale
High
Low
Degree of control desired
31
THREE OPERATIONS-RELATED THEMES FOR FINANCIAL
INSTITUTIONS

1. How to apply manufacturing techniques to
   reengineer and rethink the operations processes
2. How to use offshoring to redefine the traditional
   operations location and operating model
3. How to respond to industry planned next-day trade
   settlement (T1) initiative

32
WHAT PRODUCTS ARE COVERED BY THE T1 INITIATIVE?
Included in T1 effort
Source Streetside Fixed Income Working Group
(The Bond Market Association, SIA)
33
WHAT ARE THE BENEFITS OF MOVING TO T1?
Average daily transactions grew from 150M to
350M in the same period, a CAGR of 24
Source SIA T1 Business Case
34
ACHIEVING T1 WILL REQUIRE OVER-COMING
SIGNIFICANT LIMITATIONS OF CURRENT PROCESSING
ENVIRONMENT
35
SOLUTIONS PROPOSED BY INDUSTRY (SIA) TO THESE
CHALLENGES
36
MODULE 1 CREATE NEW MATCHING UTILITIES
From . . .
. . . to
Allocations
Confirm
Investment manager
Broker/dealer
Investment manager
Broker/dealer
Matching utility (central point of reference)
Confirm
Confirm
Affirm
Confirm
Custodian
Custodian
Affirm
Depository
Depository
37
SIA ESTIMATES OF T1 INVESTMENTS AND COST SAVINGS

• Majority of T1 investment and benefits fall on
  market participants, particularly broker-dealers,
  who also gain vast majority of cost savings
• Payback period of 3 years expected with a 28 IRR
  on total investment
• 99 of total investment within four walls
  focusing on internal changes (e.g., IT
  infrastructure and applications)
• Similarly, 78 of investment focused on two of
  ten building blocks internal STP and
  standardizing reference data and protocols

Note Based on surveys interviews and industry
data. Over 200 surveys were sent to different
industry institutions across participant types.
More detailed investment surveys were sent to
targeted brokers/dealers, asset managers, and
custodians to provide a better estimation of T1
investments Source SIA T1 Business Case
38
ECONOMICS OF T1 BY PARTICIPANT
Millions
Estimated T1 investment for large participant
Payback period Years
Comments

• B/O operations major cost for brokers/dealers and
  requires significant investment for T1
• Brokers/dealers making majority of investment,
  but receiving largest benefit
• Investment likely for large brokers/dealers given
  short payback period and business importance of
  B/O capabilities
• For medium and small brokers/dealers, however,
  outsourcing B/O more attractive due to economies
  of scale in investment

Brokers/ dealers
60-100

• BO operations small portion of costs and not
  perceived as core activity
• T1 likely viewed as compliance event
• Although investment per company less than
  brokers/dealers or custodians, relative savings
  even less resulting in longer payback period
• Despite little economics incentive for asset
  managers, industry needs their cooperation to
  move to T1

Asset managers
40

• B/O operations important cost area and key
  business capability for custodian requiring large
  T1 investment per participant
• Significant investment and benefits shared by
  small number of players with short payback period
• Large role in institutional trades combined with
  better risk management provide strong incentives
  to make investments required by T1

Custodians
60
Source SIA T1 Business Case
39
T1 IMPLICATIONS FOR BROKER-DEALERS
Approach to back-office partnering
Joint
Individual
Option 3 Share common tasks and resources for T1
Option 1 Implement changes to meet T1
compliance requirements
T1 as compliance event
Approach to back-office redesign
Option 4 Share/create a single back office
processing platform
Option 2 Leverage and extend T1 changes to
broader redesign program
T1 as catalyst for broader design
40
POTENTIAL INDIVIDUAL APPROACHES FOR BROKER-DEALERS
Individual changes (no JV)
Option 1 Implement changes required to stay in
business after T1
T1 as compliance event
Approach to back-office redesign
Option 2 Leverage and extend T1 changes to
broader redesign program
T1 as catalyst for broader design
41
POTENTIAL JOINT APPROACHES FOR BROKER-DEALERS
Approach
Individual
Joint
Option 1 Implement changes required to stay in
business after T1
Option 3 Share common tasks and resources for T1
T1 as compliance event
Approach to back-office redesign
Option 2 Leverage and extend T1 changes to
broader redesign program
Option 4 Share/create a single back office
processing platform
T1 as catalyst for broader design
42
POTENTIAL END GAMES