On Adam Smith, Financial Intermediaries and Deposits
July 4th, 2008 In The Wealth of Nations Adam Smith spoke of the profound role of specialization in the success of an economy. He recognized that the more specialized are the businesses within an economy the wealthier that nation becomes. This is the force, "the invisible hand", behind the growth of intermediaries and outsourced business processing in the wealthier economies. Such specialization extends to the increasingly widespread outsourcing of professional, administrative and financial services. Wealthy economies use many such professional intermediaries including lawyers, financial advisers, pension administrators, brokers and custodians to administer wealth; property managers who look after buildings and collect the rents on behalf of the owners. Advanced economies also outsource the processes of government administration including the collection of public access charges. Handling money on behalf of clients alters the flow of money as it is redirected via the professional intermediary. It also changes where the money deposits are held. Thus you would expect professional intermediaries to look after an increasing share of money flows and deposits. This is indeed observable from central bank analyses of deposits. Bank of England provides an easily accessible illustration.  A similar growth of deposits held by professional intermediaries is observable in ECB statistics. The chart shows that the deposits being looked after by these businesses are growing at a faster rate than balances deposited by individuals. The markets for professional intermediaries including outsourced business processors will continue to grow and attract more deposits. This is going to be true even during economic difficulties since such specialists enable head count reduction and cost saving (see the Financial Times on 25th July 2008 – "Capita benefits from credit crunch pressure"). But professional intermediaries encounter constraints to growth: competition, pricing and return on capital are key determinants in expansion. The larger business must use its financial power and skills to buy and implement technology that powers threshold changes in unit cost and service scope in order to push return on capital forward. In contrast with the banks, most third party administrators are not specialists in the infrastructure of money processing beyond the dependence upon banks to execute transactions. Their expertise is naturally in the main function of their business proposition: pension scheme management, property management, legal advice etc. Yet a big common feature in many of these businesses is that they must handle high volumes of client money deposits and high volumes of transactions. Money processing by intermediaries is more complex than bank transaction operations and the burden of compliance is greater. Success in these circumstances often depends so much upon the individual skills and experience of customer service personnel. These people are a high cost, skilled resource in limited supply. Yet their focus is essential because professional intermediaries lose customers as a result of administrative failures. And fines by regulators together with associated corrective work can cost so much of the profit and divert so much of management time. Leveraging skills in client money processing to apply consistent, high service levels at low compliance risk is a key to the continuing growth of professional intermediaries. Thus investment in smart technology to process client money is a key driver to managing the ongoing growth of the professional intermediary and to maximizing its return on capital. Paul Ormrod July 2008
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