TCS BaNCS Research Journal Issue 3 0713 1

8/12/2019 TCS BaNCS Research Journal Issue 3 0713 1

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TCSBNCS

Issue 3


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Thats certainty

Powering BankMuscats customers

with a multi-channel DMA and a 2-in-1

banking and brokerage account.

To learn how your business can experience certainty, visit www.tcs.com

BankMuscat is the largest financial services provider in Oman. BankMuscat wanted to enhance its

Investment Management and Private Banking offering by providing its customers with Direct Market

Access and Internet Trading facility. It needed an integrated brokerage and investment banking

platform that would enable clients to trade directly on multiple markets in GCC countries, besides

facilitating online risk management, Straight-Through-Processing (STP) with street-side, core banking

and internal systems. Further, BankMuscat wanted to differentiate itself by offering seamless trading

through a linked two-in-one brokerage and BankMuscat account. Tata Consultancy Services (TCS)

implemented TCS B NCS Securities Trading and Securities Processing, a comprehensive front-to-back

office solution. As one of the worlds fastest growing technology and business solutions providers,TCS enabled a common platform for securities trading, portfolio management, corporate actions

and funds, which also complied with the business regulatory requirements of the region. Empowering

BankMuscats customers with seamless trading in multiple markets via multiple channels and multi-market

portfolio management services. And, of course, enabling BankMuscat to experience certainty.


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4

Foreword

A recent report by the Boston Consulting Group provides some interesting statistics:

12 major banks representing 50 percent of the market capitalization in the Middle East

showed a cumulative average ROE of 17.5 percent in 2009.

The global average was 4.1 percent.

The forecast is indeed, optimistic for the Middle East economy, with GDP expected to grow

above average from the latter half of 2010. Reinforcing this trend is the recent move by most

banks in the region in broadening their regional presence.

The financial crisis in 2009 left most of the GCC markets grappling with a liquidity challenge,

although, on the whole, the region -- along with other emerging markets -- has proven resilient.

Apart from following prudent economic policies and the more crisis-resistant Islamic form of

banking, financial institutions in the region are proof of the fact that investments made in a

downturn are equally important to maintaining competitive advantage during growth.

This train of thought sets us on a path to consider what firms can do in a crisis, or post-crisis?

More importantly, what are the takeaways from the highly publicized financial services melt-

downs world-wide? What is needed to drive business in uncertain times? Is it strategic think-

ing and execution? Or, a renewed emphasis on people, processes, customers and, eventually,

profits?

Strategy today must mean the transformation that is required in an organization, for its people,

customers, partners and processes when it is faced with challenging times. In my opinion, it isabout the following priorities taken in the following order:

(1) Its about listening to clients, partners and employees, being flexible, being transparent and

agile in responding to situations

(2) Its about being able to cut the flab, reduce costs where they can be cut and focus on opera-

tional efficiencies

(3) Its about being able to invest where you feel the future is going to be, and being able to

nurture and motivate talent and innovation

It is about clarity regarding what an organization will and can do, and also wont do--throughcontinual engagement and communication with all stakeholders; it is also about pushing and

moving boundaries to make room for alternate business models and making our products and

services unique and relevant. And, that is possible only through technology.

Let us briefly encapsulate the economic scenario in the GCC region. From a highly pressurized

real estate market post the Dubai crisis (which caused Central banks all across the ME region

to urge banks to create more transparency and reduce exposure to risks), to the new surge in

demand for oil driving petrodollars into the region, how do these trends augur for technology

and its role in a business, especially that of a financial services institution or bank? How has the

industry been responding?


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5

Firstly, from the industry perspective. Liquidity injection has taken on multitudinous forms

from the reduction of interest rates to emergency bank lending among a host of other moves to

communicate flexibility in the systemand the regions financial health. Amidst this backdrop

is the proposal for a common currency (Khaleeji) union for the six-member states, the advance-

ments in Islamic banking and finance, and the concept of the GCC union itself.

Now, from a technology perspective:

(1) With risk management being brought to the forefront post the downturn, an increased use

of analytics and intelligence in operations, products and services for more informed deci-

sion-making took center-stage. Technology is helping Institutions to renegotiate collateral

types, assess exposures on a more real-time basis (surveillance) and be in a better position to

provide for optimal and adequate capital meeting the norms

(2) Optimization of IT took center-stage in terms of bringing about alignment of business and

IT, creating shared services, and separating Run the Bank and Change the Bank portfolios.

Run the Bank expenses were optimized. Better processes and governance meant greater

operational efficiencies and reduced cost per transaction processed

(3) Expanding existing customer relationships, delivering projects that enable business growth,

front-end and channel-related solutions, architectural projects related to SOA (Service-

Oriented Architecture) and BPM (Business Process Management) are reshaping the back-

office structures of banks. Payment applications are also gaining amplified significance

In Capital markets, the focus is on Multi-market, Multi-asset, Multi-platform, Multi-channel trad-

ing, virtualized infrastructures, higher levels of automation, flexibility to add new instruments,

the ASP and SaaS models for procurement, hosting and management, and the consolidation

of cross-asset platforms alongside holistic and transparent risk management. Efforts are being

made to excel in the form of best execution, differentiated algorithms, capital raising strategies,

diversification of debt, among others. Treasury systems are being integrated with ERP and EIPP

systems to better manage the supply chain.

The virtualization market is being driven by the need for centralized processes and infrastructure

control alongside reduction in costs and energy. Security issues are now de-selling the cloud

computing idea to some extent. SaaS is becoming a popular topic, considering the pluses it

gives organizations by helping them deploy new software rapidly, reducing time to market for

new products, and total cost of ownership.

With regulatory and governance bodies encouraging the idea of an IT-aware population in MEA,

this has pushed the adoption of middleware, portals and Web 2.0 technologies, including social

and mobile networking for retail banks. Banks are increasingly looking at how to leverage these

new developments to enhance revenue and the customer experience.

We expect firms to define and articulate their trading policy, and the level of risk they will assume

followed by liquidity management measures. With the buy sides demands growing, including

the need for control and transparency, most players will look at building a comprehensive prod-

uct set that includes algorithms, smart order routers, Multi-asset trading platforms and post- and

pre-trade transaction analysis. The need to improve technology related to OTC derivatives trad-

ing and infrastructure such that it improves operations, and measures and monitors risks in a

sophisticated manner is an imperative.


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With global banks making dramatic changes to the way they conduct their businesses, includ-

ing targeting new business segments such as Islamic Banking (analyst reports peg the number

of Islamic finance institutions at more than 300 and spread across 51 countries globally, growing

at a rate of 10-15% a year), banks will need solutions that can handle transparency and seam-

lessly move between their Islamic and non-Islamic funds, accounts and reporting systems. Thiswould not necessarily mean a dedicated and separate Islamic banking solution but on the con-

trary it could be a unified solution that can manage this complexity with ease (like TCS BaNCS)

and allow the differentiated branding of such products and services, if you will.

As awareness of Islamic Banking expands beyond existing geographies, Takaful products for re-

insurance, bancassurance and microinsurance are generating more global demand. However,

due to the lack of overall industry experience and consensus, Takaful operators are finding the

acceleration modest. They also seek to partner with experienced technology providers for au-

tomation and software. Focus areas will be efficiency in processes, product configurability, and

innovation.

To put things in a nutshell, financial services organizations are fundamentally shifting their strat-

egy canvas by not just focusing on customers and competitors, but on end-customers and new

players, or alternatives. This would mean creating new sources of value for buyers and new de-

mand, thereby shifting the strategic pricing, packaging, white-labeling and delivery of solutions.

They are also adopting different efficiency strategies for Retail and Wholesale segments and are

demanding shared infrastructure. SOA is enabling them to avoid redundant and hidden costs

of ownership. Investments or Change the Bank strategies are largely around channel-aware and

channel-agnostic initiatives to truly realize the potential of the any place is a banking place para-

digm of the future.

NG Subramaniam

President TCS Financial Solutions

Tata Consultancy Services


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Letter from the Editor

As early as the 8th century, financiers in the Islamic world were responsible for the

economic development in Muslim countries by acting as intermediaries for finance,

trade and payments. In many ways, we could say that they inspired finance in the

Western world. Following this, there was a short period when Islamic finance de-

clined but over the past few years it has re-emerged as a vital, thriving global force,

with South Asia, GCC and Iran being its largest markets. Currently, Islamic banking as-

sets represent between USD700 and USD750 billion worldwide, with marketsand

not only in Islamic lands but across the globebeing developed and evolving.

In this edition of TCS BaNCS Research Journal, we bring you insights that touch upon

the growth of Islamic finance, with emphasis on the Middle Eastern and African

(MENA) regions. We also delve into topics that are of interest to the banking and

financial services community on the wholesuch as predictive analytics, payments,

global custody, among others.

Hope you enjoy reading the articles and will get back to us with your thoughts and

opinions, and contributions.

Warm Regards,

Anjana C Srikanth

Marketing and Communications

TCS Financial Solutions

Tel: +9180-67256963

e.mail: [email protected]

2010 Tata Consultancy Services Limited. All Rights Reserved

The views expressed herein are those of the authors and do not necessarily reflect

the views of Tata Consultancy Services Ltd.


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8

Portfolio

The New Landscape in GCC 9

Integrating Risk and Business Intelligence 11

Standardized Pre-validation Models for Islamic Markets 15

Exchange-traded Funds: Yesterday, Today, and Tomorrow 18

Making Relationship-based Pricing a Reality in Financial Services 21

Mobile Payments in MENA - Driving Convergence 26

Emerging Trends and The Future of Global Custody Services 29

Regulatory Challenges & Opportunities in MENA 34

Banking on Islam - A Technology Perspective 38

Opportunities Grow for Takaful: Demographic Drivers & Technology Implications 42


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In 2010 GDP is forecast to grow by

3.8 percent across the GCC countries.

As the dust begins to settle, it is time

for banks to go back to being engines

of growth and the stabilization in the

economy, says Gopakumar, CIO, Bank

Muscat, in an interview with Shekar

Hegde, from TCS BaNCS Securities

Trading, where he shares his thoughts

on the way the financial services sector

in the Middle East is heading. Here are

excerpts from the interview.

Q. What are the key challenges faced

by financial service firms post the

Lehman and Dubai crisis?

Gopakumar: The UAE market is poised

at an interesting and challenging time.

With much publicized financial and real

estate debacles and the shaking of thefoundations of the economy, the bank-

ing sectoralong with the markets

is taking a cautious pause and awaiting

the emergence of new trends. 2009

was a year of unpredictable changes.

2010 is the year of revival and clean up.

And, also correction.

Over the last couple

of years, local bankshave also becomeactive in the wealthmanagement space andare targeting the assetmanagement market.

Primarily, most of the Gulf markets,

especially both the banking and cor-

porate sectors, propelled by excess

liquidity, speculation and growth in the

construction and financial sectors led to

a recipe for disaster, just like other parts

of the world. Post the Lehman collapse

and the resultant shutting off of liquid-

ity, made the same sector invest cau-

tiously without any long-term strategic

planning. Recovery is extremely slow

the long-term debt markets are no

longer available and real estate growth

is yet to pick up.

Q. What initiatives are being taken

by the capital markets and govern-

ments for revitalization, especially

now that the IPO market is now

moribund?

Gopakumar: I am not sure if any con-

crete measures to reinvigorate the

capital markets are being taken at thisstage. In Oman, where Bank of Muscat

is based, the focus is on market stabi-

lization. The government has created

a market stabilization fund which has

helped in making the Muscat market

less volatile compared to other markets.

The regulatory regime is encouraging

companies to go public. But, slowly, we

see signs of change with second tele-

com operator going public and herald-

ing a natural process of revival. This isthe scenario across all GCC countries.

Q. Do you expect more foreign

banks/brokerages to set up shop

going ahead? Given that most of the

brokerages are either banks/bank

subsidiaries, is there a case for spe-

cialized brokerage models?

Gopakumar: Brokerages in the Middle

East are bank brokerages and the stand-

alone brokerage model is yet to catch

on. We see many joint ventures in for-

eign banks, while there are many non-

bank brokerages being established.

Regional investment banks are show-

ing more activity in recent times. In

their efforts to beat the competition,

banks are looking at multiple ways to

relate to their customers, and this is

one approach.

Q. With the Middle East home to

more than 300,000 HNIs, how are

wealth management and asset man-

agement companies shaping up?

Gopakumar: Wealth management is an

area where international private banks,

because of their experience, are acting

as major players. However, over the last

couple of years, local banks have also

become active in the wealth manage-

ment space and are targeting the as-

set management market. They are of-

fering mutual fund products and real

estate based products although real

estate based products have now taken

a backseat.

Q. Post the meltdown, organizations

are finding themselves becoming

more risk averse. Which asset class-

es are popular today?

Gopakumar: We are seeing a shift in the

preference for asset classes. The shift is

to primarily from real estate to other

asset classes such as bonds and equi-

ties and to some extent commodities.

Bonds, as an asset class, have become

very popular. In the years 2003-2007,

because of the huge amount of liquid-

ity bonds, pricing was always more in

The New Landscape in GCC


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10 New landscape in GCC

favor of the issuer rather than the inves-

tor. However, post the financial crisis

the coupon rates are attractive leading

to a rush for bonds.

Q. The introduction of derivatives

will help in raising the capital mar-

kets to the next level by reducing

volatility and attracting foreign in-

vestment. Would derivatives be per-

missible under Islamic Finance rules

(Shariah)?

Gopakumar: Capital markets are not

at the right level of maturity for the

introduction of derivatives. Leadingexchanges in Dubai have introduced

derivatives but many other exchanges

have not done so. The pre-requisites for

introducing the derivatives segment

i.e., mechanisms such as stock lending

and borrowing and short selling are

missing here. There is also a chance for

misuse as investors are not sophisticat-

ed enough, and there is a tendency to

view the instrument with suspicion.

Q. With Islamic Banking products

growing at a CAGR of 18% in the last

five years, what are banks doing to

tap into this opportunity?

Gopakumar: Banks are interested in

Islamic banking and investments as

per Shariah law. There are a lot of Is-

lamic products which are being intro-

duced to tap the growing appetite for

Islamic products such as Musharaka,Mudaraba, and Shariah-compliant mu-

tual funds.

Q. What are your insights on the in-

troduction of a single GCC currency

and the underlying opportunities/

challenges?

Gopakumar: A single GCC currency

will lower accounting fees and trans-

action costs. It would also create the

worlds third largest currency behind

the euro and the dollar, in which case

other countries in the region might be

persuaded to use it as their reserve cur-

rency. A single currency is also the first

step towards the goal of a commonGCC market.

Having said that, a single currency can

be fraught with uncertainty and nu-

merous challenges. A common cur-

rency will require significant develop-

ment time and cooperation among

the member countries. UAE has already

pulled out of this move. The single cur-

rency that was set to roll out by April

2010 seems highly unlikely. In short, we

are not seeing any momentum in this

sphere.

Q. What are the benefits of having a

common technology platform for as-

set management and broking busi-

nesses? What are the challenges?

Gopakumar: A common technology

platform offers several benefits, the

most significant one being the abil-ity to offer integrated broking and ad-

vanced portfolio management services

to our clients. Integrating our offerings

becomes more difficult with multiple

vendors and technology platforms.

Working on a common platform makes

it easier from an IT management per-

spective by leveraging the hardware,

while having a common source of data

helps from a MIS perspective The need

is for a solution that is agile and that

can be easily scaled up to cater to high-

er volumes, help design new financial

products, while making vendor man-

agement easier. The main challenge

is to find a vendor who has a product

which can meet the varied functional

requirements of both the broking and

asset management businesses.

Q. What according to you are the

areas that will receive the most

attention Centralized Trading, Risk

Management, Clearing and Settle-

ment, CRM or Business Intelligence?

Gopakumar: At Bank Muscat, the focus

is on e-broking and efforts are being

made to service markets from Oman,

Saudi Arabia and Kuwait from a com-

mon technology platform. The value

proposition we are trying to commu-

nicate is that of making multiple prod-

ucts available to the customer from a

single software instance, for a more in-

tegrated portfolio of offerings.

Q. With banking and brokerage

revenues dipping, there is a huge

emphasis on reducing operational

costs, especially in IT. Would small

and mid-tier banks look at hosted

solutions to reduce operational

costs?

Gopakumar: I agree with the concept

of hosted services, but I dont see the

market picking up this trend soon. The

benefit of sharing costs with hosted

services is attractive but there are othernegatives such as the lack of product

differentiation, client confidential-

ity and support issues. An area where

hosted services could be relevant is

at disaster recovery sites for multiple

firms.

Q. Can you comment on risk man-

agement policies being adopted at

your bank, given the backdrop of

the crises?

Gopakumar: Two primary areas of fo-

cus for banks across the globe are risk

management and compliance today.

We see investments in an enterprise-

wide approach to governance, risk and

compliance, which will include sophis-

ticated ways of monitoring exposures

to risk across all business lines, prod-

ucts and customers. A common view

of assets and products across custom-

ers and the bank is critical.


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Predictive analytics is often seen as a

tool to improve customer retention, aid

direct marketing, detect fraud and en-

hance customer relationships. Predic-

tive analytics, without risk intelligence

being considered in conjunction with

business intelligence, will more often

than not yield inaccurate predictions.

This is clearly demonstrated by the re-cent subprime crisis. Sales executives

from the banks, burdened with their

sales targets and peer competition,

focused primarily on business intelli-

gence, ignoring the risks involved. This

resulted in large amounts of loan being

given to counterparties, leading to sce-

narios that could aggravate the situa-

tion such as increased interest rates, ad-

verse changes in credit quality, among

many others. This, as is well known, was

the primary cause of the recent finan-

cial crisis. A better understanding of

the risks associated with the business

would have induced tighter controls

or, at least, ensured better prepared-

ness to deal with the crisis.

Predictive analytics goes hand in hand

with business intelligence and recent

events have clearly highlighted the

need for integrating business intelli-

gence with risk intelligence to derive

its full benefits. Today, most organiza-

tions are discovering new approaches

to effectively couple and complement

business with risk intelligence in eachstep to get the desired results out of

predictive analytics.

Today, most

organizations are

discovering new

approaches to

effectively couple andcomplement business

with risk intelligence

to get the desired

results out of predictive

analytics.

Lets take a simplistic but intuitive ap-

proach. Every business is driven by a

defined strategy. Each strategy has its

own set of risks and rewards attached

to it as shown below (Figure 1):

Risk, often termed as a threat, can also

be seen as an opportunity. Hence, risk

intelligence is a continuum and not aone-time activity. It is an ongoing pro-

cess and should be carried on regularly

so that it remains closely aligned with

business intelligence.

Building a Risk Intelligent Enterprise

involves a process of managing an

organizations risks within a cohesive

framework fully aligned with business

objectives. By using a building block

approach to successively integrate the

risks at each level, a firm can retain the

advantage of diversification across its

business lines. The steps involved in

building a Risk Intelligent Enterprise

are as follows:

Integrating Risk and Business Intelligence

Risks Risks Risks Risks

Controls

Strategy BusinessBusiness Risk

Mitigate Manage Avoid

Mission/Vision

Approved Strategy

Business Objectives

Figure 1:


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Step 1: Laying the Foundation for

the Risk Management Architecture

within an Organization by:

a. Defining Risk Classes: Aligning

risk management to organizational

structure and business strategy has

become an integral component

today. Every organization needs

to identify risks that are applicable

and prepare strategies for each one

of them to avoid, reduce, transfer,

retain or exploit it

b. Process Metrics: Designing all

stages of business process across

the organization to optimize the

entire life cycle of processes

By using a buildingblock approach tosuccessively integratethe risks at each level,a firm can retainthe advantage ofdiversification across itsbusiness lines.

c. Risk Governance and Policies:

Designing a robust governance

framework describing the roles,

responsibilities and accountabil-

ity of the risk function across the

organization and supporting it

with policies is the foundation

for defining all the processes and

tolerances for risk activities in the

organization

d. Risk Warehouse and Systems:

Designing a proper infrastructure

so that the organization is prepared

to produce early warning bells and

has improved ability to manage risk

and execute business

Step 2: Identification & Qualitative

Assessment

At this stage, possible risks within an

organization - across all levels - are

Risk Integration

Integrateto RAROC

Risk CapitalAllocation

for Business

Strategic RiskAssessment

CurrentInitiatives

Review

Project Definition and Management

Risk Strategy& Structure

(Governance)

RiskManagement

Policies

RiskFramework

Risk Frame-work Process

Model

KnowledgeManagement

BusinessProcessOwners

RiskLibraries

AuditReports

Policies &ProcedureManuals

Business &Process RiskAssessment

Cultural RiskAssessment

Profiles:Expected &Experienced

Risk

StatisticalModeling

RiskDatabases

Risk Quan-tification

RiskTransferRisk Management

Quantification

Qualitative/Self Assessment

Risk Identification

Foundation

Program Management

SeniorManagement

Discussion

Figure 2: Risk Intelligence Architecture

Integrating Risk and Business Intelligence


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13

Tier 5 Tier 4 Tier 3

Level of Sophistication

Tier 2 Tier 1

Strategy andArchitecture

No formal co-ordinated settingof a risk management strategy

The strategy is adopted by all

business units and it is integratedinto all risk classes. There are c learmetrics to demonstrate return on

investment

The strategy is totally embeddedinto the businesses and fully

integrated into other risk classes

A strategy for risk managementset at a Group level is not clearly

linked to business strategy

Risk management strategy is

communicated and acceptedacross the business units, with

clear objectives in line withbusiness strategy.

Risk Governanceand Organization

Roles and responsibilities are notdefined or clearly allocated for

risk management function

All duplications are eliminated.There is clear role and

responsibility allocation betweenGroup center and business units

There is a fully optimised andcost efficient model in place withall responsibilities clearly defined

Some roles and responsibilitiesare defined in a co-ordinated

fashion - generally focusing onGroup center

Individual rolesand responsibilities are

aligned to the individualcomponents of risk

Risk Definition andCategorization

No overall definitionof risk factors

There is a resolution of the greyareas in the boundaries betweencredit, market, operational and

other risks

There is a fully integrateddefinition positive in nature,

decomposed into risk categories

There is a single definition butit is applied or interpreted in aninconsistent manner across the

organisation

The definition is used universallyacross the organization and

contains a clear distinction of allrisk categories

Processes andPolicies

There are limited formalprocesses for risk management,

uncoordinated across theorganization

There is a complementary andintegrated suite of tools to cover

each aspect of the process

An optimal controlframework, including full

cost vs. benefit analysis of themethodologies employed

There are Group-definedprocesses for managing

operational risk, but which lackrobustness and business buy-in

There are methodologies andtools which are consistently

applied by the business units

RegulatoryCompliance

Minimum standards ofregulatory compliance are

observed

Institutionalized complianceframework, benchmarked

against available best practices

Thought leadership incompliance, at global level

Rudimentary complianceframework in place

Deep linkagesbetween complianceoutlook and business

strategies, in focus areas

Risk Systems andTechnology

No formalized or co-ordinatedprocess for handling data.Prevalence of subjective

techniques

Data collected is more forwardlooking and there is a move awayfrom historical analysis to future

predictions

The organization hascomplete loss data, seamlessly

incorporating internal andexternal loss and near miss

experience

Some tracking of data, notuniform across the business.

Incorporation of medium scaletechnological applications

There is complete coverage ofdata management across thebusiness. Analysis of the dataremains generally historical

Skills andResources

There are only a few individualswithin the organization

who have skills within riskmanagement

There is a high degree ofunderstanding of risk across

the organization, supported bytraining

Effective allocation and use ofresources efficiently applying the

skill sets of existing resources

Risk management rolesare generally populated by

individuals with inherent skillsand experience

Operational risk responsibilitieswithin the business units are

discharged by individuals withappropriate skills

Year 1 Year 3 Year 5

Phase 1Gap Analysis & Planning

Phase 2Framework Design &Specification

Phase 3Implementation Phase

Phase 4Risk Based Decision Making

Business Gap Analysis

8 weeks

KeyMethodologies/Tools

12 - 14 weeks 12 - 18 months 6 - 12 months

Business IntelligenceFramework

Business/Risk ProcessRedesign

Implementation of RiskBased PerformanceMeasurement Tool

Risk Based Pricing Portfolio Optimization Customer Profitability

Analysis

Implementation of RiskMonitoring FrameworkDashboards Workflow

Risk ManagementFramework

Enterprise Data WarehouseSystem Implementation

System Impact Analysis Functional Architecture Reporting Infrastructure

Define Projects to fillIdentified Gaps

System Architecture Application Implementation

Data Gap Analysis

Figure 3: Integrated view of Risk Management

Figure 4: Business Transformation (Training & Communication)


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15

Standardized Pre-validation Models for Islamic Markets

Markets with specialized local practices

such as Islamic finance in the Middle

East and North Africa always pose a

unique challenge. Alongside compli-

ance with legal requirements, they are

often regulated by parliamentary de-

cree. They do not have the flexibility to

adopt global standards such as netting

of securities and cash, Central Coun-terparty Clearing (CCP), nominee ac-

counts or securities lending, unless you

create a special zone and jurisdiction

like the DFSA in Dubai, which regulates

the DIFX/NASDAQ Dubai. They have to

follow a set of practices yet modernize,

if not standardize, to be able to attract

global investment. Each market tries to

do this in its own way, thereby, result-

ing in the creation of unique models.

Islamic economic rules were formu-

lated based on analysis of the Quran

(such as opposition to riba or usury or

interest), and from Sunnah, the sayings

and doings of the Prophet Muham-

mad. Principles based on readings from

Sunnah lead to an Islamic theory and

practice of a coherent economic sys-

tem with a blueprint for a new order in

society, in which, all participants would

be treated more fairly and present a

much broader framework and identify

seven classes of financial market fair-

ness - freedom from coercion, freedom

from misrepresentation, right to equal

information, right to equal processing

power, freedom from impulse, right to

transact at efficient prices, and entitle-

ment to equal bargaining power. Trad-

ing risk, hence, needs to be disallowed

or eliminated, not managed. Settle-

ment models in the Middle East and

other markets follow Pre-validation

with three basic principles:

Pre-validation of securities at the

time of trading: Value of the assets,

which vary based on the changing

price, are to be owned by the inves-

tor at the time of trading

A guaranteed cash obligation

Gross settlement of securities at the

investor level

Trading risk needs

to be disallowed

or eliminated, not

managed.

The two BIS (Bank of International Set-

tlements) models of settlements preva-

lent in the Middle East are:

Model 1: Gross (securities) and

Gross (cash)

Requests

Orders

Investor Broker

Demat/Remat/Transfer

Depository

Settlement Caps

Bank

1

2 3

Stock Exchange

Figure 1: PVM 1


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16

Model 2: Gross (securities) and Net

(cash)

In both models, the holdings are pre-

validated when trade is matched, cashsettlement is assured either by having

a guaranteed fund deposits or by vali-

dation against a settlement cap (Prin-

ciple 2), and the security settlement is

at the investor level (Principle 3).

In Pre-validation Model

1, dematerialization,

rematerializationor transfer requests

are routed to the

depository, which is

the primary owner of

security holdings and

settlement cap details.

This paper attempts to outline twomodels of Islamic markets for clearing

and settlement:

Pre-validation Model 1 (PVM1)

Depository managed

Pre-validation Model 2 (PVM 2)

Exchange managed

It also puts forth a set of global stan-

dards that can be blended with ei-

ther of these two models to create a

set of standard practices for Islamic

exchanges, clearing and settlement

organizations.

Pre-validation Model 1 (PVM1): De-

pository Managed

In this model, dematerialization, re-materialization or transfer requests are

routed to the depository, which is the

primary owner of security holdings

and settlement cap details. The stock

exchange confirms the availability of

securities and cash obligation limit

with the depository before the trade

is matched. The balances are pre-val-

idated and updated real-time at the

depository. Hence, no reconciliation is

needed. The typical flow of events in

the depository-managed, pre-validat-

ed model is:

The clearing/central bank sends the

settlement cap details to the deposi-

tory for pre-validating the order and for

settlement of cash obligations.

While Islamic markets

can implement one of

the two pre-validation

models, it becomes

necessary for them

to comply with some

of the standards

prescribed by the G30

On-exchange transactions (in the

Stock Exchange)

o Order requests are sent to the

Depository for approval

o The depository checks the avail-

ability of the stock holdings and

netted settlement cap

Requests to the depository by bro-kers are accepted without commu-

nicating with the stock exchange,

Requests

Orders

Investor Broker

Demat/Remat/Transfer

Depository

Settlement Caps

Settlement Caps

Bank

2

2

1 3 4 5

Stock Exchange

Figure 2: PVM 2

Standardized Pre-validation Models for

Islamic Markets


17/52

17

R Vivekanand

As Global Head, Market Infrastructure,

TCS BaNCS, Vivek is responsible for theProduct businesses of TCS in the Capi-

tal Market Infrastructure space cover-

ing stock exchanges, clearing organi-

zations, central depositories/registries,

central banks and regulatory bodies.

Sasidhar Suram

Sasidhar is an Application Architect in

TCS Financial Solutions. In this role, he

works with customers and with market

research teams to translate business

processes into product specifications.

He has 10+ years of experience in Capi-

tal Market implementations.

as the depository has full control on

the balances

The depository blocks securities,

updates settlement cap if available

and responds to the stock exchange

with a positive/negative response

Pre-validation Model 2 (PVM2):

Exchange Managed

In this model, the Stock Exchange is

the owner of the security holdings and

settlement cap details during trading

hours. It uses the holding details for

pre-validation of orders when a trade

comes in and blocks the securities,if available. The depository confirms

all the debit requests it gets directly

from the Exchange and intimates the

Exchange about all credits to enable

the Exchange to have the correct bal-

ance for pre-validation. Blocked and

unblocked balance details are sent by

the Exchange to the depository at the

end of the day for reconciliation. The

typical flow of events in an Exchange-

managed model is:

1. The depository sends information

related to participants, instruments

and balances to the Stock Exchange

at the beginning of the day

2. The clearing/central bank sends the

settlement cap details to the Stock

Exchange for the pre-validation of

orders and to the depository for

settlement of cash obligations

3. Intra-day off-exchange transactions

(in the depository)

Such transactions are sent to

the Stock Exchange for approv-

al. Debit bookings are done in

the depository only on the ap-

proval of the Stock Exchange

and credits bookings are sent

to the Exchange for a balance

update

4. Intra-day on-exchange Transactions

(in the Stock Exchange)

The holdings available with

the Stock Exchange are vali-dated and, if available, they are

blocked for trade settlement

The netted cash obligation is

checked against the settlement

cap

5. The depository receives the End-of-

Day (blocked and unblocked) bal-

ances from the Stock Exchange for

reconciliation

Relevant Global Standards that can

be blended with PVM1 and PVM2:

While Islamic markets can implement

one of the two Pre-validation models, it

becomes necessary for them to comply

with some of the standards prescribed

by the G30, to give comfort to global

investors and attract investment. What

is missing today is a clear articulation

of standards that a market complies

with because of the perception that it

is difficult to marry the pre-validation

models with global standards. In order

to achieve efficient processing, Islamic

markets need to adopt the following

standards and have them coexist with

one of the pre-validation models:

Harmonize messaging standards

and communication protocols such

as:

o ISO15022/20022

o TCP/IP

Synchronize timing between dif-

ferent clearing and settlement sys-

tems and the associated payment

systems this will also be a step

in the possible integration of GCC

markets

Settle in central bank funds wher-

ever possible, to reduce the risk of

settlement failure

While both models have their advan-tages and disadvantages, the tightly

coupled nature of pre-validation has

an impact on performance and latency.

In a world moving towards low latency

trading, PVM2 has a slight edge over

PVM1 in facilitating better performance

of systems at Exchanges.


18/52

18

Exchange-traded Funds: Yesterday, Today, and Tomorrow

Emergence of ETFs

Exchange-traded funds (ETFs) have

emerged as a major investment vehi-

cle, with assets now exceeding USD 1

trillion worldwide. Their rate of growth

has been phenomenal. At the end of

1999, there were 33 ETFs listed globally,

with USD 40 billion in assets. By 2004,

this had changed to 336 ETFs withUSD 310 billion. At the end of 2009,

there were 1,939 ETFs listed on 41 ex-

changes, with assets worth USD 1,032

billion. This growth is more remarkable

when viewed in the context of the

worlds financial markets. The S&P 500

price index of US, which was 1469 on

December 31, 1999, decreased to 1212

by December 31, 2004, and fell further

to 1115 by December 31, 2009. MSCIs

All-Country World stock price index fell

from 341 to 299 over the same decade.

While stock markets suffered from the

burst tech bubble at the beginning of

this century and the recent near melt-

down of global financial institutions,

ETFs came into prominence.

ETF Primer

ETFs are a hybrid of closed-end invest-

ment funds. A closed-end fund issues

a limited number of non-redeemable

shares. After their Initial Public Offering,

closed-end funds can only be traded in

a secondary market (usually a stock ex-

change). Closed-end funds often trade

at a significant discount or premium to

their actual value, because their price

is determined by the supply/demand

dynamics of the market and is not tem-

pered by an arbitrage mechanism. Thatis, a trader cannot make an arbitrage

profit by buying shares when they are

at a discount and redeeming them for

NAV.

ETFs, similarly, trade on stock exchang-

es and do not issue or redeem shares to

individual shareholders. Unlike closed-

ended funds, however, ETFs sign con-

tracts with financial counterparties (Au-

thorized Participants, or APs) that allowthe fund to issue or redeem a round

number of shares to/from the AP, usu-

ally in exchange for a basket of securi-

ties that closely resemble or are a fully

replicated slice of the underlying fund.

This round number of shares is called

a creation unit (CU), and is usually a

multiple of 10,000.

By receiving and delivering securities

in exchange for shares, ETFs do not

have to purchase or sell securities in re-sponse to shareholder activity, and so

remain immune to the associated trad-

ing costs that affect the performance

of open-ended investment funds.

An exception to this process occurs

with the so-called swap-based ETF.

These ETFs use over-the-counter (OTC)

derivatives to deliver performance,

rather than holding the underlying se-

curities that provide investment return.This type of ETF does own securities,

but the securities are unrelated to the

ETFs performance mandate, instead of

acting as collateral, protecting the fund

against possible default of the swaps

counterpart.

In the US, the swap-based structure

is generally used in leveraged or in-

verse ETFs, which provide exposure to

risks that are otherwise available only

to investors with derivatives-trading

accounts. However, this structure is

popular outside the US even for other-

wise simple stock-index ETFs. Roughly

half of the USD 327 billion of ETFs

listed outside the US are derivatives-

based, about 15% of total ETF assets

worldwide.

The ETF creation/redemption process

makes it difficult for ETF portfolio man-

agers to pick stocks actively or to rebal-

ance their portfolios dynamically when

the market conditions change. Most

ETFs consequently provide only pas-

sive exposure to markets; they provide

a return, explicitly tied to a particular

stock, bond, or commodity index, with

no implied promise of outperforming

their benchmark.

The mechanism that allows APs to cre-

ate/redeem shares also enables them

to arbitrage the publicly traded shares

of ETFs. For liquid ETFs, robust arbi-

trage activity ensures that their publicly

traded price is a fair approximation of

its NAV at any given time. The ability to

monitor intra-day NAVs of ETFs is facili-

tated by NYSE Euronext, which calcu-

lates and publishes intra-day NAVs ev-

ery 15 seconds for the ETFs it lists. Thiscomprises a competitive advantage for

NYSE Euronext over other exchanges.

Popularity

There are several reasons why inves-

tors have flocked to ETFs. Investors

appreciate the ability to trade ETFs all

day, unlike mutual funds or other unit

trusts, which can only be traded at

end-of-day NAV. ETFs have significantly

lower shareholder servicing costs than

Exchange-traded Funds: Yesterday, Today,

and Tomorrow


19/52

19

comparable mutual funds, and this is

passed on to shareholders in the form

of relatively attractive expense ratios. In

the US, tax laws that exempt in-kind re-

demptions from realizing capital gainsresult in ETFs having lower after-tax

costs than comparable mutual funds.

Also, many ETFs offer inexpensive and

transparent means to obtain focused,

leveraged, and/or inverse exposures

to industry sectors, commodities, and

illiquid markets that are unavailable

through mutual funds. Lastly, over the

past few years, several investors have

been attracted towards the ETF due

to its passive investment style and

transparency.

Securities Processing Challenges

From the standpoint of securities pro-

cessing, ETFs are in most respects simi-

lar to normal unit trusts. So much so

that, when Vanguard entered the ETF

market, it did not create new funds, in-

stead, treated ETFs as a separate shareclass of its mutual funds. This choice

was successful, judging by the USD 92

billion of assets in Vanguards ETFs the

end of year 2009.

The key operating challenge to ETFs

is found in the in-kind free-delivery

mechanism by which, ETFs issue and

redeem shares. In the US, ETF custodi-

ans send a Portfolio Composition File

(PCF) daily, for each ETF, to the NationalSecurities Clearing Corp (NSCC). The

PCF lists a basket of security and cash

holdings that will be exchangeable the

following day for a creation unit of the

ETF. The value of these positions must

exactly match the value of a CU of the

ETF. For example, if an ETFs closing

NAV per share the following day is USD

20, and a CU is 50,000 shares, then the

value of the PCF must be equal to USD

1,000,000.

The NSCC must receive the PCF the

evening prior to the day when the list

becomes the delivery basket for a given

ETF. The NSCCs website lists detailed

specifications for the format and con-tents of the PCF as well as a protocol for

rejection and warning messages if data

in the PCF is incomplete or otherwise

problematic.

Outside the U.S., similar clearinghous-

es for creation basket data have not

emerged. However, regardless of list-

ing domicile, all ETFs AP agreements

normally include detailed provisions

for delivery of CU data in a similar time-

frame as in the U.S.

Since the PCF must be published the

day prior to its effective date, hold-

ings information must anticipate

corporate, which likewise become ef-

fective on the following day. The cash

amount must similarly anticipate fund

distribution activity. Both cash and

holdings should reflect trading activity

that the ETF expects to execute on the

next day.

The cash amount is calculable as the

difference between the value of a CU

and value of the non-cash securities in

the PCF. The cash amount published

on T-1 is considered an estimate. When

the cash component is recalculated on

T using current prices, this cash amount

will remain unchanged only in the case

where the PCF file is an exactly scaled

slice of the ETFs holdings and the next-

days corporate actions and trades are

all perfectly anticipated.

Small changes in the cash amountbetween T-1 and T are acceptable if

based on rounding or sampling error.

But APs rely on the cash estimate when

they hedge their trading of the securi-

ties in the PCF. They will not continue

to create shares for an ETF that does

not publish reliable cash estimates. The

primary source of revenue growth for

ETF providers is new assets, so accurate

and scalable data processing is a cen-

tral priority.

Table 1: Graphic Illustrations:

ETF growth in 2009

World U.S. Europe RoW

YoY % increase 45% 42% 57% 44%

YoY increase ($ bn) 321 209 81 31

2009 AUM 1032 706 224 102

2008 AUM 711 497 143 71

Worlds top ETF providers, in $ billions as on December 31, 2009

Assets % of total

iShares (BlackRock) 489 47%

SSgA 161 16%

Vanguard 92 9%

Lyxor (Societe Generale) 46 4%

Deutsche Bank 37 4%

Powershares (Invesco) 34 3%

ProShares 23 2%

882 85%


20/52

20

Process Evolution and Conclusion

The unexpected, explosive growth of

ETFs gave rise to infrastructural strains

and gaps that are being addressed on

a triage basis. These gaps are concen-

trated around the PCF and impact both

front and back office operations.

The critical role played by the PCF re-

quires that ETF portfolio managers

have discretion on its composition. As

a result, the PCF does not generate di-

rectly from fund accounting data, but

instead, moves through the front of-

fice to allow for editing, sampling, and/

or optimization before it is valued and

published. This first step in the process

of PCF creation is not supported by ex-

isting off-the-shelf portfolio manage-

ment or order management software.

To fill this gap, front offices have creat-

ed supplemental processes that often

are manually intensive.

Most ETF providers back offices do not

have well-integrated systems for pro-

cessing the preliminary PCF data pro-

vided by the front office. For example,

most systems do not support applyingnext-day mandatory corporate actions

(such as splits, rights issues, spinoffs, ID

code changes) to evanescent holdings

data. Prior to the advent of ETFs, it was

not a priority to project holdings into

the future on a daily basis. Doing so,

at many institutions, entails inefficient

use of human resources and frequent

errors and omissions.

As with the above mentioned tasks,

the process that prices the PCF and

estimates the cash component often

relies on systems that use resources

inefficiently. For example, the calculat-

ing agent must ensure that the pricing

data in the PCF is identical to that used

by the ETFs accountant. When this

agent is a different entity than the fund

accountant, establishing and maintain-

ing linkages across legal boundaries

creates challenges to systems that nor-

mally rely on their own securities pric-ing data.

These infrastructure limitations act as

a capacity constraint on the growth of

ETF products globally. It is revealing

that BlackRock, which is understood

to have the most robust ETF-related

infrastructure in the industry, has a

47% share of ETFs worldwide (with

$489 billion), and a 52% share of the

US ETF market (with USD 364 billion).

State Street, with a relatively small 16%

market share, is BlackRocks nearest

competition.

As the ETF industry continues to grow,

significant evolution will occur in secu-

rities processing infrastructure. Firms

that act aggressively to streamline will

be best positioned to threaten Black-

Rocks dominance.

Steve Wetter

Steve is a Solutions Architect in TCS

Financial Services, focusing on Securi-

ties Processing. He has over 20 years of

experience in the financial services in-

dustry as a business leader, trader, and

asset manager. As a portfolio manager,

he has managed several ETFs as well as

handling complex beta-replication as-

signments for some of the worlds larg-

est institutional clients.

References:

Source for data on ETF assets: BlackRock, ETF Landscape Year End 2009,

National Stock Exchange, IndexUniverse.com

Sources for index level data: mscibarra.com, finance.yahoo.com

Fixed Income

16%

Commodity

2%

Equity

82%

Figure 1: ETF Asset Mix (% of worldwide assets managed by ETFs as onDecember 31, 2009):

Exchange-traded Funds: Yesterday, Today,

and Tomorrow


21/52

21

Making Relationship-based Pricing aReality in Financial Services

Most financial institutions tend to pro-

vide exclusive offers to their key and

valued customers. These services do

not follow a pre-determined yardstick

as they depend on the negotiation

skills of both customers and financial

advisors. Quite often, a savvy customer

would visit a banks branches to check

out various pricing deals that she can

receive, and in instances such as mort-

gages or short-term deposits, nego-

tiation skills play a significant role in

anchoring the final rate of interest or

terms of agreement.

Customer Lifetime

Value (CLV) is the

primary driver for

relationship-basedpricing.

Although the one with the best nego-

tiation skills eventually wins, the other

party is left with a feeling of being short-

changed. This is further aggravated by

competing institutions providing a last

ditch effort to retain the customer by

offering the lowest possible price, even

at the cost of heavy risks and profitabil-

ity to the bank. At the same time, it is an

accepted market reality that the same

price cannot be applied to all custom-

ers. Therein comes the concept of dy-

namic pricing of financial products,

which is fast gaining higher priority in

business planning.

This article attempts to draw a statistical

approach to Relationship-based Pricing

(RBP) as there are no models on which

a banker can arrive at the customized

price for a deal. We desist from discuss-

ing specific statistical algorithms for us-

age as the optimum algorithm would

be determined on the nature of the

data used for the analysis. It maintainsthe discussion at an activity level and

expects the reader to leverage appro-

priate statistical talent to develop spe-

cific models for each activity.

Customer Lifetime Value

Customer Lifetime Value (CLV) is the

primary driver for Relationship-based

Pricing. Naturally, a financial institution

should maximize the CLV through a

flexible bouquet of products with spe-

cific pricing attached to each product.

How does one arrive at a specific figure

for CLV for each customer and maxi-

mize the total CLV for the entire cus-

tomer base for an institution?

Figure 1 outlines an optimized meth-

odology for CLV calculations.

Let us look at each one of these steps in

greater detail.

Customer Segmentation

For a focused approach to customer

segmentation, the bank should arrive

at customer groups or clusters based

on homogeneity and common char-

acteristics. The homogeneity may be

based on various dimensions such as

demography, product holding, trans-

actions, interactions, among others.Customers not belonging to any of

the identified segments need to be ig-

nored for the rest of the exercise.

Figure 2 shows a typical output of an

unsupervised clustering exercise on a

customer database.

The segment profiler for the above

segments is shown in Figure 3. This

helps in understanding the variables ordimensions defining a particular seg-

ment. Each segment has a different

set of significant dimensions in varying

order of importance. It also shows the

Segment the customer baseStep 1

Derive CLV for each segmentStep 2

Identify product bundlesStep 3

Determine price elasticityStep 4

Optimize product bundle allocationStep 5

Define value based targeting strategyStep 6

Deploy rule engineStep 7

Figure 1: Optimized methodology for CLV

Figure 2: Output of an unsupervised clus-tering exercise on a customer database

1

18%

9

9%

4

15%

513%

6

7%

7

4%

8

11%

9

16%

10

5%

Segment# (% of base)

2

2%


22/52

22

distribution of the dimension within

the segment as against the customer

base. For example, the Balance Total

dimension is the most prominent vari-

able for definition of Segment 9. The

customers in this segment have lower

balances as compared to distributionin the customer base. Similarly, con-

sidering the other dimensions, some

sort of inference can be arrived at for

each segment. Here, Segment 9 prob-

ably consists of customer with lower

than average total balances and with

lower profitability than the rest of the

customer base.

Deriving CLV for each Segment

The definition of CLV is taken as thediscounted cash flow of the customers

future product usage or purchases less

the cost for servicing the products and

the customer. The following equation

helps in defining the future CLV of the

customer (Refer Figure 4).

The probability for the period is a com-

posite of the following:

1. The probability of churn or early ter-

mination of product subscription

2. The probability of additional prod-

ucts that can be cross-sold

3. The probability of the willingness

of the customer to spend more andupgrade to new solutions

Identifying Product Bundles

Once the current and future value for

each product is arrived at, the next

step will be to understand the asso-

ciation between various products. This

also needs to be clubbed with possible

cross-influences between various prod-

ucts as well as within the same prod-

uct. For example, it has been observed

that the probability of pre-mature ter-

mination of a term deposit decreases

as the number of term deposit ac-

counts held by the customer increases.

Similarly, the probability of default on

a personal loan repayment decreases ifthe customer also holds a term deposit,

whereas in the case of a housing loan,

the term deposit does not hold any

correlation.

Once the current and

future value for each

product is arrived at,

the next step will beto understand the

association between

various products.

The products held by each customer

base or segment are subject to an as-

sociation analysis, which provides an

understanding of the interlinking be-

tween multiple products in the portfo-lio of the institution. Figure 5 displays

Figure 3: Segment profiler for segments in Figure 2

Figure 4: Deriving CLV for each Segment

Net present Value of the RelationshipCLV

Revenue of Product

iRi

Cost of Product

iKi

Probability for period

tp

Discount rate

d

Cost of Acquisition

I

Maintenance

- Retention L- Customer services S

Making Relationship Based Pricing a Reality in

Financial Services


23/52

23

the results of the link analysis and the

respective associations between mul-

tiple product combinations.

The existence of a connector line be-

tween products indicates the associa-

tion between them, thickness of the

line, and strength of the association.

Another version of this analysis is the

sequence algorithm. This activity con-

siders not only the products being held

by customers but also the sequence

in which each product was added to

the bundle. This gives a good under-

standing of the typical products a cus-

tomer will buy at various stages over a

lifetime.

Figure 6, called a Rule Table, also de-

picts the above analysis.

It shows frequently occurring product

combinations on the basis of the sup-

port and confidence percentages. The

combinations occurring on the top-

most rows give the dominant product

bundles subscribed to by the custom-

ers in the segment under consider-

ation. These are the possible bundles

or products that the customer will buy

over a lifetime.

Determining Price Elasticity

At this stage, the customers have been

split into homogenous clusters. For

each cluster the expected value from

each product is calculated, and, the

product bundles that each segment

is likely to subscribe to are identified.

The next step is to determine the price

at which a customer may purchase

a product. In econometric terms, the

price elasticity of each product is ar-

rived at for each segment and for eachproduct bundle. This is essential since

the existence of certain products in

the bundle impacts the price of other

products. For example, the existence of

a housing loan can lead to a successful

sale of a lower rate for a recurring de-

posit compared to the rate offered to

other customers.

The price elasticity ofeach product is arrived

at for each segment

and for each product

bundle.

This step aims at arriving at the various

price points and the probability of suc-

cessful sale or subscription by the cus-

tomer. For example, consider a personal

Figure 5: Results of a link analysis

Figure 6: Rule Table


24/52

24

loan, with a certain base rate that nor-

malizes the price across various points

in time taking into account possible

inflation. With past data on the price

point, i.e., the interest rate, at which a

customer either accepted or rejected

the product, a price elasticity model is

developed. This model will help to ar-

rive at the probability of successful sale

for various price points, i.e., the interest

rates. Probability tagged to a particular

product will vary when the product is

considered a part of a different set of

products (Figure 7).

Optimizing Product Bundle Alloca-

tion

In this step, the appropriate rate or price

point to be applied to each bundle is

determined. This is a typical operations

research problem where the objective

function is defined by the business. This

could be any of the following or maybe

even one outside those listed below:

1. Maximize the number of products

sold

2. Maximize the expected revenue

from the products sold

3. Maximize the product holding ratio

for given customer segment

4. Minimize the capital adequacy

required

5. Maximize customer relationship

lifetime

6. Minimize risk exposure

Using this objective and the product

bundle, the product expected value,

product lifetime period, product rate

card and the probability of success for

each rate card option, the application

of an optimization algorithm gives the

optimum product bundle to be sold to

Figure 7: Product Probability

Figure 8: Optimized Product Bundle

Making Relationship Based Pricing a Reality in

Financial Services

Credit Card

1. APR 8.0%

2. APR 8.5%3. APR 9.0%

4. APR 9.5%

5. APR 10.0%

6. APR 10.5%

Credit Card

1. APR 8.0%

2. APR 8.5%

3. APR 9.0%

4. APR 9.5%

5. APR 10.0%

6. APR 10.5%

Housing Loan

1. Base + 25bps

2. Base + 50bps

3. Base + 75bps

4. Base + 100bps

5. Base + 105bps

Housing Loan

1. Base + 25bps

2. Base + 50bps

3. Base + 75bps

4. Base + 100bps

5. Base + 150bps

Arrive at

probability for

each rate / price

in each product

Savings Account

1. Free bill payment

2. Overdraft

3. Multi city

checking

4. Gold Debit card

5. Silver Debit card

Savings Account


2. Overdraft

3. Multi city

checking

4. Gold Debit card

5. Silver Debit card

Bundle #1

1. Credit Card APR 8.0%

2. Housing Loan Base + 75bps

3. Saving Overdraft

Bundle #31. Credit Card APR 8.5%


3. Saving Overdraft


5. Gold Debit card

Bundle #4



3. Gold Debit card

4. Overdraft

5. Multi city checking

Bundle #2




25/52

25

each customer or customer segment.

Figure 8 depicts the possible outcome.

Defining a Value-Based Targeting

Strategy

The optimum product bundle and

product pricing are now available for

each customer or customer segment.

Assuming this as the most probable

scenario, the future value of each cus-

tomer can be arrived at. This coupled

with the current value gives us a 2 x 2

matrix with relation to the current val-

ue derived from the customer and the

future potential value expected fromthe relationship. A financial institution

may decide on a 3 x 3 matrix or even a

4 x 3 matrix depending on its customer

management strategy. Lets look at a

2 x 2 matrix between the current val-

ue and the future potential value of a

customer segment. This leads to a four-

part strategy for each customer based

on the quadrant each segment is on

(Refer Figure 9).

The above matrix using current (actual)

valuation and potential valuation pro-

vides insights into the most effective

approaches for customer segments

based on the incremental value avail-

able within the customer segment.

Figure 10 is another way of utilizing the

available valuation information to de-

rive a customer differentiation strategy.

Deploying the Rules

The last step in this exercise is to op-

erationalize the strategic information

derived so far. At this stage, the infor-

mation about customer segments, the

product bundle to be pitched as well as

Feroz DSilva

Feroz DSilva had served as the head of

the Customer Intelligence Practice at

SAS Institute India Private Limited for

over three years. He can be contacted

at [email protected]

the right price to sell for each product

is known. A rule engine will enable the

customer facing entity to determine

the appropriate product and price to

close for each sale to the customer. This

will help enforce the optimum alloca-

tion and go a long way in achieving the

desired results.

Any possible deviation from the ex-

pected result needs to be noted and

fed back into the step 1 so that chang-

ing consumer preferences can be ac-

commodated, and the model tweaked

accordingly.

This approach is a radical shift in the

way financial institutions currently ap-

proach the customer with their basket

of offerings. As such, there is a sig-

nificant impact on the processes and

technologies employed in the opera-

tional activities involved. However, the

benefits far outweigh the efforts to be

invested to enable the institution to

treat each customer as an individual,

and provide products and services in

a personalized manner. This also en-

ables the institution to arrive at an ap-

propriate relationship definition and

strategy.

Figure 9: Customer Strategy

Figure 10: Customer Differentiation

KeepHigh

Actual Value

MostValuable

Customers

MostGrowable

CustomersMost

GrowableCustomers

Low ValueCustomers

Migrators

High

contributionHigh

unrealizedpotential

Highpotential new

customers

Potential Value

Actual Value

Negativecontribution

Neither a high currentcontribution nor high unrealized

potential

Potential ValueHigh

Low

Low

Keep/Grow

Efficiencies Grow


26/52

26

Mobile Payments in MENA - Driving Convergence

Mobile phones are fast becoming a

substitute for underdeveloped or non-

existent financial infrastructure in de-

veloping countries. It is estimated that

the number of mobile payment users

will be more than 30% of the MENA

regional subscriber base by 2012

(Figure 1).

Here is what V Ramkumar, Direc-tor and the Global Practice Head of

Business Technology at Cedar Man-

agement Consulting International,

opines about the growing importance

of mobile payments in the MENA re-

gion in an interview with TCS BaNCS

Research Journal.

What is the potential for provid-

ing mobile financial services to the

unbanked population in emerging

markets/MENA?

The impact of mobile payments is

more in poorer economies than in

advanced ones, with market dynam-

ics that are starkly different. The greater

impact of mobile payments in emerg-

ing markets is also due to the demand

from consumers who have lower in-

comes and lack bank accounts. Inter-

estingly, the highest growth rates of

worldwide non-cash transactions are

in CEMEA and BRIC countries, suggest-ing that the proliferation and adapta-

tion of mobile payments will leapfrog

in these countries, addressing the de-

mand for low-value, high-frequency

transactions. (Figure 2)

Over two billion people in the world

do not have a bank account. The dis-

tribution network in rural areas is far

better penetrated by mobile handsets

than bank branches. In markets like

India, while there is a bank branch for

every 16,000 people, one in every third

person has a mobile phone, and this

provides a great opportunity for finan-

cial services institutions to reach out to

unbanked populations.

The benefits of mobile penetration

are already here to see. From eliminat-

ing middlemen to tracking the prices

of commodities, small and individual

businesses across the world have seen

significant benefits. A 10% increase in

mobile phone penetration is estimated

to potentially increase the annual per

capita GDP by 0.8% for the lower and

middle-income economies.

What type of transactions are ex-

pected to be addressed through

mobile payments, and what could

be categorized under early adap-

tors?

Airtime top-up is the most common

type of money transfer that the mo-

bile phone has enabled in the pre-paid

user market. Mobile banking and pay-

ment of bills using portals are already

in vogue in most parts of the world.

SMS-enabled parking fee payments

are common-place in many countries

including the GCC. Mass transit, traffic

fares and retail payments are the other

important applications of mobile pay-

ments. The drivers for mobile contact-

less payments are essentially shorter

transaction time, plastic card substitu-

tion, reduced cost and, most impor-

tantly, convenience.

More active use of mobile payments

is expected in domestic and interna-

tional remittances business, or what is

commonly called as mobile-money.

0

100

200

300

400

500600

700

800

2012E2011E2010E200920082007

Total Mobile Subscribers

Source: Cedar Research

445

528

584 621 648

667

Mobile Payment Users

Figure 1: Mobile phone subscriber statistics in MENA

Mobile Payments in MENA - Driving

Convergence


27/52

27

Figure 2: Growth of Non-cash Transactions

Figure 3: Cash-in-circulation/per capita non-cash transaction

0% 5% 10% 15% 20% 25% 30%

N.America (US+Canada)

Europe (incl Eurozone)

Japan+Aus+S.Korea+Singapore

Rest of Asia

L. America w/o Brazil

CEMEA

BRIC

Overall CAGR 8.6%

26%

25%

19%

16%

16%

6%

5%

Mature Economies

Developing

Economies


Services such as Kenyas M-Pesa allow

mobile subscribers to send text mes-

sages to make or transfer payments

from phones, registering high rates of

acceptance and adaptability in a short

timeframe.

Where do you see mobile operators

and banks in International Money

Transfers?

International remittances pegged at

more than USD 230 billion a year, are

already a major source of income for

many developing countries and a very

important factor in their economic

development. India, for instance, is

both the worlds fastest growing mo-

bile services market and the biggest

recipient of overseas remittances in

the world, accounting for around 10%of the world market, and 30% coming

from the Middle East. The remittance

inflow is almost four times as much as

the FDI, and hence, a key factor for its

economy.

Globally, 200 million international mi-

grant workers have a need for making

easy and secure remittances to their

dependents, many of whom dont

have bank accounts. The number of

recipients of international remittances

is expected to be one in four people

over the next four years, and the size

of the international remittances market

is expected to grow over four times to

more than USD 1 trillion. With a mobile

network that is expected to cover ge-

ographies that have more than 80% of

the world population, there is clearly

an opportunity to exploit the extensive

reach of mobile networks, which can

complement existing local remittances

channels and make international mon-

ey transfers affordable.

Would Near Field Communication

(NFC) or mobile payments ever re-

place cash?

Mobile payments provide banking andcredit access to a large percentage of

unbanked customers thus increasing

the pie of transactions. While a major

portion of this increased pie will be

driven by new payment mechanisms,

NFC is unlikely to cannibalize the exist-

ing share of card or online transaction

in the near future. While mobile pay-

ments may not exactly replace cash, it

will significantly address the increasingvolume and frequency of cash trans-

actions of smaller ticket size, which

are primarily driven by the benefit of

convenience that the consumer would

experience. The proliferation of mobile

cameras can be seen as a representa-

tive analogy in this context.

Historically, with every non-cash pay-

ment mechanism cheques, cardsand direct debits, there was an alterna-

tive payment technology expected to

replace cash. Interestingly, as Figure 3

indicates, cash in circulationeven in

2.0

2.2

2.4

2.6

2.8

3.0

200720062005200420032002


Euro (Bn)

2.04

2.202.26

2.35

2.49 2.53


28/52

28

V Ramkumar

V Ramkumar is Director and the Global

Practice Head of Business Technol-

ogy at Cedar Management Consult-

ing International. He has significant

experience in the areas of bank-widetechnology platforms, including core

banking systems, credit cards, loyalty

and payment systems. He specializes

in business-aligned technology strat-

egy formulation, application selection

and implementation management,

with a primary focus on the banking

and financial services industry. He can

be reached at v.ramkumar@cedar-con-

sulting.com.

the Euro-zonehas grown faster than

the non-cash transaction per capita in

the same period.

India, is both the

worlds fastest growing

mobile services market

and the biggest

recipient of overseas

remittances in the

world, accounting for

around 10% of theworld market, and

30% coming from the

Middle East.

One more interesting phenomenon

that is expected to happen in this de-

cade is the convergence of all smart

card applications into mobile devices,

thus leading to a consolidation of cards

and mobiles. This could include loy-

alty cards, gift cards, public transport

passes, access control devices or even

simple data storage applications.

What are the key challenges for the

advancement and proliferation of

NFC and mobile payments?

Every revolution be it the internet orcredit cards or e-mails or, even the good

old locomotive, has gone through a

process of evolution before becoming

a well-accepted part of life, and NFC is

no exception. Universal standards and

mandatory security evaluations for

payment applications across different

regions will need to evolve to shape

the handset architecture, infrastructure

and roll-outs.

It is estimated that about 20% of the

handsets sold in 2012 will be NFC-en-

abled. Also important is the aligned ad-

aptation of supporting infrastructure.

For example, while buying a movie

ticket through the mobile phone via

an NFC-enabled poster, it is also im-

portant to streamline the payment andticketing.

Implementation of NFC will depend

on the emergence of a collaborative

model (Figure 4) with both banks and

mobile operators joining hands. There

is a very important role that the mobile

operators will need to play in terms of

sourcing and distribution of handsets,educating and supporting customers

and managing the storage of applica-

tions on SIM cards alongside the asso-

ciated security.

Hence, what we would see over the

next decade is increased convergence

and partnerships between banks and

mobile operators, driven by the latent

demand that mobile proliferation is

likely to bring in by way of convenience

in financial transactions.

Financial & Securityknowhow

Sales Channels & PaymentOfferings

Stability & Security

Enable new payment &settlement system

Customer convenience

Mobile knowhow Sales channels & mobile

offerings Technology & tools

Banks Mobile Operators

Collaboration

Figure 4: Bank-Mobile Operator Collaboration

Mobile Payments in MENA - Driving

Convergence


29/52

29

Emerging Trends and The Future ofGlobal Custody Services

The recent financial crisis has provided

custodians the right opportunity to

evaluate their business models and

potentially set new trends that could

change the face of the business. In this

article, we explore these opportunities

in greater depth.

The custody business came into ex-

istence when the US government

passed the ERISA act in 1974, mandat-

ing the separation of investment man-

agement activities from the custody of

underlying assets. It has since evolved

into a highly specialized and complex

global service, offering a wide array of

services. Assets under management

(AUM) have also grown explosively

and are estimated to grow up to USD

200 trillion by 2015. (Source: Global Fi-nance, Sept 2008, A Safe Heaven). The

recent slowdown led to the industry

safeguarding itself through consolida-

tion activities, and by foraying into new

markets.

Driven by risk averse

investors and the

demand for morevalue for money, a

global custodians role

today also includes

specialized, complex

value-added services.

Complex financial instruments, cross-

border investments and the develop-

ment of emerging markets propelledthe growth of the global custody

business. Driven by risk averse inves-

tors and the demand for more value

for money, a global custodians role

today also includes specialized, com-

plex value-added services such as per-

formance measurement, compliance

monitoring and commission recapture,

among others.

The nature of custody services offered

has changed from regional to global,

back-office operations provider to cus-

tomer relationship management, core

to value-added, processing to analytics,

and, commodity to liability. The custo-

dy business is considered to be one of

scale, with the management of niche,

value-added services being crucial to

success. With fierce competition, mar-

gins on value-added services are alsogetting thinner.

Increasing costs, decreasing margins are paving way forcustodians to increase their breadth of services

Initial CustodyOffering

Enhance Custody Servicesto cater to globalizationand increased customerdemands

Core Services Safekeeping Settlement Corporate Actions

Management Income Processing

Portfolio Administration Cash Management Tax Management Reporting Record-keeping Investment Accounting Funding Securities Lending, Equity

Repos & Collaterals Trustee Services Performance Measurement Transition Management

Value Added Services Collateral Management Risk Analysis Outsourcing Compliance Monitoring

Commission Recapture

Custody Services to caterto heightened regulation,risk averse customers and

increase

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