#33 - The Case for Innovation in Corporate Banking

Why Corporate Bankers need to embrace technology in their strategic thinking

Sep 13, 2021

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Introduction

Most discussions of Fintech or in general the role technology is playing in the changing financial landscape tends to focus on retail propositions. From the payment giants in India and China to Neobanks across South America, Europe and the USA and finally to Mobile money and Neobank propositions in Africa.

Very little is said about the innovations in Corporate financial service provision and this is an area that should also come into focus. It is no surprise that there’s little excitement in the corporate/wholesale banking space. This is a vector that is meant to work and be stable given the negative blowback that occurs when mistakes are made. In my experience, Corporate Banking is a negative art, it’s one where the focus is on not making mistakes rather than innovating. The recent experience with Credit Suisse and Greensill perfectly illustrates this.

Corporate banking thrives on tradition, process, precision and custodianship; themes that are similarly found in the military. Whenever Corporate bankers have broken out of this mould and adopted a more gung-ho entrepreneurial spirit, often bad outcomes such as the Global Financial Crisis have materialised. You are not necessarily rewarded for taking unnecessary risks in finance and when you are, incentive misalignments often form. In my view, this is why banks that have built a heritage of Corporate or Wholesale banking have struggled with Retail Banking. On the other hand, banks that thrive in Retail Banking fumble about with their Corporate arms. Corporate bankers are a completely different animal compared to Retail bankers, from their demeanour to their mindset.

All that said, technology is changing everything and Corporate bankers should open up their eyes to the different ways in which technology is changing the financial landscape particularly as regards service provision. In this article, I will map out the Corporate Banking space in Africa in terms of the clientele served, main products, processes and traditions and why much hasn’t changed. Thereafter I will map out some of the interesting things that are happening and how Corporate Banks should respond.

Corporate Banking in Africa

Banking services in Africa have evolved largely around the main events that shaped the continent. Kenya Commercial Bank for instance traces its history to the development of trade in East Africa through the National Bank of India which later merged with Grindlays and was headquartered in Nairobi, the then hub of the East African Railway project that was to terminate in Kampala. Standard Bank of South Africa traces its history to the diamond mines in Kimberley and the Gold Mines in Gauteng province. The traditional banking giants regionally were built around the historical events that shaped the continent. This is not much different to the rest of the world, Wells Fargo for instance traces its history to the gold rush in California.

Currently, the main types of Corporate clientele in Africa can be divided into the following sub-groupings;

MultiNational Companies such as MTN, Diageo, Lafarge, Heineken Group and trading companies such as Bunge;
African Corporations such as Dangote, Mabati Rolling Mills and Shoprite;
NGO’s and International agencies such as the UNICEF, WFP, Care, Oxfam and others;
Local Corporate customers in each country;
Government agencies and institutions including multilateral institutions such as ECOWAS, African Union etc;

In Corporate Banking, the key economic activities undertaken by corporate clients include manufacturing, trading (particularly in landlocked or unstable countries), agriculture, telecoms, Oil and Gas (Upstream or downstream), Mining and Construction.

These companies have diverse banking needs with the servicing of these needs being dictated by the specific markets in which they operate. The types of services range from;

Payments both payables and receivables;
Cash collection and handling;
Credit facilities - plain vanilla term loans, overdraft facilities, syndicated loans and in more sophisticated markets products such as corporate bonds;
Trade finance with standard products such as Letters of Credit, Guarantees and Standby LCs;
Forex trading with more complex products such as forwards and swaps being provided in more sophisticated markets;
Financing products such as supplier finance, warehouse finance and value chain financing schemes;

These are some amongst a number of products that largely cover credit, payments, trade, cash handling and forex.

There are over 50 countries in Africa each with unique banking regulations and particularly exchange restrictions. Kenya for instance is the financial hub of East Africa due to a relatively sophisticated banking system and a largely liberal exchange rate. Next door in Tanzania, exchange restrictions abound. A company that operates in both Tanzania and Kenya can therefore not have a centralised Treasury due to the exchange controls. In Nigeria, the dollar markets are deep due to the oil and gas industry but exchange restrictions make it difficult for companies to buy foreign currency as well as conduct proper cash forecasting given the volatility in both the price and supply of foreign currency.

Banking in Africa is therefore a very localised business where banks thrive based on spheres of influence. In East Africa for instance, large Kenyan banks dominate in the Kenyan market but are yet to reach the same scale and influence in other markets. West African banks do very well in West Africa. GT Bank for instance makes over 86% of its revenues in Nigeria with another 11% coming from Ghana. Its East African subsidiaries generate less than 1.5% of total revenues. KCB Group generates 77% of its revenues in Kenya with all its subsidiaries operating within East Africa. Equity has done well in this regard with its non-Kenyan subsidiaries generating 36% of its revenues with this being driven largely by its Congolese businesses that are now generating almost 10% of group revenues.

Corporate banking in Africa has largely been driven by spheres of influence either national or regional as well as the economic activities that occur within these regions. These in turn have been shaped by forces such as the colonial legacy and the larger forces shaping Africa's economy. Processes have largely been dictated by local issues such as;

Sophistication of local payments systems - some countries have delayed to roll out RTGS systems and cheque payments are still quite dominant;
Culture and traditions - for instance electronic payments for bulk payments are favoured in Kenya due to issues around security and cost. In a country such as Burundi for instance, it’s not unusual to see people carrying wads of cash to make a large payment as there’s no culture of theft;
Sophistication of local procedures - most companies operate manually through “wet signature” type processes from procurement to delivery note generation to invoicing. Banks therefore have to operate at the level of their clients;
Lastly, relational business dynamics. Corporate banking the world over is largely a relationship based dynamic. This is even more the case in Africa where a commercial director can control a large portion of the P&L, keeping him thus becomes a board level concern.

Corporate Banks are Sitting Ducks

The above discussion lends itself to the conclusion that nothing much has changed in terms of how Corporate Banking is done. In fact, technology has largely been an appendage or improvement to existing procedures rather than a paradigm shift in how corporate services are delivered.

Additionally, two forces tend to shape Corporate Bankers;

Risk is not rewarded. Unlike equity investments, debt investments do not grow in proportion to the revenues generated by the business. If a business 100x its revenues on a fixed borrowed amount, the amount it owes to the bankers stays the same. In an equity investment, the amount owed to investors in the form of dividends is meant to grow in proportion to revenues and profitability. This then makes lending a negative art where Hippocrates maxim of “Primus non Nocere” or “First do no harm” is followed. You’re rewarded for not messing up rather than being bold and entrepreneurial;
On the other hand, given at a certain level, corporate banking is a commodity product, the long-term outcome is that revenue is driven by those who can drive sales and relationships. Relationship Manager then rise to the top based on their ability to market existing products. The same dynamics happens in companies like breweries and cement manufacturers. At worse, the commodity product and non-changing dynamics leads itself to corruption where bribes are the only way to get business. I was told by a leader in the industry of how people even split interest i.e., you agree to a deposit at 9% but only reimburse the deposit at 7% whilst you split the 2%. I was like;

The video below by Steve Jobs aptly describes this dynamic;

The two forces intersect to create corporate bankers who are thus largely suspicious of innovation or at worst default to their “relationships and contacts” whenever the discussion veers into generating long-term revenue and commercial value. Corporate Banking thus in the long-term seems perfect for disruption due to the incumbent mentality.

Opportunities for Disruption in Corporate Fintech

Open Banking and Payments

The open banking and payments space is witnessing significant change particularly as standardisation such as PSD2 and laws such as GDPR as well as local data laws come into force. The focus on Open Banking and Payments has largely been on retail account switching but its implications for Corporate Banking are quite large.

I was having a chat with the team at Churpy, a start-up that is building tools for corporate payments and financial automation. It’s interesting how current payment mechanisms are so unfit for purpose. One thing Churpy is working on is Accounts Receivable (AR) automation.

The problem is that companies issue invoices to their customers in B2B industries such as manufacturing or wholesaling. Most of their customers have credit lines that are maintained within their corporate ERP’s. Multiple invoices can then be issued over their trading cycle whilst the client is still within their limit. However, once the customers start paying back the invoices, their corporate clients struggle to reconcile the incoming payments to their old invoices. Some of these payments are made via cash, others via M-Pesa, others via cheque and others as a direct deposit into the corporate account. Given their inability to reconcile, the corporate accounts receivable balloons whilst its back-office is filled with AR clerks who are burning the midnight oil to reconcile. Eventually, due to IFRS guidelines, some companies have to write off their receivables and take a direct hit on their profitability. Worse still, supplier relationships are strained as their clients cannot access stock since they’ve reached their credit limit despite faithfully paying their invoices.

The problem is brought about by; thin payment information coming from the bank statement, the inability of the corporate to integrate their ERP’s into their banking partners’ systems and payment systems that don’t communicate to each other. Additionally, the absence of Request to Pay Functionality further hampers this as payment links can be generated per invoice to aid in direct reconciliation.

When you speak to the Churpy team, it’s clear that API initiatives by banks are far from being useful to their corporate clientele. On one hand, there’s lack of focus and support from the top level management and on the other hand, banks have focused on the presentation layer of API’s rather than having true open banking capabilities. The diagram below from a talk given by Eyal Sivan best explains the issue;

Open Banking goes deeper into the infrastructure, Open-API programs should do more than just present their APIs.

The full video is below;

Open API’s can also power the following use cases;

More intuitive SWIFT GPI integrations that can enable corporate clients to track both payables and receivables made through SWIFT as well as documentary credits - this can further be integrated into the ERP’s and therefore the accounting process;
Future payment of things for instance, enabling fleets of truck to pay their own insurance, toll fees and refuelling;
Creditor confirmations e.g. enabling corporates to verify whether their intended recipient received the funds;
Banking as a Service - Banking Fintechs will end up being big business. Payroll software companies will process huge volumes and will be powered by a bank at the back-end;
All the above can drastically reduce payments fraud thus driving sticky customer relationships;

Interestingly, Citibank is doing well with their CitiConnect API platform. In Africa for instance, one single API integration can enable you to expose your services to all their clients globally and particularly within the EMEA region. Standard Chartered have also done well on their open API journey. When you speak to practitioners on the ground, most will say that Citi and Stanchart in Kenya particularly may take market share in corporate banking as local banks are yet to properly invest in their open API platforms. South African banks all have open API initiatives that go deeper than presentation and GT Bank in Nigeria also seems to be doing well.

Trade Finance

If a technologically savvy non-banker is thrown into a trade finance department, his head will probably explode due to the incredulity of it all. Trade Finance is one function that probably hasn’t changed over the last 50 or 60 years. Trade Finance is involved in services such as the issuance of Letters of Credit, Guarantees and more local services such as supplier finance and purchase order finance.

Taking an LC for instance, LC’s are largely necessitated due to the risk in international trade where you cannot immediately verify the quality of goods, trustworthiness of the supplier and whether the goods will actually be received or not due to exogenous factors. An LC thus works through banks with banks providing the service of confirming to the seller that if specific conditions are met, we will make payment to you. These conditions are often determined by the commercial contract signed and include things such as we will make payment once we receive the “Bill of Lading”. Such trade transactions have multiple dependencies from a documentary and counter-party perspective and are prime for fraud. Additionally, given that the exporter relies on the creditworthiness of the bank rather than the client, whole countries can be adversely impacted if the creditworthiness of that country is in question. Try getting an LC in Zimbabwe!

Companies like “Contour” are introducing block-chain based solutions to trade. Blockchain and in particular smart contracts lend themselves intuitively to trade finance given that they solve for trust and risk allocation. Ping An’s One Connect is also innovating within this space.

The problem of course is that trade remains archaic because of so many dependencies from port operators to shipping companies to health authorities and the list goes on. To modernise trade you have to modernise all these processes. It’s simply too gargantuan a task. One of the areas I keep an eye on is the Chinese Belt and Road Initiative. It has to be seen in context of not only the physical infrastructure but the tech that’s being built back in China such as 5G, IoT, Smart Contract standards, Smart logistics and the cherry on top being the digital RMB. Quite simply, it’s the most comprehensive approach to trade modernisation and banks have to keep an eye out for this, particularly in Africa where China is the largest trading partner for most countries.

Artificial Intelligence and Advanced Analytics;

AI coupled with open banking can drive enhanced value for corporate customers in the long-term. Of course, a simple wedge case would be using AI to drive better pricing powered by improved credit analytics. Nonetheless, for the whole ecosystem, factoring, supplier financing, purchase order finance and value chain finance seem like they will benefit the most.

One thing that underpins all these products is that historically they both suffer from asymmetric information constraints as well as manual procedures. For instance in invoice financing, often you have to make a decision based on whether the principal i.e. the entity that is to pay the invoice is reputable and can be trusted to pay the invoice on time. You also have to ensure that the invoice is genuine. Often these are done through manual procedures such as presentation of an invoice for factoring (Invoice Discounting). The same happens in purchase order finance.

Open Banking and AI can power these processes, on one hand, once an ERP issues an invoice, this data can go directly to the bank and a factoring offer can be issued. What is more, advanced analytics can calculate based on multiple data points including existing credit conditions whether that credit can be issued and at what price. AI can also be used for advanced fraud detection.

Jobs to be Done;

There is no magic bullet when it comes to digital transformation. Nonetheless, other banks have succeeded with the following initiatives;

Upgrading the core where possible;
Investing in API based payments systems and digital banking platforms - Separation of payments from the core can enable richer payments data including invoice numbers and additional data that can be used for reconciliation. Additionally, they can integrate multiple payment sources into a single source of payments truth;
Investing in true open banking capabilities not only the API layer but also cloud and CI/CD capabilities;
Investing in changing mindsets - in Africa too often the advanced thinking is not happening at the top level but at the middle level and often in the I.T department - EXCO mindsets need to shift;
Creating a CTO dynamic in each business unit e.g. Corporate Banking should be run by a Corporate banker as well as a CTO with technology moving up the decision making ladder;

Wrapping it all Up;

In a previous article on “The Future of Finance”, I argued that finance will change gradually then suddenly. Bankers should focus on not just the changes occurring within the Financial Sector but also outside where disruption is happening in all industries. Trade is moving digital through e-commerce and one day, buying a consignment of goods worth 10m$ will be as seamless as buying airtime on your phone.

The banks that don’t invest in tech capabilities now will one day just wake up and find that they can no longer serve their clients. Corporate Banking needs to wake up from the comfort of pure relationship driven and static commercial practices and move towards consumer centric and technology driven thinking. Alternatively, one needs to look at the growth of GT Bank and Equity Bank. The founders at the time were focused on serving clients better and grew national banking champions based on customer service. It may be that the inability of African corporate banks to innovate will create the conditions for a new digital tech driven corporate bank that will become a titan in 15 years.