Corporate Banking in an Ecosystem World

The power of many: Corporate banking in an ecosystem world

August 2019 Authors and acknowledgements

Akash Lal Senior Partner Mumbai

Daniele Chiarella Senior Partner London

Feng Han Partner Shanghai

Giulio Romanelli Partner Sydney

Markus Röhrig Partner Munich

Vincent Zheng Associate Partner Beijing

Xing Liu Consultant Beijing

The authors would like to acknowledge the contributions of Roger Rudisuli, Kevin Buehler, Jacob Dahl, Joe Ngai, John Qu, Andras Havas, Istvan Rab, Fumiaki Katsuki, and Shinichiro Oda to this report. The power of many: Corporate banking in an ecosystem world Corporate banking is being transformed by digitization. From core business processes to the way that clients engage and transact, digital has become the sine qua non of almost every action. However, digitization is still in the early stages in corporate banking. As it matures, more fundamental changes will ensue, enabled by the free flow of data between banks, their clients, and third parties. The resulting “ecosystems” will catalyze new operating models and disruption on an unprecedented scale.

Already, tech giants such as Alibaba, Tencent, strategies, talent, and IT to do so. They need to and Amazon operate ecosystems with multiple identify potential partners, and determine which businesses. Some already offer financial services, business models work best for them. The task is from trade finance, to payments and marketplace nuanced and complex, but in a world of increasing lending. The implication of these changes is that the competition, it represents an opportunity that traditional boundaries between corporate banks cannot be ignored. and the industries they serve can no longer be taken for granted. In an ecosystem context, information, Corporate banking’s performance resources, and expertise have coalesced; everything challenge is up for grabs. Corporate banking plays a vital role in the wider Banks in China are already getting involved, with a industry’s performance, accounting for around range of adoption models emerging, from fintech- one third of total revenues.¹ However, the segment based platforms, to marketplace ecosystems and has come under pressure in recent years, amid partnerships with large companies. European and intensifying competition, technology, innovation, US banks are also taking steps, with some investing and weak performance in some markets. heavily in fintechs and application programming Revenue growth has averaged around 5 percent interfaces (APIs). since 2009 and average return on equity reached The benefits of joining ecosystems include 9 percent in 2016. These healthy top-line numbers expansion into new geographies, markets and disguise concerning underlying dynamics. The vast products, added value from sharing of intelligence, majority of positive performance has come from and in some cases technology, and more effective emerging markets, particularly in Latin America risk mitigation—partly the result of enhanced access and Asia, while Western Europe has seen return on to data across the network. equity fall far below its cost. There is also significant variance within regions, with leading banks Incumbents have first-mover advantage, but to accounting for the lion’s share of value creation, thrive in an ecosystem world they must choose while the rest tread water or lose money. the role they want to play, and develop the right

1 We define corporate banking as banking services provided from a variety of financial institutions to companies with more than $100 million in revenues and their subsidiares, as well as similar companies that participate in ecosystems.

The power of many: Corporate banking in an ecosystem world 1 A particular concern for corporate banking executives may no longer be as attached to the idea executives is that they have operated over that banks are the only source of financial services. recent years in a “goldilocks” macroeconomic It is easy to imagine a situation in which other environment—neither too hot, nor too cold—and industries (particularly in the tech space) may have aided by almost limitless cheap money from central the customer relationships, financial firepower, and banks. Of course, this is unlikely to last. The financial strategic intent to compete.

cycle will turn, bringing higher interest rates and a These trends matter to the banking industry normalization of credit conditions and risk costs. because the corporate segment remains key to The effects of the latter are already manifest in the health of the wider industry. Corporate-related some emerging markets. In China, in particular, risk banking activity generated around $1.25 trillion in costs have risen sharply, driven by nonperforming revenues in 2016. Slower growth, more regulation, loans and unsustainable corporate leverage. rising competition, and the critical emergence of A further pressure is regulation, the roll-out of which ecosystems put that revenue pool in play. is set to continue at pace over the coming years.

Banks under the Basel framework must persist in Ecosystems will change everything building out their capital buffers, implementing new risk measures, and taking steps to ensure they hold Individual digital technologies offer convenience sufficient liquid assets. From 2019, the Financial and the ability to work more efficiently and serve Accounting Standards Board’s Current Expected customers better. However, the whole is greater Credit Loss Model will impose much higher impaired than the sum of its parts. The most successful loan provisions on US banks. The alternative businesses have grasped how digitization enables International Financial Reporting Standard 9 will diversification; that if you can sell books on your lead to an increase in realized earnings volatility. platform then you can also sell cars, holidays, and Banks in Europe must also manage the impact of financial services. Companies such as Alibaba, regulation aimed at fueling competition (Europe’s Facebook, and Tencent have evolved into multi- PSD2, the UK’s Open Banking initiative) and new business behemoths, or ecosystems, that bring rules to boost transparency under the Markets in together interconnected services to meet a variety Financial Instruments Directive. By our estimate, of needs in a single integrated experience. global regulation in aggregate has the potential to McKinsey estimates that in the next ten years depress average industry ROEs to a low of 3 percent ecosystems will replace numerous value chains before mitigation over the coming years. globally. We believe that by the mid-2020s they will Finally, corporate banks face competitive account for $60 trillion in revenues and span 30 headwinds. Fintechs are targeting attractive percent or more of global gross economic output. links in the value chain, including payments, cash In banking, ecosystems offer the opportunity for management, asset financing, and trade finance. providers to tap into new customers, markets, and While companies such as ThinCats, Creditshelf, data, leading to the potential for greater scale and and LendingClub are making a mark in the small more complete resources for managing risk. They and medium size enterprise (SME) lending space, are already making waves in the retail segment, different platforms are already eating away at the where open-banking initiatives are encouraging corporate business. For instance, FX platforms third parties to get involved. Ecosystem plays are such as T360 and FXall and payments providers like now also starting to appear in corporate banking, Ripple are taking away the corporate business. A with companies, finance providers, incumbents, tough competitive environment is only going to get and technology providers exploring how they can more challenging in the years ahead. achieve critical mass under a single digital umbrella. As the market and economic environment Ecosystems are likely to thrive in the corporate shifts, corporate banks are also under rising context because there are clear potential benefits pressure to offer faster, more efficient, and more for both clients and providers: connected services, in line with the trends in retail banking. Clients increasingly expect streamlined —— A single gateway means clients get frictionless experiences, integrated solutions, and value- access to a broader range of products and added services. In addition, as digital disruption services than through a conventional linear softens the borders between industries, corporate relationship.

2 The power of many: Corporate banking in an ecosystem world —— Partnerships and service integration between data that becomes available. companies across sectors create the potential Still, alongside the many opportunities, there are for innovation, cross-selling, and data-sharing, also risks. McKinsey research shows that while as well as the opportunity to develop new digital technology propels some companies to business models and value-added services. become clear market winners, it depletes corporate —— Ecosystems create an opportunity to earnings and overall value for others. More players expand into new territories (geographic and naturally increase competition and the threat of client segment), broaden ranges of products disintermediation. There is a well-rehearsed concern and services, and overcome the capability among bankers that new technology gateways constraints inherent to being an individual player. could create a barrier between themselves and their clients, with other players controlling the —— More effective risk mitigation is enabled by relationship. That way lies a utility model that is multi-dimensional data and information available unlikely to be an attractive end game. In addition, in the ecosystem. Orders, transaction data, data sharing is itself a double-edged sword, creating logistics, and other information from partners business opportunities but also offering competitors such as tax bureaus and customs will support the chance to create value from formerly proprietary credit facility and post-loan management. assets. Finally, there is inherent risk in sharing A particular benefit for corporate banks is the data with third parties, particularly as banks come chance to partner with organizations outside under rising regulatory imperatives to protect banking. For example, companies, banks, and their customers. securities houses on a single platform can leverage scale to put together cheaper and more accessible China taking the lead financing packages (Exhibit 1). Ecosystems may also bring technology-based opportunities, such Local regulation, culture, and business practices as easier data-sharing, and better information mean the development of ecosystems is likely to exchange across the front, middle, and back offices. proceed at different paces around the world. To There are also potential operational improvements. date the biggest businesses have evolved in China. Risk management and credit assessment, for E-commerce giant Alibaba, for example, offers example, may be better served with the additional numerous financial and other services to companies

Exhibit 1 Ecosystems create opportunities for banks and enable better services.

Three key bene ts

Cater to diverse Clients can access a more comprehensive range of products and services needs and address Partner with numerous players across sectors, including banks, non-bank nancial institutions, more pain points ntechs, enterprises, and professional services rms, to oer integrated solutions

Tap into new client Enable regional players to bring innovative solutions to new geographies and client segments segments and Enable new business models such as integrated supply-chain solutions based on core enterprise’s geographies credit Accelerate business expansion for regional players leveraging the ecosystem’s nationwide online platform

Enhance risk Leverage data from real transactions to enhance risk management controls Host-to-host transaction data to validate real trade background and support credit facility as well as post-loan management

Source: McKinsey analysis

The power of many: Corporate banking in an ecosystem world 3 on its platform. Social media platform Tencent and document management. The distributed has launched a bank that leverages data from ledger forms a tamper-proof “golden record” platform partners to make loans. Another Chinese of transactions in negotiable debt certificates. ecosystem, Ant Financial (founded in 2014 out of the Financial companies on the platform include world’s biggest online payments provider Alipay—a banks, trust funds, securities firms, and factoring subsidiary of Alibaba) runs a money-market fund companies. Core enterprises receive credit lines with $165 billion of assets under management. that can be extended down the supply chain. In bringing together a group of enterprises, Linklogis The common theme running through these increases collective bargaining power and boosts businesses is that they are sustained because the stability of supply chains. they create a hive effect in which mutual benefits accumulate. For the most part they are orientated • The banking arm of Ping An Insurance, China’s toward the retail space and mass market. However, second-largest life insurer, is leveraging a range that is beginning to change, and a variety of new of technologies (blockchain, AI, cloud computing) models are emerging that are directly relevant to to expand its retail-focused ecosystem and build corporate banking propositions: a supply-chain accounts-receivable platform (Exhibit 2). The platform aims to bring together core Fintech or bank-led ecosystems companies, their suppliers, factoring interests, securities firms, trust companies, and related • Linklogis (backed by Tencent) is a fintech startup businesses to enable asset-based financing. The that helps banks build blockchain-based platforms resulting network supports securitization and trading on which core enterprises and their supply chains opportunities, and financing can be extended can access asset-based finance. Blockchain through the supply chain to second-order suppliers technology supports identity checks, asset review, and potentially beyond, according to Ping An.

Exhibit 2 Ping An’s SAS platform helps corporates and value-chain players obtain nancing and value-added services.

Blockchain Arti cial New technologies as enablers Information Inteligence tracing and validation Identity veri cation Factoring asset securitization and exchange Securities companies Private equity Trust funds Accounts/receivable nancing based on credit of core enterprises Core companies Immediate suppliers Upstream suppliers

Leasing companies Factoring companies

Banks

Cloud storage Automatic registration New technologies as enablers on People’s Bank of Cloud-based China system platform Fraud prevention

Source: Ping An annual report; expert interviews

4 The power of many: Corporate banking in an ecosystem world Industrial enterprise + big bank Marketplace ecosystem

ecosystem The marketplace model enables a bank to A group of 11 industrial companies, including rolling partner with cross-sector players to discover new stock manufacturer CRRC and China Aerospace relationships and expand (Exhibit 4). A leading Science and Technology Corporation, partnered regional bank is working with banks, non-bank with two state-owned banks (ICBC and PSBC), six financial institutions, factoring companies, core local state-owned enterprises, and four privately enterprises, and technology companies to build a owned enterprises, to build a trade-finance platform. platform that enables participants from within and The CSCC platform (Exhibit 3) includes more than outside the region to access trade finance, asset 900 core companies, roughly 35,000 multi-layer exchange, payments, and value-added services. value-chain players, and over 20 national and The bank gains from cooperation with the factoring regional banks and non-bank financial institutions. companies and by building alliances with other Transaction volume reached approximately RMB financial institutions. The relationships on the 240 billion by 2019, according to CSCC’s web site. platform are designed to be mutually beneficial; banks obtain high-quality credit assets, factoring The platform incorporates multiple business companies source new business, and corporates models, including financing, client brokerage access a wider choice of financing options. services, and IT solutions to help banks build or The plan is to expand the platform and to grow white-label platforms. It also offers services such as interbank sharing to include activities such as data order and invoice reconciliation and documentary exchange for onboarding and know your customer servicing.Companies on the platform can access (KYC). During the course of the project, the bank value-chain financing on a T+0 timeline based on a transformed its customer-facing and IT systems. It range of assets.

Exhibit 3 CSCC’s trade nance ecosystem incorporates a range of models.

Multiplayer platform Company ~ RMB 240 billion in transaction volume by 2019 Leading banks E-bill payments Non-bank FIs Core companies 1st-tier supplier Core companies, multi-layer Over 900 core ~ 35,000+ accounts value-chain players companies across China Split and endorse Client Various business models: brokerage 2nd- and 3rd-tier Multi-layer value-chain by the platform suppliers nancing based on core companies’ e-bill payments Financing Asset-backed security Client brokerage service to banks onboard Financial Asset exchange institution Banking partnersNon-bank IT solution to help banks nancial institutions build or white-label platforms Over 30 national Factoring companies Value-added document and regional banks service ABS such as ICBC exchange Leasing companies Leasing companies

Source: CSCC website

The power of many: Corporate banking in an ecosystem world 5 set up a digital innovation garage, bringing together services, business models, and technologies teams from business, IT, and operations. available, compared with traditional platforms. The scale and diversity create significant Regulator + banks + fintech ecosystem opportunities for lenders, borrowers, and providers A partnership between China’s central bank of adjacent services (Exhibit 6). (PBOC), Standard Chartered Bank, automaker

BYD, and Ping An (as technology provider) created Banks outside China are innovating the China Bay Area Trade Finance Blockchain Regulation such as Europe’s Payment Services Platform (Exhibit 5). Stakeholders include the Directive (PSD2) and the UK’s open banking Bank of China, China Construction Bank, and initiative provide a productive medium for the China Merchants Bank. The aim of the project is to cultivation of ecosystems. Both initiatives aim to enable participants, and SMEs, to access financing open up bank databases to third parties through and services including logistics, customs, and tax APIs. Participants are likely to benefit from advisory. Proposed benefits include lower interest shared data, wider client reach, more numerous rates and much faster loan approvals—20 minutes touchpoints, and the opportunity to offer better compared with weeks previously. Orders, logistics, customer experiences. Banks in the United States and transaction data are stored on the blockchain are also experimenting. Citi, for example, has ledger, which was launched for testing in September launched treasury and trade solution APIs through 2018. The platform is also designed to connect its integration platform. The solutions enable with the Internet of Things to enable automated corporate clients to make payments instantly and contract execution. access real-time information on FX, accounts, direct debits, cut-off times, and payments. Ecosystems are a game-changer in supply-chain finance, because of the much larger range of

Exhibit 4 Marketplace ecosystems enable geographic expansion and create new business models and sources of nance.

Marketplace ecosystem

Suppliers Distributors 1 Business expansion Accounts 1 Leveraging quasi-FIs: Accounts receivable Non-bank FIs payable 3 factoring companies as Core corporates partners, enabling regional Factoring company banks to extend client coverage Leasing company High-quality asset Supply chain company 2 Various funding partners exchange Partner banks to join the ecosystem Trust companies, securities companies 2 Banks 3 Bundling core enterprises Holistic industry supply chain nance: stabilize the Banking alliance Interbank cooperation Fintech partnership chain, optimize nancials and accelerate turnover cycles Reginal banking participants

Source: McKinsey analysis

6 The power of many: Corporate banking in an ecosystem world A common dynamic across these initiatives is that are leveraging APIs to open data and services banks are seeking partnerships that can help them to third parties. In one example, BBVA allows innovate, expand, control costs, and accelerate time third parties to retrieve business user balances to market. In the process, three distinct species of and transactions in market-standard format. nascent ecosystem are emerging: CitiConnect has processed millions of API calls for payment initiation and data inquiries. APIs —— Investment and M&A in fintech. Bigger banks connect ecosystem partners, organizations, are investing in fintechs that can help them and clients seamlessly, enabling the integration incorporate new technology and develop use of capabilities and offering of new products cases. Almost all major banks have taken this and services across ecosystems. The future of approach in some form. In one example, Westpac corporate banking is likely to be characterized strategically invests in around 20 fintechs, some by ecosystem-like interactions, enabled by APIs of which it has integrated into its business. In and platforms built by clients, banks, and third- another, Bocom International, the investment party providers. Potential API use cases exist banking arm of China’s Bank of Communications, in areas such as trade finance, cross-border has partnered with Hong Kong fintech firm FDT- payments, transaction monitoring, and corporate AI to develop solutions from artificial intelligence lending (for example, syndicated loans and and big data. credit scoring). —— Banking-as-a-service platform (open banking API). Banks including BBVA, Citi, and DBS,

Exhibit 5 People’s Bank of China coordinated a new platform leveraging blockchain technology to improve capital eciency and enable nancing.

In September 2018, China Bay Area Trade Finance Blockchain Platform, coordinated by PBOC, ran a Phase I trial for accounts-receivable nancing Highlights:

Open and Blockchain endorsed scalable Greatly enhanced platform for Headlight Order sheet Automaker credibility and nancial supplier A (anchor authenticity; institutions (upstream Shipment company) decentralized, traceable, and SME) tamper-free companies Logistics Order information information Eciency improvement A reserved data interface 23 20 for customs, Loan application China Bay Area weeks mins regulatory, tax Loan extension Trade Finance t Block-chain Platform More information to Before After enhance a higher number AR paymen of use cases Bank transfer Authentication Lower-cost nancing information

78% 5.56% Bank’s funding

Before After

Source: McKinsey analysis

The power of many: Corporate banking in an ecosystem world 7 Exhibit 6 Ecosystems create signicant opportunities for lenders, borrowers and providers of adjacent services.

Ecosystem platform versus Traditional supply-chain nance

Players Broader types of market players Mainly trilateral parties All membership banks Only the operating bank Multiple corporates Single corporate Multiple layers of suppliers and distributors Immediate suppliers and distributors Factoring companies Securities Trust companies

Solutions Various banking solutions and Only two major solutions value-added services Supplier nance Extended nancing by “e-draft” circulation Distributor nance Factoring ABS exchange Supplier nance Distributor nance

Business Membership-based trading platform Supply-chain nance model Asset marketplace and exchange Client brokerage IT solution service

Tech Blockchain Internet enabler Distant/shared KYC recognition Internet

Source: McKinsey analysis

—— Strategic alliances. Banks are creating informal Ecosystems create an opportunity for corporate or formal partnerships to share knowledge and banks to expand into new territories and client best practices. Rabobank, for example, formed segments, launch more products and services, and an alliance with banks in around 40 countries, as overcome the capability constraints inherent to well as NGOs and research institutes, aiming to being an individual player. In accounts receivable expand its network in the agriculture industry. trade finance in China alone, the market has grown at 10 percent a year over recent years to pass RMB What’s next? 14 trillion (Exhibit 7). Banking industry executives are attuned to the As executives consider how to position their need to manage the challenges of economic companies, they first need to consider their own uncertainty, and are preparing for the rise in risk market positions, priorities, and levels of ambition. margins that will likely accompany any cyclical However, there are also rules of thumb that can downturn. The industry is making efforts to become help guide the choices they make. Larger banks, leaner and more robust, and many large banks have for example, can leverage their resources to build partnered with fintechs to develop and expand their ecosystems through accelerated investment services. However, only a few have formulated a in fintechs. Regional players are often more comprehensive strategy for the innovation that is constrained, but have much to gain from working fueling the growth of ecosystems. closely with peers, clients, and partners. In doing

8 The power of many: Corporate banking in an ecosystem world so they can reasonably expect to reap benefits of —— Identify your role. Banks must decide how they scale that include greater client reach, enriched want to play. For some, it might make sense to products, and enhanced services. However, the task orchestrate an ecosystem, taking the lead in is complex, and requires a strong sense of mission, bringing the elements together and controlling as well as budget and technological resources. the point of entry. Alternatively, a bank could join other ecosystems, accessing scale much McKinsey sees five key actions that may help faster and gaining access to new industries and corporate banks find the right path: businesses. One leading US bank has invested —— Start from the top. Commitment from the CEO billions of dollars in building relationships with and board is essential. However, this must go hundreds of fintechs, including online brokers, beyond high-level mission statements. There payments providers, and marketplace lenders. must be ongoing conversations between top Banks must align their roles to their strategic decision-makers and those leading ecosystem positioning, product focus, and market. initiatives. Areas such as data science are —— Create win-win synergies. In successful relatively new and require investment of time and ecosystems, every member benefits from the resources. It may be useful to set up workshops, involvement of other members. Banks must where directors can ask questions and deepen identify win-win value propositions and clear their understanding. External experts can incentives for their clients and partners. Every also play a role, bringing different skill sets to company that takes part needs to contribute. In enrichen the ecosystem mindset. Banks must assessing partnership candidates, leaders might combine technological expertise with business- consider industries that are changing fast and process knowledge and strength in risk and which offer new sources of value, or are most regulation. Finally, the bank’s data strategy meaningful in terms of client base. Executives must be connected to its business goals and may consider how they can leverage their own core operations, so the proposition creates data to benefit themselves and others, and how excitement through the organization.

Exhibit 7 The market for trade nance ecosystems in China is an estimated RMB 14 trillion.

Industrial companies accounts receivables volume RMB trillion

+10% p.a. 14.3 13.5 12.6 The large marketplace 11.5 attracts innovators and rst movers such as CSCC Finance, the trade nance ecosystem built by a group of leading 6.5 state-owned enterprises and partner banks.

2010 2015 2016 2017 2018

Source: Wind

The power of many: Corporate banking in an ecosystem world 9 that will impact internal roles, operating models, data diversity—achieved in part through and business goals. partnerships—which will enable tailored services and create more value for the ecosystem —— Define use cases. Banking executives must as a whole. Information from a shipping identify the areas early on where they can company, for example, may help banks market generate the most value for themselves and trade-finance and FX services. Deeper data their clients. In some regions that may be in insights can establish previously undetected trade finance, while in others it may be corporate connections between companies, people, and lending or data-driven applications. The relationships. More extensive data can also ecosystems with strong early growth in China are support analytically driven scenario planning, the trade-finance platforms that bring together helping banks understand how ecosystems may industrial enterprises, national and regional develop, and where data can add value. Still, banks, and financial institutions. Potential API banks may not wish to share everything—there use cases are also emerging in trade finance, must be policies about what should remain cross-border payments, transaction monitoring private. Equally, they must ensure that partners including anti-money laundering and KYC, and share back any proprietary information they corporate lending. have transformed or enriched. Banks should —— Get the IT and data right. The lifeblood of any ask whether there is some target end state commercial ecosystem is a digital platform for data management that will drive value and data. This will feed cross-fertilization and creation. Technology is an important enabler, enable new insights, more accurate pricing, with cloud-based databases proliferating and and innovative services. A critical goal is AI applications including natural language

Exhibit 8 Banks can choose one or multiple models depending on product area and market segment.

Products (nancial and beyond)

Both own Own and third party Third party Traditional banks 1 o er principally their own 1 4 5 products through their own channels

Traditional Solution Aggregator/ “All things to all people” Own bank provider solution 2 model prioritizes own manager products but creates competition on distribution

Channels Ecosystem orchestrators 3 facilitate collaboration (branches, between multiple e-bank, participants apps, etc) 2 3 Solution providers 4 create end-to-end solutions “All things to Ecosystem by combining best-of-breed Both own all people” orchestrator products, either their own or and third from a third party party Aggregators and solution 5 managers create transparency and promote competition

Source: McKinsey analysis

10 The power of many: Corporate banking in an ecosystem world processing, deep learning and neural networks banking. These players understand that in a fast- increasingly available to help banks achieve new moving and increasingly competitive environment insights. Banks must also be willing to review the whole is greater than the sum of its parts. data and application architecture, and to invest Ecosystems enable expansion, innovation, data- and build new capabilities in APIs that will enable sharing, and new business opportunities. Regional external connections. players may benefit in particular from extended reach and scale. Given the range of possibilities, Corporate banks are specialized providers of and the chance to create critical mass, ecosystems sometimes complex financial services, and are are likely to be a key disruptive threat to corporate therefore relatively protected from the huge banking over the coming decade. If banks are to ecosystems that are emerging in the retail context. catch the wave, the time for action is now. However, it would be a mistake for executives to think they are immune. Already in China corporate banks are taking part in ecosystems in a variety of models. Large European and US-based banks are also engaging, primarily through partnerships with fintechs and exploration of the implications of open