How Banks Think...and why you should care about it.

27 August 2024

Written by Viktoria Soltesz

Viktoria is the founder and CEO of PSP Angels Group, an independent payment consulting firm. With deep knowledge of the payment market and a vast network of banks and financial providers, Viktoria helps clients navigate their payment and banking options. Her team offers personalised consulting services to optimise payment strategies, reduce risks, and facilitate international fund transfers. Viktoria’s expertise in the evolving payments industry makes her a trusted advisor for businesses looking to expand globally. She ensures clients access the best payment solutions, including alternative methods like crypto payments, open banking, and fraud prevention tools, tailored to their specific needs.

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Introduction

Focusing on perfecting the product, competing for new markets, or spending millions on marketing is known to be necessary. But meanwhile, companies might be paying unnecessary banking fees and facing unexpected operational risks without even realising it. Planning for banking and payments is often overlooked, which can be a costly mistake.

To understand how banks (and other financial institutions, such as NeoBanks and wallet providers) think, we need to consider their primary goals and strategies. Banks focus on managing risk, maintaining profitability, and adhering to regulatory requirements. These elements shape every decision-making process within banks and influence how they interact with clients and the broader financial system.

International Regulations

Banks operate within a framework influenced by regulations and policies set by central banks and governments. These policies aim to achieve two main outcomes: taxing and maintaining legitimacy. Human nature dictates that if we can avoid paying tax, we often do, so there must be a built-in system in the payment flow to block tax evasion and illegal activities. This regulatory environment ensures that all financial activities are monitored and reported accurately, preventing tax evasion and maintaining the financial system's integrity. This oversight shapes how banks manage their operations and make decisions.

Risk Management

Risk management is another crucial element in understanding banking operations. Banks categorise businesses into different risk levels to assess potential issues. If they see an opportunity for tax evasion or illegal activities, they classify these businesses as high-risk - due to their potential for errors. Although its very subjective, banks also consider reputational risks when deciding to work with certain clients, such as those in controversial industries like arms manufacturing or adult entertainment. By balancing high-risk and low-risk clients, banks manage their overall risk exposure, ensuring their portfolios remain within acceptable limits.

Banks are stringent and cautious because they must report back to their regulators – the central banks. Central banks conduct regular examinations and audits of banks to ensure compliance with regulatory standards. They assess the financial health of banks, review their risk management practices, and ensure they adhere to laws and regulations. Central banks also use various tools and strategies to implement monetary policy, influencing the economy's money supply and interest rates. By adjusting the monetary base and controlling inflation, central banks help create a stable environment for economic growth.

Banks must also comply with international regulations, such as those enforced by the Office of Foreign Assets Control (OFAC). These regulations require banks to continuously update their systems and procedures to avoid penalties and maintain their ability to operate globally. Compliance with these regulations is crucial for banks to continue providing services across different regions and avoid legal repercussions.

Today, the rise of digital banking and financial technology (fintech) solutions pushes traditional banks to innovate and keep up with the latest technologies. However, this is a significant challenge. Many banks still operate on outdated systems, making it difficult to adopt new technologies and improve efficiency. Neobanks have technological advantages over traditional banks because they offer services primarily through mobile apps, providing innovative features and lower fees. But despite technological advancements, even neobanks depend on correspondent accounts for international transactions, facing similar risks and regulatory challenges as traditional banks. This interconnectedness underscores the importance of maintaining a robust risk management framework.

Banks operate within a complex framework shaped by central bank policies, fiscal policies, and international regulations. Knowledge of these factors helps create allies instead of adversaries in banking relationships. Understanding banking reasons and mechanisms allows for better risk assessment and cost evaluation, leading to informed decisions.

Getting Advice

Understanding how banks think requires recognising their need to balance risk management, regulatory compliance, and profitability. Mistakes might be very costly when making inexperienced or unintentionally bad decisions leading to costly or fatal consequences, not only in terms of lost funds but also in the valuable banking or payment relationships of the business.

It is crucial to have a payment and banking expert any time you plan any money movement. Ony professionals have a wealth of experience and in-depth knowledge of the latest banking and payment networks, bring a vast network of providers and banks, know the limits and risk appetite, and other valuable internal information, which is vital in a competing environment. The payment industry is characterised by rapid technological advancements and sophisticated regulatory frameworks, which only experienced payment professionals can navigate.