Mid-tier banks are facing unique challenges in securities finance technology and business models

In our recent survey of banks on securities finance technology we found that mid-tier banks are facing some particular challenges not shared by their large or small competitors. There are clear indications that mid-sized firms have some very different strategic and technology priorities than either smaller or larger firms – in some cases, dramatically different.

In our survey, we interviewed bank professionals on key aspects of strategy and how technology was being used to facilitate these goals. We found that small and large firms often have more in common than those in the middle. Both small and large firms are likely to be investing in various revenue generating strategies. Mid-tier firms on the other hand are much more likely to be investing in cost reduction measures. As we note, “mid-size firms are more likely to cross an operating cost threshold in which the scale of their business generates higher operating overhead than smaller firms that can still handle the workload manually without an increase in human resource costs.”
There are other market realities unrelated to technology and operating costs impacted mid-tier firms in unique ways. Generally speaking, all banks are limited by the following factors:

  • Access to credit
  • Capital reserve requirements
  • Cost of liquidity

Access to credit: Small firms are much less likely to run up against credit limits in the normal course of their business, and large firms are much more likely to have generous credit lines with their counterparties. Those firms in the middle, though, may find their “upside” revenue potential hitting a credit wall. Many of these firms are operating at the upper end of their limits, leaving them little room to do more business and generate more revenue without a CCP or other factor that could free up credit access.
Capital reserve requirements: Small firms have limited capital (by definition) but the day-to-day variability in their capital reserve needs is both predictable and containable. Large firms are certainly encumbered by huge capital requirements and these are obviously limiting, but the market reality is that there is simply not enough business out there in many cases to really test these limits. For the firms in between, however, they are more likely to be in a squeeze. As with credit, these firms are usually operating at the upper limits of allowable capital utilization, making it problematic to grow or take on more of a share of the available business. Again, a CCP could be a mechanism to free up capital.
Cost of financing: Big firms get the most favorable pricing, small firms get the worst pricing – and mid size firms are somewhere in between. Transparency and narrow spreads, however, have substantially hurt the mid sized firms… all firms now have access to reliable, independent pricing data. In prior periods, mid sized firms benefited from “book based pricing” inefficiencies: they were big enough to get reasonable pricing from their larger counterparties and were able to price up the same positions with their smaller counterparties to make a comfortable spread. Most match book/conduit business was conducted by these mid sized firms. This is no longer as true as it was. Spreads simply aren’t wide enough to cover the costs of capital with all firms have similar degrees of transparency.
For more on how large, small and mid-sized banks are tackling their different market problems through technology, please check out our recent survey on bank technology in securities finance.

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