Banking behind

the scenes
Driek Desmet, David Fine, and Jacques Meyer
World-class banks manage their back-office and
IT activities as a portfolio of individual opera-
tions, each demanding a unique solution.
Banks constantly battle to streamline their
back-office factories, with good causethese facilities
can be responsible for up to half of their operating costs, excluding inter-
est. Yet whether the factories process mortgages, securities, or other
products, banks tend to use the same approach across the board:
process reengineering and general cost cutting are the usual favorites,
but outsourcing is gaining ground. Most banks also treat the IT opera-
tions that support back-office processes as a single, separate function
requiring a separate cost-cutting program. But world-class banks take
a different approach.
During 2001 and early 2002, we studied the relative efficiency of the
back-office operations of 13 European banks as well as how 20 banks
in Europe and North America handled such operations. Our two samples
included various types of banks, with a wide revenue range. We found
that the world-class banks manage their back-office and IT operations
as a portfolio of individual factories, each demanding a unique solution
depending on its characteristics. Using these findings, we developed a
guide to help banks choose the right sourcing solutions.
Our first study, on the relative efficiency of the back-office operations of
different banks, showed that unit-processing costs for the same product
can vary a good deal. In mortgage processing, for example, a cluster of
banks had unit costs in the range of $100 to $200 for each mortgage,
while others had unit costs as low as $50. Such variations, closely linked
to scale, were largely explained by how well the banks had designed their
factories. Banks with low processing costs had intrinsically inexpensive
operations because they had developed focused products, flexible IT
platforms, and lean, highly automated processes. These banks could
also support a massive increase in volume without raising fixed costs,
thus sharply reducing unit-processing costs (Exhibit 1).
The second study, on the way banks run their back offices, found that
the wide range of options fall into five smart-sourcing categories:
6 THE McKI NSEY QUARTERLY 2 0 0 2 S P E C I A L E DI T I ON: T E CH N OL OGY
KEVIN CURRY
Q4a_CRmini_Bank 10/28/02 11:55 AM Page 6
Internal upgrades:
Most banks pursue
the familiar path of
business process
reengineering and IT
rationalization for their
factories. But few
upgrades are success-
ful enough on their own
to yield a lasting com-
petitive advantage.
Outsourcing: A
favorite way of stream-
lining standardized,
small-scale noncore
operations is to outsource them. Abbey National, for instance, turned
over its credit card processing to the US specialist MBNA. Banks cur-
rently outsource roughly 10 percent of their factory operations. Our
research suggested that most could outsource far more.
External co-sourcing: In a new variation on outsourcingexternal
co-sourcingseveral banks pool their operations. This is an attractive
approach if no large-scale provider exists, but so far, given the prob-
lems of integrating different legacy IT platforms, a rare one. Three
mortgage banks in Germany, however, have decided to combine their
volumes in a jointly upgraded platform. We expect to see more such
ventures.
Internal co-sourcing (shared service centers): Multinational banking
groups typically have each bank in each country they cover process its
own product lineup. But by concentrating their operations for a particu-
lar product, such as loans, in a single factory serving many countries,
they can capture substantial benefits. ING, for example, is setting up
such service centers for several of its products, including mortgage
processing, and HSBC is consolidating its wholesale-banking factories.
Since connecting these central factories to a number of geographically
dispersed banks within the same group is difficult, only a handful of
players are attempting this strategy, but as banks adopt more advanced
middleware we expect that it will become easier to execute. An increas-
ingly popular variant is to move factories to cheaper locations offshore:
Citigroup, HSBC, and Standard Chartered, for instance, have used their
knowledge of Southeast Asia to move activities such as IT development
and credit card processing to that region.
7 BA N K I N G BE H I ND T H E SC E N E S
E X H I B I T 1
When skill meets scale
1
Disguised examples.
Source: American Banker; McKinsey analysis
Number of mortgages
1
250,000 500,000 750,000 1,000,000 0
100
150
200
250
0
Skill impact through
increased automation,
process improvements,
simplicity of product
Scale impact through
increased volume
C
o
s
t

o
f

s
e
r
v
i
c
i
n
g

m
o
r
t
g
a
g
e
,
1

$
Q4a_CRmini_Bank 10/28/02 11:55 AM Page 7
Insourcing: Best-practice factories take on outside business to reach
more efficient volumes. The South African bank Nedcor, for example,
has cut its credit card processing costs through an internal upgrade
and now insources from a European credit card issuer. Mergers are
another way of gaining scale in operations. The Royal Bank of Scotland,
for instance, is now moving the processing factories of NatWest (which
was twice its size in risk-weighted assets at the time of the acquisition)
to its own more efficient platforms.
Best-practice banks decide which smart-sourcing option to use by exam-
ining the relative efficiency and scale of the back-office operation behind
every product line. First, a bank must assess the strengths of each fac-
tory and the complexity and sales volumes of its products, as well as its
operational processes, IT platform, and IT architecture. Using the kind of
broad categorization depicted in Exhibit 2, the bank can then classify the
factory by such measures as efficiency and the potential for scaling up.
Next, a map like the one in Exhibit 3 helps the bank choose the smartest
sourcing option for each product line, depending on its strategic impor-
tance and the starting position of the back office.
Small, inefficient operations are nonperformers, best suited to outsourc-
ing or to small-scale internal upgrades. Most banks will find that their core
factory operations, such as processing current and savings accounts, are
laggardshigh-volume activities inextricably embedded in custom-
made, undocumented legacy systems. Despite these operations ineffi-
ciency, internal improvement may be the only option, not least because
their sheer size makes them so important strategically.
8 THE McKI NSEY QUARTERLY 2 0 0 2 S P E C I A L E DI T I ON: T E CH N OL OGY
E X H I B I T 2
Assess the starting point of each factory
From low volume to
high volume
From inefficient
to efficient
Laggards
Innovators
Relative scale
U
n
i
t

c
o
s
t
Nonperformers
Shapers
Low High
Low
High
Market average
Market
average
Q4a_CRmini_Bank 10/28/02 11:55 AM Page 8
Innovators are highly efficient processors lacking the scale to exploit
their full value. For them, managers should consider scale-enhancing
options, such as insourcing or building shared service centers to con-
centrate internal volume. Last, the shapersbig, efficient processors
should pursue insourcing, either from less well-favored banks or through
mergers.
Driek Desmet is a principal in McKinseys Amsterdam office; David Fine is a principal
and Jacques Meyer is an associate principal in the Johannesburg office.
9 BA N K I N G BE H I ND T H E SC E N E S
Nonperformer
E X H I B I T 3
Smart-sourcing options
Core
Retail-banking product lines
Current accounts
Laggard Innovator Shaper
Noncore
Savings accounts
Payments
Checks
Loans
Mortgages
Mutual funds
Debit cards
Credit cards
5 4 3 2 1 5 4 3 2 1 5 4 3 2 1 5 4 3 2 1
4. External co-sourcing 5. Insourcing 2. Internal upgrades 3. Internal co-sourcing 1. Outsourcing
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