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An Intro to the Financial Services Industry


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The Financial Service Industry is one of the most attractive industries to target if you are a consultant. However, when selling into, or delivering for, Financial Services Institutions (FSIs), it is useful to have some understanding of how FSI business models work, and the unique requirements that drive their IT strategies.This deck is a living document that hopes to act as a primer for consultants who need to support FSI clients, but who may not have prior experience in the sector.

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An Intro to the Financial Services Industry

  2. The Financial Service Industry is one of the most attractive industries to target if you are a consultant.
  3. To give a sense of scale, in 2014, Bank of America had over 100,000 Tech and Ops headcount and a $9B annual IT budget. americas-cathy-bessant/d/d-id/1317757
  4. However, when selling into, or delivering for, Financial Services Institutions (FSIs), it is useful to have some understanding of how FSI business models work, and the unique requirements that drive their IT strategies.
  5. This deck is a living document(*) that hopes to act as a primer for consultants who need to support FSI clients, but who may not have prior experience in the sector. (*) If you have an idea on how to improve this deck, mail
  6. In this deck we’ll cover 4 topics 1. What are Financial Assets 2. What are Financial Markets (Where Financial Assets are traded) 3. What are Financial Institutions (The players that act within Financial Markets) 4. Special Topics: FinTech & Regulators (Oooh…sexy) • I won’t be covering case studies. We can do a separate session on those • I also won’t go into the details of each type of product. That’s too detailed…
  7. Along the way, we’ll stop to discuss ENGAGEMENT INSIGHTS which are observations that should help consultants understand how to better sell and deliver solutions that are specifically tailored to the industry.
  9. Before talking about financial institutions (FIs), it is important to first understand financial assets, because everything about how different FIs do business ultimately stems from the properties of the assets they manage.
  10. An asset is any possession that has some value in an exchange.
  11. Tangible assets are physical things with properties that create value. Like a cow.
  12. Intangible assets represent legal claims to some future benefit. The physical form has nothing to do with the value. Seashells (or shell scripts) work just as well as dollar bills, so long as the legal structure says so.
  13. When we talk about Financial Assets, we’re talking about intangible assets. And the future benefit we’re talking about, is the right to claim cash.
  14. With a Financial Asset, one party, the issuer, agrees to make future payments to the owner of the financial asset, the investor. Examples of Issuers (and investors) include central governments or their agents, municipal governments, supranationals, non-financial businesses, financial businesses, and households (individuals)
  15. Here are some Financial Assets: a US Government Bond Stock in a Home Loan a Certificate of Deposit A Corporate Bond from General Electric
  16. There are generally 2 types of claims that an investor can make: fixed cash amount or a varying amount. * Some financial assets can actually be a hybrid of the 2 (such as preferred stock or convertible bonds), but let’s not worry about that for now
  17. If the claim is for a fixed amount, we call that a debt * Sometimes we refer to these assets as fixed-income products
  18. Debt payments can come all at once, or be spread across a period, but there is always a total, specific amount claimed. A US Treasury Bond is an example of Debt.
  19. If the claim is for a variable amount, we call that equity. * Sometimes equity is referred to as a security, or a stock
  20. Equity obligates the issuer to pay the investor an amount based on future value (such as earnings), usually after debt holders have been paid off first. stock is an example of equity. * Equity can sometimes also pay a dividend
  21. Because both debt and equity represent a promise to get future cash, to figure out how much a financial asset is worth, the financial asset needs to go through a process of valuation. * Think of it this way, would you rather me give you $1000 today, or next year? Today right? See? Present money is more valuable than the promise of future money. That is why we do valuation!
  22. Roughly speaking, Valuation is calculated using the timing of when you expect the future cash, the impact of inflation and prevailing interest, and, most importantly, the risk that something may happen and you don’t get the money back when it was promised
  23. Generally speaking, timing of cash flows, inflation, and interest rates are easy to predict. That is not true with risk. Thus, calculating and managing risk becomes an absolutely central focus of all financial institutions because it drives valuations and returns. So, if you sell or deliver into banks, Risk Management must be at the heart of your engagement. ENGAGEMENT INSIGHT 1
  25. Issuers and investors need a safe and efficient place to find each other, agree on valuation, and transact – enter Financial Markets.
  26. FSIs need to constantly innovate to remain competitive. The areas in which you can help them innovate are tied to the scope of Financial Markets. More specifically, they are looking for 1) new ways to find market opportunities more quickly, 2) develop new products to sell, 3) transact at the best possible price and lowest cost, 4) reduce risk, and 5) improve the Customer Experience Innovation around any of those is good! ENGAGEMENT INSIGHT 2
  27. One way to categorize Financial markets is by asset type. For example Debt Market versus Equity Market. * Sometimes, because of hybrid assets, we merge Debt Assets and Preferred Stock into Fixed-Income Markets, and the non-preferred equity assets are grouped into a Common Stock Market.
  28. Another way to categorize Financial Markets is by the maturity of claims (when you actually get your money). Short-term assets (like a certificate of deposit that matures in 3 months) are traded in a Money Market. And assets that mature over longer periods (like a 10-year bond) are traded in the Capital Markets * The cutoff between short and long-term is roughly 1 year
  29. A third way to categorize is based on whether the financial assets are newly issued, which are sold in a Primary Market, or whether the financial asset was previously purchased and is now being re-sold in a Secondary Market.
  30. Finally, investors can buy (or be granted) the obligation, or the choice, to buy or sell a financial asset based on various triggers. The specific terms are defined in contracts and are traded in a Derivative Market. For example, if you act within the next year, you have the option to buy a stock at $10 per share, even if the market price is $20 per share, but if the stock price drops to $8 you MUST buy it at $8.
  31. There are as many derivative instruments as can be concocted by human imagination, but common ones include Options, Futures, Forwards, Swaps, and Cap and Floors. Each of these contracts is designed to help investors manage their financial risk. Unfortunately, they can also be used to double down on bad bets!
  32. Understanding which market(s) your customer is playing is important because the business models that customers employ in each market is going to be quite different, because the needs of the customers in each market are very different. For example, a Bank’s customers in the Derivatives market are looking for risk management or high margin/high risk. Bank customers in the Debt Market are looking for low risk- low return. ENGAGEMENT INSIGHT 3
  33. At the end of the day, these financial markets take physical form in Exchanges (such as a stock exchange) – a marketplace where securities, commodities, derivatives and other financial instruments are traded in a fair, transparent, and orderly fashion.
  35. Issuers and Investors are not often financial experts themselves, and so Financial Markets are usually composed of FIs that serve as agents (or Intermediaries) that act on behalf of issuers and investors.
  36. Oh, and Financial Market Regulators will try to poke their heads in from time to time to make sure that no one is burning down the house.
  37. In addition, FSI industry service providers like credit-ratings agencies or equity research firms support specific needs of the FIs.
  38. But, in short, FIs…. 1) Take financial assets and repackage them for various financial needs 2) Exchange assets on behalf of customers or themselves and facilitate payments 3) Assist in the creation of financial assets 4) Perform proprietary research and provide advice around economic forecasting, investment strategies, and capital building or preserving recommendations 5) Manage customer portfolios to make money and/or reduce risk
  39. Roughly, FIs can be segmented into: Depository Institutions Non-Depository Institutions
  41. HOW DO DI’S MAKE MONEY? Depository Institutions hold money for customers, usually charging a fee. They then take a good chunk of that money and invest it (often in the form of Loans or investment in Securities), keeping some amount in Reserve to support the day-to-day withdrawal needs of their customers. They also charge money for services, take interest on the loans they make, and charge transaction fees for just about everything.
  42. DI’S ARE VERY REGULATED As you might imagine, DIs are the most regulated and most protected (i.e.:FDIC insurance) of the FIs because, well, that is all of our savings! A run on the banks (where depositors ask for so much of their money back that the Reserve dries up and the bank cannot support withdrawals in cash) could wipe out a national economy.
  43. Depository Institutions include Commercial Banks (or simply ‘Banks’) Savings and Loan Associations Credit Unions * Commercial Banks represent the vast majority
  44. Within the segment of Commercial Banks there are additional sub-segments, each with quite unique business models. The sub-segments include: Individual Banking Institutional Banking Investment (Global) Banking (quasi depository) Universal Banking
  46. CUSTOMERS OF INDIVIDUAL BANKS Individual Banks provide Services to…well….individuals, like you and me. We want… 1. a safe, transparent place to store our money 2. the ability to use that money wherever, whenever, and through any channel we want to (in as convenient a way as possible) 3. access to more money (for a period of time) 4. good advice on how to protect and grow our money 5. great and value-for-money service when providing the above
  47. PRODUCTS OF INDIVIDUAL BANKS Individual Banking includes services such as managing deposits, consumer and mortgage lending, payment and withdrawal, checking and bank drafts, credit card financing, car and student loans, specialized services such as safety deposit boxes, and individual investment / advisory services.
  48. HOW ARE INDIVIDUAL BANKS SEGMENTED? Individual Banking roughly segments by the amount of money the typical customer deposits. There are 2 segments, Retail Banking (for you and me) and Wealth Management (for the fortunate few). * Wealth Management is sometimes called Private Banking
  49. Wealth Management, in turn, breaks again into: Mass Affluent Banking (250K->2M AUM) Wealth Management Clients (2-50M AUM) High Net Worth Individuals (50-250M AUM) Ultra High Net Worth Individuals (>250M AUM) AUM = Assets Under Management
  50. As you might imagine, the services offered get much more profound, complex, value additive, and expensive the more money one deposits, especially when it comes to advisory.
  51. HOW ARE RETAIL BANKS STRUCTURED Generically, Retail Banks will be structured into 1) a Retail Branch Operations Group, 2) Individual Lines of Business, 3) a Back Office Group and 4) Misc (Legal, HR, Audit/Risk, Admin, Change & Strategy, etc). The Back Office will include 1) Technology, 2) Back Office Operations (Transaction Settlement & Risk) sub-groups, and 3) Treasury
  52. HOW ARE WEALTH MANAGERS STRUCTURED Generically, Wealth Managers will be structured into 1) Financial Advisory Group (segmented by region or AUM, 2) a Back Office Group, and 3) Misc (Legal, HR, Audit/Risk, Admin, Change & Strategy, etc). The Back Office will include 1) Technology, 2) Back Office Operations (Transaction Settlement & Risk) sub-groups
  53. Individual Banks are constrained by a few parameters. First, because they are playing with our money, their tolerance for risk is extremely low. That means that when they invest deposits, they must be careful to assume a low risk profile. Check out Glass-Steagall on Wikipedia if you want some nighttime reading As a result, return on assets is much lower than much riskier business models such as Investment Banking. ENGAGEMENT INSIGHT 4
  54. When selling or delivering, Retail Banks and Wealth Management Banks should be considered as separate segments with different buying needs and behaviors. Because retail banks serve the everyman, who are generally price-sensitive, product pricing tends to be low and margins razor thin. As such, Retail Banking is a volume- based business and deeply paranoid about operational costs. Wealth Management is the opposite. Customers are generally not price sensitive, but expect very tailored services from their Financial Advisors. Wealth Management firms tend to be more willing to make large expenditures if they can produce big customer experience gains. However, the typical Wealth Management client is not at all keen on their bank experimenting with new, and potentially risky, technology, since they have consolidated so much in one place - so the perception of stability and security is probably higher. For example, 2-factor authentication (RSA tokens) was adopted much faster by the retail Banks then it was for the Wealth Managers. Lastly, note that most Wealth Management clients have a separate Retail Banking relationship for their day to day needs ENGAGEMENT INSIGHT 5
  55. Although it is annoying to change banks, retail bank customers are far less sticky (locked-in) than a corporate bank, wealth management advisory, or an investment bank. That means competition can be very fierce for every customer in the Retail space. Retail Banks tend to be very marketing/brand conscious and the role of IT tends to focus on providing new services and channels for customers. User Experience is king in the Retail Bank market, and Retail banks are usually the first to adopt new digital technologies. Wealth Managers are managing customers who have more at stake (more to lose), so although customer experience is critical, most WM Banks prefer stickier person-to-person relationships with Financial Advisors and tend to be technology late adopters, waiting until new technologies are well tested in the market before risking them on their valuable customers. ENGAGEMENT INSIGHT 6
  56. With the cost of acquiring new retail, small business or commercial customers being five to ten times the cost of retaining an existing one, and with the average spend of a repeat customer being 50-100% more than a new one, bank marketers need to remember that the most efficient investment of marketing funds is to market to customers that already bank with you. As part of that Retail Banks love to white label product (act as distributors) such as credit cards, insurance policies, mutual funds because they can add value without absorbing operating costs. Wealth Managers tend to prefer proprietary systems that help the differentiate from other advisors. Both are highly interested in user experience, especially when it comes to new, and more integrated channels, and using their massive data stores plus Big Data to help target and provide new value to customers (especially when it is real-time and tailored to each customer. Both have a deep desire to cross-sell and up-sell. ENGAGEMENT INSIGHT 7
  57. In terms of organizational power and influence, central IT departments in Retail Banks are by far the most powerful of all the FIs. In Wealth Management Banks, things look a bit different. Power and influence rest with Financial Advisors who have the most assets under management. If you take care of the big, juicy clients, you have much more power than anyone else in the bank. Because of that, the power of Central IT recedes in favour of shadow IT (business groups drive their own mini-IT strategy). With that said, most Wealth Management firms also have reasonably strong central IT functions to drive cost efficiency and standardization. ENGAGEMENT INSIGHT 8
  59. WHAT ARE INSTITUTIONAL BANKS? Institutional Banks do not serve individuals. Instead, they face off to, usually the Treasury Departments of, Corporations. They can generally be segmented into SME Banking and (large) Corporate Banking depending on the annual revenue of their customers.
  60. CUSTOMERS OF INSTITUTIONAL BANKS Corporate Treasurers want… 1. Everything that an individual bank provides, but for a business (on a much bigger scale) 2. Value-added services specific to businesses 3. Seamless integration/automation to their business financial systems 4. Support for compliance regimes
  61. HOW DO INSTITUTIONAL BANKS MAKE MONEY? Institutional Banks primarily provide high-margin trade financing, cash management, leasing, and invoice factoring services on top of payments and risk or capital-building advisory. They often also front Investment Banks to provide Investment Banking products. They will charge service and transaction fees and will often leverage deposits like individual banks do, but for Corporate Savings accounts.
  62. HOW ARE INSTITUTIONAL BANKS STRUCTURED Generically, Institutional banks will be structured into 1) Corporate Banking and Trade Services, 2) Asset Management Services, 3) a Back Office Group, and 4) Misc (Legal, HR, Audit/Risk, Admin, Change & Strategy, etc). The Back Office will include 1) Technology, 2) Back Office Operations (Transaction Settlement & Risk) sub-groups
  63. CFOs are always interested in personalized services and a wealth of financial tools that they can use to more efficiently and effectively manage the finances of the firms they look after. As a result, Corporate Banks tend to have much wider and diverse product portfolios than Individual Banks. When it comes to margins, Corporate Banks tend to fall in the middle on average. On the one hand, as customers, corporate CFOs tend to be quite cheap (money minded), so product margins in corporate banking are pulled downwards. However, Corporate Banks counter this downwards pull with lots of boutique, personalized products and high customer lock-in. While it is possible to move from one corporate bank to another, it is MUCH harder than moving your personal account, because once you are on- boarded onto corporate banking systems, you get pretty stuck. ENGAGEMENT INSIGHT 9
  65. HOW DO INVESTMENT BANKS MAKE MONEY? Next, Investment Banks provide services including helping institutions raise money through corporate financing (e.g.: underwriting bonds or raising funds via private mergers and acquisitions or public IPO), support for foreign exchange transactions, research, asset management, and provide dealer/broker services to buy and sell securities and derivatives
  66. CUSTOMERS OF INVESTMENT BANKS Investors want… 1. Unequal access to market intelligence & opportunity 2. Access to many markets and products 3. Transaction speed 4. Low-cost, high volume transactions
  67. HOW ARE INVESTMENT BANKS STRUCTURED Generically, Investment banks will be structured into 1) Front office (investment banking, sales & trading, and research), 2) Middle Office (risk management, financial control, corporate treasury, corporate strategy, and compliance), 3) Back Office (Tech and Ops), and 4) Misc (Legal, HR, Audit/Risk, Admin, Change & Strategy, etc). Note that most lines of business, especially in Sales and trading will have Front-Office aligned IT organizations, that might be funded differently from the Back Office.
  68. Today, realistically, many Investment Banks compete with Institutional Banks in terms of service offerings. It is also important to note that the Investment banking business model is HIGHLY leveraged which means they are highly profitable, but highly risky. Finally, sometimes the investment Bank will be more than a broker/dealer. Sometimes, they will take ownership stakes in securities. In this case, they are called Merchant Banks ENGAGEMENT INSIGHT 10
  69. Investment Banks have the highest margins in the industry - and also the risks. Because of this, central IT has very little power. Instead, because the individual lines of business have so much cash, IT power federates into fiefdoms aligned to product lines such as Equity or FX, and/or to geos such as Americas or APAC). Shadow IT, inefficient, redundant, and sometimes contradictory enterprise architecture is rife. Also, because risk is high, Investment Banks must set aside huge amounts of short-term assets (cash) as Reserve. Because there is so much sitting idle in reserves and because Investment Banks have such return on assets, they can often make more profit by freeing up cash in reserve to invest in the top line rather than cutting costs. PS: After the 2008 crash, regulatory pressures have escalated dramatically, and this impacts both the size of reserves plus the cost of internal compliance programs ENGAGEMENT INSIGHT 11
  71. Finally, Universal Banks occur when one bank integrates horizontally and vertically, acting as a Retail Bank, an Institutional Bank, and an investment Bank, all in one.
  72. Here is an interesting infographic showing the growth of universal banks….
  73. Such dramatic industry consolidation over the last 2 decades has resulted in massive Industry-wide Technical Debt. If you buy 10 banks, you may have 10 duplicate systems, each of which, because it is connected to everything else like spaghetti, become almost impossible to decommission. There is a great Technical Debt Primer here: underestimate-the-danger ENGAGEMENT INSIGHT 12
  75. The most commonly known Nondepository institutions are Insurance Companies. Insurance Companies sell insurance policies, which are legally binding contracts that pay the insured an amount of money in the case of future events, so the business is all about which risks to take. Sometimes a Commercial Bank will act as a Distributor for an Insurance Company, in which case it is called Bankasssurance. When multiple insurance companies share risk by purchasing policies from other insurance companies, it is called Reinsurance
  76. The business model is to collect more in premium and investment income than is paid out in losses, and to also offer a competitive price which consumers will accept.
  77. CUSTOMERS OF INSURANCE COMPANIES Insurance customers want… 1. To feel secure 2. To feel as if their insurance portfolio is personalized 3. Their claims to be honored quickly and easily
  78. Insurance is all about making great predictions using statistics. And the better the data, the better the predictions. Thus, Big data and Internet of Things is critical for insurance Companies. Interestingly though, in recent years, the focus has moved away from predictive models and more towards preventative models – use Big data and IoT to prevent risks from occurring by providing advanced notice of increasing risks (such as…you are more likely to have a heart attack now that (according to your watch) you’ve just finished that Big Mac….) Insurance companies tend to be quite profitable, which means that they can invest. However, their lifeblood is the army of individual agents (who are sometimes independent) and white-label organizations that actually sell their policies, which means that adoption (change management) is very difficult. ENGAGEMENT INSIGHT 13
  79. Another type of Nondepository institutions are Investment Companies which are financial intermediaries that sell their own shares to the public, and invest the proceeds in a diversified portfolio of financial assets. These open end funds like mutual funds or closed end funds like pension funds, unit trusts or private funds (foundations) such as venture capital funds or family funds Sometimes investment banks are called Sell Side and Investment Companies are called Buy Side
  81. Finally, it is probably worth making mention of FinTech, which is a relatively new FI segment that is composed of a motley of start-up, small, and medium-sized companies that are trying to disrupt the Financial Services Industry using cutting edge technology and business models.
  82. Venture Scanner’s FinTech Map
  83. These guys, at the same time, scare the cr@p out of FIs, and offer them a path into the future. Most banks have developed a FinTech strategy that involves copying, acquiring, investing, distributing, or ignoring.
  85. We mentioned earlier that governments have an interest in making sure that FIs don’t cheat individuals or burn down the economy.
  86. As a result, the Financial Services Industry is one of the most highly regulated industries.
  87. FIs must put in place a host of financial and operational controls to prevent or mitigate risks such as: How much cash they hold in Reserve How much risk / leverage they take How they manage their IT How they manage their operations How much, how fast, how often, and with whom they trade or do business with
  88. And, following the 2008 crash, these controls have gotten far more severe, all over the world.
  89. This can be very expensive because FIs must hold more cash in Reserve, spend more money to implement (and audit) operational controls, and pay fines when they are caught screwing up.
  90. Being a Global FI is particularly challenging when it comes to Regulation. Because they traded in several countries and across several product classes (each with their own specialized regulator) one customer I worked with had over 70 regulators, each with similar, but not entirely similar, regulatory requirements. ENGAGEMENT INSIGHT 14
  92. Hopefully this has been a useful primer to an industry, which is actually a collection of many fairly large and complex sub markets, each with very different characteristics. * Actually, it is only an intro. I cut a few corners to make some of the text digestible to a newbie
  93. As a next step, I would recommend heading over to Wikipedia and start learning about individual product classes (what is the difference between a SWAP and a FORWARD and why would you want one) in each of the markets.
  94. Or simply go out and talk to bankers to learn more about what gets them out of bed, or opens their wallets.