Hemingway, outsourcing and the Eurozone crisis
Hemingway, outsourcing and the Eurozone crisis
As Ernest Hemingway reportedly said there are only three sports: mountain climbing, motor racing and bullfighting; all the rest are merely games. To that illustrious list I think we can add outsourcing. And here’s why…
Having spent the past couple of weeks in Spain and Italy talking to a some leading outsourcing advisory firms, I have come to believe that outsourcing can help to provide an elegant and innovative ‘out’ to the current financial crisis in the Eurozone.
Spain is dangerously close to needing support from the International Monetary Fund (IMF) and / or the European Central Bank (ECB). As the G20 leaders are gathered in the Mexican beach resort of Los Cabos, Europe’s beach-front restaurant owners in the Costa Del Sol could very well see the single currency fall apart unless its leaders decide within weeks to initiate a consolidated budget and tax policies for the Eurozone, and agree a strategy to pool responsibility for failing banks.
Paul Taylor, ratings president of Fitch has recently reported that, “there is a complete lack of confidence in the system, in the use of tools that could be available and even in the ones that have been announced. The problem through this crisis is that there has been a lack of a central view point.”
Governments and finance ministers inside the currency union remain divided on how to support Spain as its undercapitalised banks threaten to destabilise the Euro area’s fourth largest economy. Just two weeks after it agreed a €100bn bailout for its banks, it looks like the sovereign itself might need to be bailed out too. The interest rate (yield) on Spanish debt has in the past couple of days risen to a new high of 7.3%. At that level the cost of the interest on its loans will inevitably ensure that Spain becomes insolvent. Fidelity has estimated that Spain needs another €300bn over three years to meet its borrowing needs and it appears that the door to the bond market is now essentially closed.
How can Europe pull back from this brink? According to Roger Altman, the former US deputy Treasury secretary, it needs to immediately install a series of emergency financial tools to prevent an implosion and put forward a detailed, public plan to achieve full integration within 6 to 12 months.
Altman says there are three necessary elements to this plan. First, a larger and instantly available sovereign rescue fund that could temporarily finance Spain, Italy or others if (or when) those nations lose access to financing markets. Presently, the proposed European Stability Mechanism is too small and not ready for deployment.
Second, the Eurozone needs a central mechanism to insure all deposits in Eurozone banks. National governments should provide such insurance to their own depositors first but backup insurance is necessary to prevent a disastrous bank run, which has quietly been going on at Spain’s banks (particularly Bankia and BBVA) over the past couple of months.
Third, a unit like the US $700bn Troubled Assets Relief Program needs to be created, capable of injecting equity into the most delicate banks and forcing them to recapitalise.
With a distinct lack of solidarity coming from Chancellor Merkel (unsurprisingly given that she is trying to balance domestic politics with Eurozone economics), the chances that the ECB will become the lender of last resort and initiate the issuance of Eurobonds looks unlikely to happen in a timeframe that could keep Spain from further grief.
So how does outsourcing fit into this mix? Well, there appears to be two ways of handling the situation: to run away and wait for the dust to settle or take the ‘bull by the horns’ (sorry) and innovate.
The first of these options is being taken by Infosys, as reported by Reuters and The Times of India. "We have stayed away from these markets," said BG Srinivas, head of Europe at the Bangalore-based provider, referring to Greece, Portugal, Italy and Spain. "Especially in a crisis, I don't think that we will revisit that decision soon. It's the wrong time to enter."
This attitude strikes me as being eminently sensible, cautious… and wrong.
Outsourcing at its best is dynamic, innovative and drives positive change for clients and vendors alike. It was just this sort of situation that got me into outsourcing in the first place.
In the dim and distant past, the UK monopoly that was the Electricity Board was broken up into 12 regional electricity companies (RECs). At the bottom of this heap in terms of value, market cap and dynamism was East Midlands Electricity (EME).
Someone in that moribund business had the foresight to see that in order to transform the business they would have to get the firm’s aged technology refreshed – and approached the outsourcing market for help.
EME was in such a mess at the time that the vendors all thought that any investment they might make would be lost when the business either went bust or got snapped up by one of the bigger RECs; the risks were just too great.
Then along came Perot Systems.
Perot was just building its business in Europe and realised that they could radically transform EME using technology as the enabler. Perot did this by hiring not technicians, but change agents (when they were called business process re-engineering consultants!). These BPR specialists converted EME into a thriving business: the market cap moved EME from twelfth to sixth in the REC league table; Perot doubled the size of its original ITO deal from $300m to $600m; and using EME as its case study, went on to win California Light & Power (a $1.2bn deal).
I thought, “Anything that can make that much difference to service provider and client just has to be the way forward.”
But how is this relevant to the current Eurozone crisis? The answer comes from using outsourcing (and some clever thinking) to recapitalise the fragile banks.
Spain’s main problem is the unsustainable level of public and private debt driven by the real estate collapse since 2008. Mortgages that are not being paid sit like a suffocating mass on the banks’ balance sheets. If the banks can’t lend – and can’t borrow to lend – then we get the results we have been seeing across the Eurozone.
In the UK, there is currently £30bn worth of mortgages tied up in banks that are three months or more in arrears, creating both an impairment to balance sheets and a liquidity problem. Quite simply, the banks cannot lend against these distressed assets.
In order to avoid this, borrowers and lenders can agree to spread repayment of arrears, known as loan modification or capitalisation.
However, even if there is agreement between borrower and lender, the securitised nature of the mortgage market means that permission is needed from the bond holder – or holders. With the previous collapse of several banks in the US following Lehman Brothers, approvals teams have been disbanded or dissipated. In the US, Barack Obama has dedicated $75bn to the problem with little or no result.
The squeeze on Mr and Mrs Eurozone’s household budget as a result of falling real incomes, cost of living rises and increasing unemployment is negatively affecting households, and will inevitably lead to increased arrears in the coming quarters. Extended forbearance by lenders has clearly been successful to date in keeping the vast majority of households facing payment difficulty in their homes, but on-going pressures remain and the economic backdrop represents a significant challenge to the recent improving trend in arrears.
Data from the Bank of Spain this week showed Spanish banks’ “bad” loans rose to 8.72% of their outstanding portfolios in April, the highest since April 1994; this is over double the current UK position, highlighting concerns about the country’s financial sector.
If these distressed loans could be modified without recourse to the existing (and failed) approvals process, two things would happen. Firstly, fewer delinquent borrowers would lose their homes – which would save Europe on social housing and other costs. Secondly, if lenders no longer have an impairment, they will be able to start lending (and borrowing) again.
An astute outsourcing service provider in the Perot mould could capitalise on this to create a transaction-priced utility platform to provide such a loan modification service.
In a report just published by RBC Dexia, The Spanish investment market, evolution and change, it predicts that the shape of the Spanish banking industry is set to change dramatically in the future, as it faces the twin challenges of building growth and coping with reform within the on-going financial crisis.
Spanish investment managers are showing a strong interest for the outsourcing model. Most managers surveyed expect an increase in the number of fund managers outsourcing certain functions in coming years.
"The vast majority of our survey respondents said they felt there would be an increase in the outsourcing of certain functions. Up to 90% of those surveyed said there would be an increase in the diversity of functions outsourced in coming years, though there is a broad consensus some outsourcing processes may prove to be difficult," notes the report.
Cost reduction is no longer the only driver of outsourcing. Key drivers are the desire to reduce costs, access new technologies and improve service quality whilst keeping the cost of investment to a minimum.
Moreover, market complexity resulting from continuous adaptation to new regulations and the development of business models suggests a trend towards outsourcing solutions to simplify processes and lower access barriers to new technologies.
Even if the full benefits of outsourcing may only be seen in the medium term, the practice will have a strong impact on the shape of Spanish investment management companies and banks.
Ernest Hemingway was a gambler as much as a writer; he loved the thrill of ‘sports’. I think it’s high time that the outsourcing community gets its collective thinking cap on and demonstrates some of that Perot spirit. Let’s see if we can come up with ideas that might help us, our clients and the Eurozone countries in the coming months.