Banking survival 101: in Latin American banking, the momentum is toward consolidation and outsourcing. It's either that, or losing marketshare to foreign banks - Final Thoughts

THE GLOBAL environment in which financial institutions compete has changed dramatically over the past three years. The emerging markets crisis, mega-mergers and technological advances have all caused financial services providers to conclude that change will be a constant. In Latin America, a new wave of acquisitions, mergers and consolidations has forever altered the playing field. These acquisitions and investments began with the Spanish banks a few years ago. Now we are seeing US, Dutch and Canadian financial institutions looking to the Latin American region as a future market.

In Brazil, for example, there have been more than 50 acquisitions since 1994, with the effective marketshare by foreign banks doubling from 10 percent in 1996 to 20 percent in 1999. In Venezuela, foreign banks account for approximately 50 percent of the banking system -- compared to less than 2 percent in 1994. In Chile, foreigners control more than 40 percent of banks, while in Peru foreign banks account for 57 percent of the total marketshare.

There are several reasons why foreign banks continue to acquire additional marketshare in the region. The Latin American crisis of the mid 1990s and the global emerging market crisis of 1997-99 weakened many local banks and left them with few options other than to sell or merge. As a result, many Latin American governments changed their banking laws to put foreign banking ownership on par with local banks. From the perspective of local government, foreign ownership of banks means a greater financial commitment to local business, with a promise of long-term investment and support for indigenous markets. Overall, the mergers and consolidations have strengthened local banking systems, adding liquidity, lowering costs, improving technology and diversifying products and services.

For the acquiring foreign banks, new markets offer fresh opportunities for new revenue. Economies of scale mean that unit costs are lower. This, in turn, allows the "mega" banks to reduce fees, leading to higher volumes. Eventually, local competition becomes driven by and measured against global standards. Local banks can, at best, attempt to compete in a niche. But if local banks fail to compete by global standards, they will ultimately lose customers and marketshare.

In this dynamic win-win situation for local economies and global banks, the only losers are the indigenous banks, if they remain independent. They are faced with high operating costs, declining marketshare, increased competition and the need to make huge investments to upgrade. These local banks must consolidate, merge or acquire in order to maintain marketshare. Smaller banks that try to remain independent have to make a proactive choice in which areas they want to compete. They will need to lower transaction costs and strengthen product scope. But in order to lower costs, they must invest huge sums. These costs cannot be passed on to customers.

Rather than incurring the capital costs of upgrading, local banks can outsource functions to international banks that already have the infrastructure in place. Outsourcing these functions enables them to replace the fixed costs of infrastructure investments with variable, per-transaction costs. As these services are private-labeled, customers continue to maintain their relationships with their local banks. Partnering is also a way in which a financial institution can overcome perceived product gaps. Plus, the indigenous banks often have access to their partner banks' international networks and scope of products.

Financial institutions can outsource their trade reimbursements, clearing, check, collections, disbursements and other services. By outsourcing, these banks reduce costs, including those relating to staffing, systems, maintenance and development, regulatory compliance and operational space.

At the same time, per-transaction costs are substantially reduced, because economies of scale enable these services to be provided at a lower unit cost. In addition to the cost and competitive benefits, outsourcing frees capital for other business development.

Competition among Latin American and global banks is not going away anytime soon. In fact, globalization of the playing field is a dynamic that will continue to gain momentum. The hotly contested Banespa privatization demonstrates such globalization, as local and foreign banks jockey for position. For local banks, the new competitive landscape is forcing a re-evaluation of business practices, with a greater emphasis on long-term strategic planning. By taking a proactive approach -- and using outside resources to help control costs and widen product innovation -- local banks can meet the competitive challenge in their own backyards.

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