An Intro to the Financial Services Industry

A BRIEF INTRODUCTION TO THE FINANCIAL
SERVICES INDUSTRY (FSI)
FOR TECH CONSULTANTS NEW TO THE SECTOR

The Financial Service Industry is one of
the most attractive industries to
target if you are a consultant.

To give a sense of scale, in 2014, Bank of
America had over 100,000 Tech and Ops
headcount and a $9B annual IT
budget.
http://www.informationweek.com/strategic-cio/digital-business/it-chief-of-the-year-bank-of-
americas-cathy-bessant/d/d-id/1317757

However, when selling into, or delivering
for, Financial Services Institutions (FSIs),
it is useful to have some understanding
of how FSI business models work,
and the unique requirements that
drive their IT strategies.

This deck is a living document(*) that
hopes to act as a primer for
consultants who need to support FSI
clients, but who may not have prior
experience in the sector.
(*) If you have an idea on how to improve this deck, mail eric@savantdegrees.com

In this deck we’ll cover 4 topics
1. What are Financial Assets
2. What are Financial Markets
(Where Financial Assets are traded)
3. What are Financial Institutions
(The players that act within Financial Markets)
4. Special Topics: FinTech & Regulators
(Oooh…sexy)
• I won’t be covering case studies. We can do a separate session on those
• I also won’t go into the details of each type of product. That’s too detailed…

Along the way, we’ll stop to discuss
ENGAGEMENT INSIGHTS
which are observations that should help
consultants understand how to better sell
and deliver solutions that are specifically
tailored to the industry.

Before talking about financial institutions
(FIs), it is important to first understand
financial assets, because everything
about how different FIs do business
ultimately stems from the properties of
the assets they manage.

An asset is any possession that has
some value in an exchange.

Tangible assets are physical things with
properties that create value.
Like a cow.

Intangible assets represent legal claims
to some future benefit.
The physical form has nothing to do with
the value. Seashells (or shell scripts)
work just as well as dollar bills, so long
as the legal structure says so.

When we talk about Financial Assets,
we’re talking about intangible assets. And
the future benefit we’re talking about, is
the right to claim cash.

With a Financial Asset, one party, the
issuer, agrees to make future payments
to the owner of the financial asset, the
investor.
Examples of Issuers (and investors) include central governments or their agents,
municipal governments, supranationals, non-financial businesses, financial businesses,
and households (individuals)

Here are some Financial Assets:
a US Government Bond
Stock in Amazon.com
a Home Loan
a Certificate of Deposit
A Corporate Bond from General Electric

There are generally 2 types of claims
that an investor can make: fixed cash
amount or a varying amount.
* Some financial assets can actually be a hybrid of the 2 (such as preferred stock or convertible bonds), but let’s not worry about that for now

If the claim is for a fixed amount, we call
that a debt
* Sometimes we refer to these assets as fixed-income products

Debt payments can come all at once, or
be spread across a period, but there is
always a total, specific amount claimed.
A US Treasury Bond is an example of
Debt.

If the claim is for a variable amount, we
call that equity.
* Sometimes equity is referred to as a security, or a stock

Equity obligates the issuer to pay the
investor an amount based on future
value (such as earnings), usually after
debt holders have been paid off first.
Amazon.com stock is an example of
equity.
* Equity can sometimes also pay a dividend

Because both debt and equity represent a
promise to get future cash, to figure
out how much a financial asset is worth,
the financial asset needs to go through a
process of valuation.
* Think of it this way, would you rather me give you $1000 today, or next year?
Today right? See? Present money is more valuable than the promise of future
money. That is why we do valuation!

Roughly speaking, Valuation is calculated
using the timing of when you expect the
future cash, the impact of inflation and
prevailing interest, and, most
importantly, the risk that something may
happen and you don’t get the money
back when it was promised

Generally speaking, timing of cash flows, inflation, and
interest rates are easy to predict. That is not true with risk.
Thus, calculating and managing risk becomes an absolutely
central focus of all financial institutions because it drives
valuations and returns.
So, if you sell or deliver into banks, Risk Management must
be at the heart of your engagement.
ENGAGEMENT INSIGHT
1

Issuers and investors need a safe and
efficient place to find each other, agree
on valuation, and transact – enter
Financial Markets.

FSIs need to constantly innovate to remain competitive. The
areas in which you can help them innovate are tied to the
scope of Financial Markets.
More specifically, they are looking for 1) new ways to find
market opportunities more quickly, 2) develop new products
to sell, 3) transact at the best possible price and lowest cost,
4) reduce risk, and 5) improve the Customer Experience
Innovation around any of those is good!
ENGAGEMENT INSIGHT
2

One way to categorize Financial markets is by
asset type. For example Debt Market versus
Equity Market.
* Sometimes, because of hybrid assets, we merge Debt Assets and Preferred Stock
into Fixed-Income Markets, and the non-preferred equity assets are grouped into a
Common Stock Market.

Another way to categorize Financial Markets is
by the maturity of claims (when you actually get
your money).
Short-term assets (like a certificate of deposit
that matures in 3 months) are traded in a Money
Market. And assets that mature over longer
periods (like a 10-year bond) are traded in the
Capital Markets
* The cutoff between short and long-term is roughly 1 year

A third way to categorize is based on whether
the financial assets are newly issued, which are
sold in a Primary Market, or whether the
financial asset was previously purchased and is
now being re-sold in a Secondary Market.

Finally, investors can buy (or be granted) the
obligation, or the choice, to buy or sell a
financial asset based on various triggers. The
specific terms are defined in contracts and are
traded in a Derivative Market.
For example, if you act within the next year, you have the option to buy a stock at
$10 per share, even if the market price is $20 per share, but if the stock price drops
to $8 you MUST buy it at $8.

There are as many derivative instruments as can
be concocted by human imagination, but
common ones include Options, Futures,
Forwards, Swaps, and Cap and Floors.
Each of these contracts is designed to help investors manage their financial risk.
Unfortunately, they can also be used to double down on bad bets!

Understanding which market(s) your customer is playing is
important because the business models that customers
employ in each market is going to be quite different,
because the needs of the customers in each market are very
different.
For example, a Bank’s customers in the Derivatives market
are looking for risk management or high margin/high risk.
Bank customers in the Debt Market are looking for low risk-
low return.
ENGAGEMENT INSIGHT
3

At the end of the day, these financial markets
take physical form in Exchanges (such as a stock
exchange) – a marketplace where securities,
commodities, derivatives and other financial
instruments are traded in a fair, transparent, and
orderly fashion.

PART THREE
FINANCIAL INSTITUTIONS (FIs)

Issuers and Investors are not often
financial experts themselves, and so
Financial Markets are usually
composed of FIs that serve as agents
(or Intermediaries) that act on behalf of
issuers and investors.

Oh, and Financial Market Regulators will
try to poke their heads in from time to
time to make sure that no one is burning
down the house.

In addition, FSI industry service
providers like credit-ratings agencies or
equity research firms support specific
needs of the FIs.

But, in short, FIs….
1) Take financial assets and repackage them
for various financial needs
2) Exchange assets on behalf of customers
or themselves and facilitate payments
3) Assist in the creation of financial assets
4) Perform proprietary research and provide
advice around economic forecasting,
investment strategies, and capital
building or preserving recommendations
5) Manage customer portfolios to make
money and/or reduce risk

Roughly, FIs can be segmented into:
Depository Institutions
Non-Depository Institutions

PART FOUR
DEPOSITORY INSTITUTIONS

HOW DO DI’S MAKE MONEY?
Depository Institutions hold money for
customers, usually charging a fee. They
then take a good chunk of that money
and invest it (often in the form of Loans
or investment in Securities), keeping
some amount in Reserve to support the
day-to-day withdrawal needs of their
customers. They also charge money for
services, take interest on the loans they
make, and charge transaction fees for
just about everything.

DI’S ARE VERY REGULATED
As you might imagine, DIs are the most
regulated and most protected (i.e.:FDIC
insurance) of the FIs because, well, that
is all of our savings!
A run on the banks (where depositors ask
for so much of their money back that the
Reserve dries up and the bank cannot
support withdrawals in cash) could wipe
out a national economy.

Depository Institutions include
Commercial Banks (or simply ‘Banks’)
Savings and Loan Associations
Credit Unions
* Commercial Banks represent the vast majority

Within the segment of Commercial Banks there
are additional sub-segments, each with quite
unique business models.
The sub-segments include:
Individual Banking
Institutional Banking
Investment (Global) Banking (quasi depository)
Universal Banking

PART FOURDOTONE
INDIVIDUAL BANKS (RETAIL BANKS &
WEALTH MANAGERS)

CUSTOMERS OF INDIVIDUAL
BANKS
Individual Banks provide Services
to…well….individuals, like you and me.
We want…
1. a safe, transparent place to store our money
2. the ability to use that money wherever, whenever, and
through any channel we want to (in as convenient a way
as possible)
3. access to more money (for a period of time)
4. good advice on how to protect and grow our money
5. great and value-for-money service when providing the
above

PRODUCTS OF INDIVIDUAL BANKS
Individual Banking includes services such as
managing deposits, consumer and mortgage
lending, payment and withdrawal, checking and
bank drafts, credit card financing, car and
student loans, specialized services such as safety
deposit boxes, and individual investment /
advisory services.

HOW ARE INDIVIDUAL BANKS
SEGMENTED?
Individual Banking roughly segments by the
amount of money the typical customer deposits.
There are 2 segments, Retail Banking (for you and
me) and Wealth Management (for the fortunate
few).
* Wealth Management is sometimes called Private Banking

Wealth Management, in turn, breaks again into:
Mass Affluent Banking (250K->2M AUM)
Wealth Management Clients (2-50M AUM)
High Net Worth Individuals (50-250M AUM)
Ultra High Net Worth Individuals (>250M AUM)
AUM = Assets Under Management

As you might imagine, the services offered get
much more profound, complex, value additive,
and expensive the more money one deposits,
especially when it comes to advisory.

HOW ARE RETAIL BANKS
STRUCTURED
Generically, Retail Banks will be structured into 1)
a Retail Branch Operations Group, 2) Individual
Lines of Business, 3) a Back Office Group and 4)
Misc (Legal, HR, Audit/Risk, Admin, Change &
Strategy, etc).
The Back Office will include 1) Technology, 2) Back
Office Operations (Transaction Settlement & Risk)
sub-groups, and 3) Treasury

HOW ARE WEALTH MANAGERS
STRUCTURED
Generically, Wealth Managers will be structured
into 1) Financial Advisory Group (segmented by
region or AUM, 2) a Back Office Group, and 3)
Misc (Legal, HR, Audit/Risk, Admin, Change &
Strategy, etc).
sub-groups

Individual Banks are constrained by a few parameters. First,
because they are playing with our money, their tolerance for
risk is extremely low. That means that when they invest
deposits, they must be careful to assume a low risk profile.
Check out Glass-Steagall on Wikipedia if you want some
nighttime reading
As a result, return on assets is much lower than much riskier
business models such as Investment Banking.
ENGAGEMENT INSIGHT
4

When selling or delivering, Retail Banks and Wealth Management Banks should be
considered as separate segments with different buying needs and behaviors.
Because retail banks serve the everyman, who are generally price-sensitive, product
pricing tends to be low and margins razor thin. As such, Retail Banking is a volume-
based business and deeply paranoid about operational costs.
Wealth Management is the opposite. Customers are generally not price sensitive, but
expect very tailored services from their Financial Advisors. Wealth Management firms
tend to be more willing to make large expenditures if they can produce big customer
experience gains.
However, the typical Wealth Management client is not at all keen on their bank
experimenting with new, and potentially risky, technology, since they have consolidated
so much in one place - so the perception of stability and security is probably higher. For
example, 2-factor authentication (RSA tokens) was adopted much faster by the retail
Banks then it was for the Wealth Managers.
Lastly, note that most Wealth Management clients have a separate Retail Banking
relationship for their day to day needs
ENGAGEMENT INSIGHT
5

Although it is annoying to change banks, retail bank
customers are far less sticky (locked-in) than a corporate
bank, wealth management advisory, or an investment bank.
That means competition can be very fierce for every
customer in the Retail space.
Retail Banks tend to be very marketing/brand conscious and
the role of IT tends to focus on providing new services and
channels for customers. User Experience is king in the Retail
Bank market, and Retail banks are usually the first to adopt
new digital technologies.
Wealth Managers are managing customers who have more
at stake (more to lose), so although customer experience is
critical, most WM Banks prefer stickier person-to-person
relationships with Financial Advisors and tend to be
technology late adopters, waiting until new technologies are
well tested in the market before risking them on their
valuable customers.
ENGAGEMENT INSIGHT
6

With the cost of acquiring new retail, small business or commercial customers
being five to ten times the cost of retaining an existing one, and with the
average spend of a repeat customer being 50-100% more than a new one,
bank marketers need to remember that the most efficient investment of
marketing funds is to market to customers that already bank with you.
As part of that Retail Banks love to white label product (act as distributors)
such as credit cards, insurance policies, mutual funds because they can add
value without absorbing operating costs. Wealth Managers tend to prefer
proprietary systems that help the differentiate from other advisors.
Both are highly interested in user experience, especially when it comes to
new, and more integrated channels, and using their massive data stores plus
Big Data to help target and provide new value to customers (especially when
it is real-time and tailored to each customer.
Both have a deep desire to cross-sell and up-sell.
ENGAGEMENT INSIGHT
7

In terms of organizational power and influence, central IT
departments in Retail Banks are by far the most powerful of
all the FIs.
In Wealth Management Banks, things look a bit different.
Power and influence rest with Financial Advisors who have
the most assets under management. If you take care of the
big, juicy clients, you have much more power than anyone
else in the bank. Because of that, the power of Central IT
recedes in favour of shadow IT (business groups drive their
own mini-IT strategy). With that said, most Wealth
Management firms also have reasonably strong central IT
functions to drive cost efficiency and standardization.
ENGAGEMENT INSIGHT
8

PART FOURDOTTWO
INSTITUTIONAL BANKS

WHAT ARE INSTITUTIONAL BANKS?
Institutional Banks do not serve individuals.
Instead, they face off to, usually the Treasury
Departments of, Corporations.
They can generally be segmented into SME
Banking and (large) Corporate Banking depending
on the annual revenue of their customers.

CUSTOMERS OF INSTITUTIONAL
BANKS
Corporate Treasurers want…
1. Everything that an individual bank provides, but for a
business (on a much bigger scale)
2. Value-added services specific to businesses
3. Seamless integration/automation to their business
financial systems
4. Support for compliance regimes

HOW DO INSTITUTIONAL BANKS
MAKE MONEY?
Institutional Banks primarily provide high-margin
trade financing, cash management, leasing, and
invoice factoring services on top of payments and
risk or capital-building advisory. They often also
front Investment Banks to provide Investment
Banking products.
They will charge service and transaction fees and
will often leverage deposits like individual banks
do, but for Corporate Savings accounts.

HOW ARE INSTITUTIONAL BANKS
STRUCTURED
Generically, Institutional banks will be structured
into 1) Corporate Banking and Trade Services, 2)
Asset Management Services, 3) a Back Office
Group, and 4) Misc (Legal, HR, Audit/Risk, Admin,
Change & Strategy, etc).
sub-groups

CFOs are always interested in personalized services and a
wealth of financial tools that they can use to more efficiently
and effectively manage the finances of the firms they look
after. As a result, Corporate Banks tend to have much wider
and diverse product portfolios than Individual Banks.
When it comes to margins, Corporate Banks tend to fall in
the middle on average. On the one hand, as customers,
corporate CFOs tend to be quite cheap (money minded), so
product margins in corporate banking are pulled
downwards. However, Corporate Banks counter this
downwards pull with lots of boutique, personalized products
and high customer lock-in. While it is possible to move from
one corporate bank to another, it is MUCH harder than
moving your personal account, because once you are on-
boarded onto corporate banking systems, you get pretty
stuck.
ENGAGEMENT INSIGHT
9

PART FOURDOTTHREE
INVESTMENT BANKS

HOW DO INVESTMENT BANKS MAKE
MONEY?
Next, Investment Banks provide services including
helping institutions raise money through
corporate financing (e.g.: underwriting bonds or
raising funds via private mergers and acquisitions
or public IPO), support for foreign exchange
transactions, research, asset management, and
provide dealer/broker services to buy and sell
securities and derivatives

CUSTOMERS OF INVESTMENT
BANKS
Investors want…
1. Unequal access to market intelligence & opportunity
2. Access to many markets and products
3. Transaction speed
4. Low-cost, high volume transactions

HOW ARE INVESTMENT BANKS
STRUCTURED
Generically, Investment banks will be structured into
1) Front office (investment banking, sales & trading,
and research), 2) Middle Office (risk management,
financial control, corporate treasury, corporate
strategy, and compliance), 3) Back Office (Tech and
Ops), and 4) Misc (Legal, HR, Audit/Risk, Admin,
Change & Strategy, etc). Note that most lines of
business, especially in Sales and trading will have
Front-Office aligned IT organizations, that might be
funded differently from the Back Office.

Today, realistically, many Investment Banks compete with Institutional
Banks in terms of service offerings. It is also important to note that
the Investment banking business model is HIGHLY leveraged which
means they are highly profitable, but highly risky. Finally, sometimes
the investment Bank will be more than a broker/dealer. Sometimes,
they will take ownership stakes in securities. In this case, they are
called Merchant Banks
ENGAGEMENT INSIGHT 10

Investment Banks have the highest margins in the industry - and also
the risks.
Because of this, central IT has very little power. Instead, because the
individual lines of business have so much cash, IT power federates
into fiefdoms aligned to product lines such as Equity or FX, and/or to
geos such as Americas or APAC). Shadow IT, inefficient, redundant,
and sometimes contradictory enterprise architecture is rife.
Also, because risk is high, Investment Banks must set aside huge
amounts of short-term assets (cash) as Reserve. Because there is so
much sitting idle in reserves and because Investment Banks have such
return on assets, they can often make more profit by freeing up cash
in reserve to invest in the top line rather than cutting costs.
PS: After the 2008 crash, regulatory pressures have escalated
dramatically, and this impacts both the size of reserves plus the cost
of internal compliance programs

PART FOURDOTFOUR
UNIVERSAL BANKS

Finally, Universal Banks occur when one bank
integrates horizontally and vertically, acting as a
Retail Bank, an Institutional Bank, and an
investment Bank, all in one.

Here is an interesting infographic showing the
growth of universal banks….

Such dramatic industry consolidation over the last 2 decades has
resulted in massive Industry-wide Technical Debt. If you buy 10
banks, you may have 10 duplicate systems, each of which, because it
is connected to everything else like spaghetti, become almost
impossible to decommission.
There is a great Technical Debt Primer here:
http://www.slideshare.net/lemiorhan/technical-debt-do-not-
underestimate-the-danger

PART FIVE
NON-DEPOSITORY INSTITUTIONS

The most commonly known Nondepository
institutions are Insurance Companies. Insurance
Companies sell insurance policies, which are
legally binding contracts that pay the insured an
amount of money in the case of future events, so
the business is all about which risks to take.
Sometimes a Commercial Bank will act as a Distributor for an Insurance Company, in which case it is called
Bankasssurance. When multiple insurance companies share risk by purchasing policies from other insurance
companies, it is called Reinsurance

The business model is to collect more in
premium and investment income than
is paid out in losses, and to also offer a
competitive price which consumers will
accept.

CUSTOMERS OF INSURANCE
COMPANIES
Insurance customers want…
1. To feel secure
2. To feel as if their insurance portfolio is personalized
3. Their claims to be honored quickly and easily

Insurance is all about making great predictions using statistics. And
the better the data, the better the predictions. Thus, Big data and
Internet of Things is critical for insurance Companies. Interestingly
though, in recent years, the focus has moved away from predictive
models and more towards preventative models – use Big data and IoT
to prevent risks from occurring by providing advanced notice of
increasing risks (such as…you are more likely to have a heart attack
now that (according to your watch) you’ve just finished that Big
Mac….)
Insurance companies tend to be quite profitable, which means that
they can invest. However, their lifeblood is the army of individual
agents (who are sometimes independent) and white-label
organizations that actually sell their policies, which means that
adoption (change management) is very difficult.

Another type of Nondepository institutions are
Investment Companies which are financial
intermediaries that sell their own shares to the
public, and invest the proceeds in a diversified
portfolio of financial assets. These open end
funds like mutual funds or closed end funds like
pension funds, unit trusts or private funds
(foundations) such as venture capital funds or
family funds
Sometimes investment banks are called Sell Side and Investment Companies are called Buy Side

Finally, it is probably worth making mention of
FinTech, which is a relatively new FI segment
that is composed of a motley of start-up, small,
and medium-sized companies that are trying to
disrupt the Financial Services Industry using
cutting edge technology and business models.

Venture
Scanner’s
FinTech Map

These guys, at the same time, scare the cr@p
out of FIs, and offer them a path into the future.
Most banks have developed a FinTech strategy
that involves copying, acquiring, investing,
distributing, or ignoring.

We mentioned earlier that governments have an
interest in making sure that FIs don’t cheat
individuals or burn down the economy.

As a result, the Financial Services Industry is one
of the most highly regulated industries.

FIs must put in place a host of financial and
operational controls to prevent or mitigate risks
such as:
How much cash they hold in Reserve
How much risk / leverage they take
How they manage their IT
How they manage their operations
How much, how fast, how often, and with whom
they trade or do business with

And, following the 2008 crash, these controls
have gotten far more severe, all over the world.

This can be very expensive because FIs must
hold more cash in Reserve, spend more money
to implement (and audit) operational controls,
and pay fines when they are caught screwing up.

Being a Global FI is particularly challenging when it comes to
Regulation. Because they traded in several countries and across
several product classes (each with their own specialized regulator)
one customer I worked with had over 70 regulators, each with similar,
but not entirely similar, regulatory requirements.

Hopefully this has been a useful primer to an
industry, which is actually a collection of many
fairly large and complex sub markets, each with
very different characteristics.
* Actually, it is only an intro. I cut a few corners to make some of the text digestible to a newbie

As a next step, I would recommend heading over
to Wikipedia and start learning about individual
product classes (what is the difference between
a SWAP and a FORWARD and why would you
want one) in each of the markets.

Or simply go out and talk to bankers to learn
more about what gets them out of bed, or
opens their wallets.

An Intro to the Financial Services Industry

Recomendados

Recomendados

Más contenido relacionado

La actualidad más candente

La actualidad más candente (20)

Destacado

Destacado (20)

Similar a An Intro to the Financial Services Industry

Similar a An Intro to the Financial Services Industry (20)

Más de Eric Tachibana

Más de Eric Tachibana (20)

Último

Último (20)

An Intro to the Financial Services Industry