US regional banks need to up their digital game

Key Takeaways

• Cultural rethink needed by regional banks to modernize systems.
• They should be grabbing a bigger slice of the FX pie.
• Closer ties with LPs and technology vendors are also important.

Regional banks have not had an easy time of it. There is growing competition from their larger counterparts as well as fintechs digitizing customer journeys, automating the back office, and gearing up for next-gen technologies like artificial intelligence (AI). Stubbornly high inflation and elevated interest rates, not to mention more stringent regulation, have also taken their toll.

If they do not embrace the digital world brimming with API-driven, cloud-native solutions, they will fall even farther behind their peers as customers turn to more innovative players for cross- and real-time payments, financial services, and day-to-day banking. This requires banking innovation through rethinking systems and processes, and a cultural shift regarding how to deal with the legacy systems that have long been hampering growth and creativity.

It’s far from a new problem and the industry remains split as to the best way forward. While some advocate a complete overhaul, others believe this would be too expensive and disruptive. They rather see parallel systems built that could be migrated to a new platform.  This would be more cost-effective and also efficient, as existing customers would not plug into the framework until it was tried and tested.

Other options mooted have been moving the functionality of the legacy core to a so-called sidecar which handles specific tasks or data processes scaled independently. This enables the bank to adapt quickly to market conditions, introduce new products, and improve customer experience. However, running two cores is burdensome. There is also the incremental strategy to introduce modern banking systems,  which sees legacy components being replaced one by one. This may be slower, but it allows for a modern infrastructure to emerge with lower risk attached.

Getting more of out of FX

While each of these methods has its proponents, keeping the status quo is not an option. This is particularly the case for foreign exchange, which, according to the Bank for International Settlements’ 2022 Triennial Survey, is the largest asset class in the world with an average global turnover of over USD 7.5 trillion per day in April 2022.

Running 24 hours a day, companies are busy converting currencies for their international trade settlements and investments. Unsurprisingly, behemoths like JP Morgan are stealing a march. Last year, the US giant reported USD 5.5 billion in FX trading revenue, which exceeded the net income of all but nine other US banks in 2023.

However, regional banks should be doing a better job of grabbing a slice of the FX pie. They may not have the scale of a JP Morgan, but they have several strengths including local community ties, faster and more flexible decision-making, and the ability to tailor their product offering and expertise to local requirements.

Rewiring payments

There are protocols such as the ISO 20022 that require every institution sending cross-border payments to be prepared. This new standard from SWIFT for exchanging electronic messages between financial institutions has been heralded as one of the most significant changes in the payment arena since online transactions became the norm. This is because it standardizes financial communication and encourages banks to reimagine data’s role in payment transactions.

However, as with many standards, implementation has not been easy as it requires rewiring the entire payments industry, including 11,000 banks, who must undertake the cumbersome task of reviewing masses of data. This explains why SWIFT has pushed back the deadlines several times since 2020 with all eyes now on next year. However, market participants believe the effort will be worth it in terms of better-quality reconciliations, real-time and/or automated payments, and fraud prevention.

ISO 20022 cannot be viewed in isolation. Regional banks need to adopt a much more holistic approach to technology, resources, data and analytics. This means adopting modern banking systems such as integrated online, mobile, and branch platforms offering FX and cross-border transactions. Workflows must be automated for payment capture, verification, and release, FX pricing, FX hedging and risk management. This reduces the cost, risks and straight-through processing (STP) mistakes.

Tools, tech and relationships

Building a better FX business is not just about the tools and tech. It also requires forging relationships with liquidity providers, correspondents, and technology providers to deliver FX and cross-border capabilities to the highest standard.

Value-added services should also be part and parcel of the package. Customers expect bread and butter FX and cross-border transactions, but including risk management advice, hedging strategies, market insights and even additional products such as foreign currency accounts in a single platform will sharpen the competitive edge.

Paying more attention to the different client segments and their specific needs is also key. For example, transactional, personal or small to medium-sized enterprises typically deal via request for quote and bulletin pricing for spot FX for cross-border payments. Their commercial and wealth cohort clients have a similar payment-driven transaction profile but are more price sensitive, deal in larger amounts, and, in addition to spot, will enter forward contracts and more complex transactions.

Corporate and institutional clients, on the other hand, have both transactional and financial FX needs and prefer to process FX and payments separately. They are much more price-aware, often preferring multi-dealer FX platforms with streaming execution, and use more complicated product types such as swaps and strips of forwards.

Regional banks that modernize their technology stacks and automate tasks to be able to stay compliant with ever-changing cross-border requirements will be better placed to cater to the needs of their customers, regionally or beyond. In globalized, 24-hour financial markets, it’s a strategic imperative.