The operational maturity of a financial institution determines its ability to effectively process the accounting, cash flows, trading and transactional activity that supports its core business with the least associated cost and minimum risk. Today, reconciliation and system validation play a key role in a financial institution’s journey to operational maturity and constitute a significant part of core middle- and back-office processes. Effectively and efficiently managing these processes has never been more critical.

The back office accounts for around 20% of bank operating expenditure and McKinsey believes this can be reduced by up to 12% through simple, tactical improvements such as automation and consolidation, in areas including trade confirmation and reconciliation. This realisation is hitting home with financial institutions and is highlighted in a recent study by TowerGroup confirming that reconciliation investment is on the rise.

So financial institutions are starting to see there are rewards to be reaped through increased focus on reconciliation. But what is influencing this new found focus?

This greater focus on reconciliation is being driven by three primary factors. First, more robust internal system validation as well as more traditional ledger/accounting vs. external statement reconciliation is needed to comply with new regulations. Second, a greater level of reconciliation is also needed to achieve transparency of end-to-end business processes and more clearly identify compliance and market and operational risk. Third, lower performance and profitability of the financial sector from banks to hedge funds has resulted in greater cost pressures leading to a focus on operational cost reduction.

So let’s look at these three primary factors in more detail.

Firstly, regulation, arguably the biggest banking business shaper today, is changing the face of reconciliation by driving an increase in internal reconciliations processing. This has created an expansion into front-to-back, system-to-system style reconciliation through pressures from internal compliance and controls. This, in turn, has raised the profile of the reconciliation function above operational concerns of settlement and client reporting. The SEC highlighted the growing importance of system-to-system reconciliations in the recent UBS loss, stating  “controls in the inter-desk reconciliation process within the equities and fixed income, currencies and commodities businesses to ensure that internal transactions are valid and accurately recorded did not operate effectively”.

Secondly, complementing drivers around regulation, comes the increased need for transparency of end-to-end business processes to help clearly identify compliance and operational risk. This requires greater levels of reconciliation and a wider demographic of recipients. Regulations such as Dodd-Frank demand more transparency and accountability, mandatory clearing, execution and reporting for swaps, and higher capital and margin requirements for uncleared swaps. Organisations are already preparing for the impact on the back office, as trading migrates from bilateral agreements requiring collateral dispute management to central clearing models requiring discrepancy identification and repair. The effect on existing swap positions, which are reportedly $2 trillion under-collateralised, will mean organisations must sharpen their focus on optimising their collateral allocation and managing the process effectively in a timely fashion. Outside of OTC derivatives, liquid asset definitions in Basel III, as well as changes to Tier 1 capital requirements for financial institutions, have increased the need for accurate calculation, validation and visibility into cash positions to support intra-day liquidity, driving real-time reconciliation requirements.

Thirdly, operational cost pressures have put reconciliation further into the spotlight. As an area that carries the highest number of full time equivalents compared to other post-trade functions, systems and resource optimisation across reconciliation functions can result in a significant reduction in operational costs.

So while research suggests that financial institutions are planning to increase spending on reconciliations, what is the state of play today and how do they intend to disperse this investment?

Those that are leading the pack are rolling out enterprise reconciliation in rapid phases not only to boost customer service levels, satisfy growing regulation and cut operational risk, but to slash costs and build efficient frameworks to support ongoing growth, consolidation and optimisation.

Here is how they are winning the race to operational maturity:

■ Growth – by working to improve and automate the reconciliation environment, financial institutions can initiate rapid on-boarding of new business processes and expand existing ones with full change management controls in place which all helps to better manage business growth

■ Consolidation – through consolidation of operational environments, financial institutions can obtain economies of scale, greater visibility across processes and regions and lessen administrative burdens.

■ Optimisation – deploying business process analytics helps financial institutions track the effectiveness of rules and processes to identify areas of degrading automation or potential opportunities for further rules and enhanced levels of automation to boost optimisation.

As the economic winds of change gather pace and we swing from commodities resurgence, to debt crises, to the reshaping of the euro, life in operations looks set to be one fraught with challenges. It will be the institutions that can respond rapidly to change and deliver high quality and efficient services through streamlined operational processes that emerge intact. Those institutions that have been slow to react may find themselves limping into an operational chasm that, this time, they simply cannot climb out from.