Survey Paper PDF

PRODUCTION AND OPERATIONS MANAGEMENT
Vol. 19, No. 6, NovemberDecember 2010, pp. 633664

ISSN 1059-1478|EISSN 1937-5956|10|1906|0633
POMS
10.3401/poms.1080.01163
r 2010 Production and Operations Management Society
DOI
Operations in Financial ServicesAn Overview

Emmanuel D. (Manos) Hatzakis
Goldman Sachs Asset Management, Goldman, Sachs & Co., New York, New York 10282-2198, USA, manos.hatzakis@gs.com
Suresh K. Nair
Department of Operations and Information Management, School of Business, University of Connecticut, Storrs, Connecticut 06269-1041, USA,
suresh.nair@business.uconn.edu
Michael L. Pinedo
Department of Information, Operations and Management Science, Leonard N. Stern School of Business, New York University,
New York, New York 10012-1106, USA, mpinedo@stern.nyu.edu
e provide an overview of the state of the art in research on operations in financial services. We start by highlighting a
number of specific operational features that differentiate financial services from other service industries, and discuss
how these features affect the modeling of financial services. We then consider in more detail the various different research
areas in financial services, namely systems design, performance analysis and productivity, forecasting, inventory and cash
management, waiting line analysis for capacity planning, personnel scheduling, operational risk management, and pricing
and revenue management. In the last section, we describe the most promising research directions for the near future.
Key words: financial services; banking; asset management; processes; operations

History: Received: November 2009; Accepted: July 2010 by Kalyan Singhal, after 2 revisions.
insurance (other than health), credit cards, mortgage

banking, brokerage, investment advisory, and asset
management (mutual funds, hedge funds, etc.).
1. Introduction
Over the past two decades, research in service operations has gained a significant amount of attention.
Special issues of Production and Operations Management
have focused on services in general (Apte et al. 2008),
and various researchers have presented unified theories
(Sampson and Froehle 2006), research agendas (Roth and
Menor 2003), literature surveys (Smith et al. 2007),
strategy ideas (Voss et al. 2008), and have discussed
the merits of studying service science as a new discipline
(Spohrer and Maglio 2008). A few books and a special
issue of Management Science have focused on the operational issues in financial services in particular (see
Harker and Zenios 1999, 2000, Melnick et al. 2000).
However, financial services have still been given scant
attention in much of the literature relative to other
service industries such as transportation, health care,
entertainment, and hospitality. The dilution of focus, by
concentrating on more general distinguishing features
does not do justice to financial services where some of
these characteristics are not central. (The more general
features that are typically being considered include
intangibility, heterogeneity, contemporaneous production and consumption, perishability of capacity, waiting
lines (rather than inventories), and customer participation in the service delivery.)
In this overview, we mean by financial services
primarily firms in retail banking, commercial lending,
1.1. Importance of Financial Services

Financial services firms are an important part of the
service sector in an economy that has been growing
rapidly over the past few decades. These firms primarily deal with originating or facilitating financial
transactions. The transactions include creation, liquidation, transfer of ownership, and servicing or
management of financial assets; they could involve
raising funds by taking deposits or issuing securities,
making loans, keeping assets in custody or trust, or
managing them to generate return, pooling of risk by
underwriting insurance and annuities, or providing
specialized services to facilitate these transactions.
Services is a large category that encompasses firms
as diverse as retail establishments, transportation
firms, educational institutions, consulting, information, legal, taxation, and other professional, real estate,
and healthcare. Even within financial services, there is
a wide variety of firms which are characterized by
unique production processes and specialized skills.
The processes and skills required for banking are
quite distinct from solicitations for credit cards, acquisitions of new insurance accounts, or the handling
of equity dividends and proxy voting, for example.
633
Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview
634
Table 1
Production and Operations Management 19(6), pp. 633664, r 2010 Production and Operations Management Society
Employment within Financial Services
Table 2 A sample of Financial Service Operations Job Titles, Responsibilities, and Products
Total employees
NAICS code
Title within financial services
Number
Titles
Products
Premiums, Claims, Refunds, Cash
flow and treasury management,
Customer statements, Loan servicing and support, Trade
confirmations, Reconciliations, Tax
reporting, Security settlements,
Mortgages
21,510
0.4
1,816,300
30.7
Non-depository credit intermediation

(credit cards, mortgage lending, etc.)
659,930
11.2
5223
Activities related to credit intermediation

(brokers for lending)
294,910
5.0
Vice President, Operations, Operations Manager, Financial Operations

Supervisor, Foreclosure and Bankruptcy Operations Manager, Risk
Operations Team Manager, Team
Manager Ops Control-Fixed Income,
National Director Operations, Hedge
Fund Operations Specialist, VP/
Director Of Operations
5231
Securities and commodity contracts

intermediation and brokerage
516,010
8.7
Nature of work/responsibility
5232
Securities and commodity exchanges
8,010
0.1
5239
Other financial investment activities

(mutual funds, etc.)
344,950
5.8
5241
Insurance carriers
1,258,050
21.3
5242
Agencies, brokerages, and other

insurance-related activities
907,880
15.3
5251
Insurance and employee benefit funds
47,730
0.8
5259
Other investment pools and funds
41,190
Brokerage operations, Improve customer service, resolves customer issues,

Review security pricing, Vendor support, Authorize net settlement, Hand-off of
data, ensure data integrity, Verifying transactions, Tracking missing transactions,
Leverage technology, Maintain ops controls, update policies, procedures, Backoffice support, Understand regulations, Ensure compliance, Attain profit and
revenue benchmarks, Reduce risk, Improve quality, Six sigma, Operational
processing efficiency, Problem solving, Ensure best practices, Streamline
activities, Manage key expenses, Work management tools, Monitors work flow,
Production/testing
5211
Monetary authorities-central bank

(Federal Reserve banks, etc.)
5221
Depository credit intermediation

(banks, credit unions, etc.)
5222
5,916,470
0.7
100.0
Source: Bureau of Labor Statistics, stat.bls.gov/oes/home.htm, May 2008.
Even though services account for about 84% of the

total employment in the economy, only about 4% of
this workforce is employed in financial services. This
might come as a surprise to some because financial
services transactions in one form or another are so
ubiquitous in our lives. Not surprisingly, however, the
number of financial services firms is about 7% of the
total non-farm firms and contributes about 13% of total non-farm sales. Only wholesale trade has a similar
employment and number of firms with a larger contribution to sales.
Table 1 provides employment information for the
sub-codes within financial services. As can be seen,
retail banks, insurance companies, and insurance brokers together employ about two-thirds of the financial
services workforce. A cursory look at the table gives a
sense of the diversity of the services sector. Clearly
operations management problems and approaches
used to solve them have to be customized for particular types of serviceswe already know that what
works for manufacturing may not work for services,
but by looking at Table 1 we can also realize that what
works for retail trade or recreational services may not
work for financial services. A quick glance through
Monster.coms job openings for operations managers
in financial service firms shows a wide variety of titles, responsibilities, and products related to such
jobs. This is shown in Table 2, and gives a sense of the
wide swath of topics that could be covered in academic research on financial services operations. As
financial services are such an important segment of
Source: Monster.com jobs listings during the week of March 8, 2009.
the services economy, we wish to explore whether

operations in financial services are indeed unique, or
share several characteristics with services in general.
That is the motivation for this special issue.
1.2. Distinctive Characteristics of Operations in
Financial Services
There are several unique operational characteristics
that are specific to the financial services industry and
that have not been given sufficient attention in the
general treatment of services in the extant literature.
We list below a number of these unique operational
characteristics and elaborate on them in what follows:
Fungible products with an extensive use of
technology
High volumes and heterogeneity of clients
Repeated service encounters
Long-term contractual relationships between
customers and firms
Customers sense of well-being closely intertwined with services
Use of intermediaries
Convergence of operations, finance, and marketing.
1.2.1. Fungible Products with an Extensive Use
of Technology. One obvious difference between
operations in financial services and operations in
manufacturing and in other service industries is that
the widgets in financial services are money, or related
financial instruments. As there is a declining use of the
physical vestiges of money such as coins, currency,

bond, or stock certificates, much of the transactions are

in the form of bits and bytes. Thus inventory is fungible
and can be transported, broken up, and reconstituted
(facilitating securitization, e.g.) in malleable ways that
are simply not possible in manufacturing or in other
service industries (see, e.g., the recharacterization of
bank reserves in Nair and Anderson 2008).
The increased use of online transactions (in brokerages, credit card payments, retail banking, and retirement accounts, e.g.) are forcing fundamental changes in
the way operations managers think about capacity issues (for statement mailing and remittance processing,
or for transfer of ownership in securities, e.g.). The fact
that adoption of online transactions is still growing and
has not yet matured and leveled off makes capacity
planning a big challenge. Yet we are aware of very little
research that would help managers deal with this issue.
1.2.2. High Volumes and Heterogeneity of Clients.
Financial services are characterized by very high
volumes of customers and transactions. Furthermore,
customers are not all alike. In many firms, a small
fraction of the customers generate most of the profits,
giving the firms an incentive to view them differently
and provide differential treatment, given the firms
limited resources. For example, high net worth
individuals may be treated differently by asset
management firms; banking clients who keep high
balances in checking accounts and transact heavily may
be handled differently from depositors who keep almost
all their funds in savings accounts and certificates of
deposits (CDs) and transact minimally; revolvers (i.e.,
customers who carry over balances from one month to
the next) may be regarded differently from transactors
(customers who do not revolve balances) by a credit
card firm. In most non-financial services, because of
a limited number and sporadic interactions with
customers (e.g., in restaurants and amusement parks),
one customer is considered, for the most part, similar to
the next one in terms of margins and attention required.
1.2.3. Repeated Service Encounters. In contrast to
other service industries, where research typically
focuses on a single encounter (the moment of
truth, when the rubber hits the road), financial
services are characterized by repeated service
encounters or potential encounters between the firm
and its customers due to regular monthly statements,
year-end statements, buy/sell transactions, insurance
claims, money transfers, etc. Anecdotal evidence from
the brokerage and investment advisory industry
suggests that clients with low asset balances and
transaction volumes contribute the least to firm revenue
and the most to operational cost through calls for
customer service. One online bank discouraged calls to
customer service because it found that just a few calls by
635
a client could wipe out all the profit from the clients
savings account. Very little research in service operations
management has focused on this issue. New customers
constitute another major group that is more likely to
make calls with billing questions or inquiries regarding
their statements. Should billing and statementing to new
customers be handled differently, perhaps with more
care, than to existing customers? Obviously, if this
observation is true, differential handling can reduce the
traffic to call centers. Existing call center research usually
assumes the call volume to be a given, for the most part,
and the focus is on managing the traffic. This is akin to
traditional manufacturing where it was assumed that
large setup times were a given, and a good way to
manage would be to use an optimal batch size. One
learns to live with such a constraint. Not until just in
time (JIT) manufacturing came along did managers
question why setup times were large and what could be
done to reduce them.
At one credit card company, operations managers
struggled for years to cope with volatile demand in
bill printing, mailing, remittance processing, and call
center operations. Daily volumes could fluctuate
easily between half a million and one and a half
million pieces of mail in remittance processing, and
managers were reconciled to high overtimes and idle
times because they felt they had no control over
when customers mailed in their checks, and reducing float was important. Call volumes at the call
centers were similarly volatile, as were volumes in
the bill printing and mailing operations. This situation continued until someone recognized that all
these problems were interconnected and to a large
extent within the control of the firm. As it happens,
the portfolio of current customers is distributed into
about 25 cycles, one for each working day of the
month. For example, customers in the 17th cycle are
billed on the 17th working day of the month. Care is
taken to ensure that customers in the same zip code
are put in the same cycle so volume-mailing discounts from the US postal service can be obtained,
and the cycles are level loaded. However, this allocation to cycles was carried out several years back
and over time some customers had closed their
accounts while new customers had been added to
existing cycles, resulting in large differences in
the numbers of customers in the various cycles,
and in a wide variability in the printing and mailing
of monthly statements. On the remittance side, an
analysis found that there was less randomness in
customer payment behavior than one would expect.
There were broadly four cohorts of customers:
one that sent in payments on receipt of the statement, a second that mailed checks based on due
date, a third that acted based on salary payment
date, and a fourth that acted randomly. The first two
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cohorts, the largest ones, were in fact dependent on

the cycles that the firm had set up many years back.
Similarly, billing calls were also heaviest soon after
the statement was received by the customer, again
traffic that was determined by the cycles created by
the firm.
If the cycles could now be level loaded, many of
these problems would disappear (similar to what
happened in manufacturing when setup times were
dramatically reduced thereby enabling lean operations). But there was a problemthe firm needed to
inform each customer if their cycles were moved, for
good reason because customers needed to plan their
finances. However, this notification was not necessary if the move was to be within 3 days from
their current cycle. An optimization model found
that this constrained move was sufficient to take care
of the vast majority of moves that were initially
thought to be necessary.
This example illustrates how stepping back and
taking a broader view of the situation and collaborating across processes can have a major impact on
financial service operations, something that is lacking in the current literature.
1.2.4. Long-Term Contractual Relationships Between
Customers and Firms. Connected to the previous
characteristic of repeat encounters is the recognition
that, unlike in other services, in financial services the
firm and the customer have a relatively long-term
contractual arrangement. However, technology and information availability makes comparison shopping
easy, resulting in easy switching between firms, and
therefore high attrition. This loss of customers makes the
acquisition process very important to the continued
growth and profitability of the firm. Similarly, loyalty
programs (such as rewards and balance transfer
programs in the credit card business) are important to
stanch the bleeding. The design and execution of these
programs are based on complicated processes that need
to consider risks, costs, redemptions, incremental sales,
scheduling and sequencing of offers, etc. Researchers in
financial services operations, by not making their
presence felt in these areas, are missing the boat with
regard to issues that are the most important (must do
activities) for the firm, and may be paying instead too
much attention to relatively mundane and low-impact
issues (good to do activities).
Just as the above processes aim at increasing revenue, there may be other processes that are put in
place to reduce unnecessary costs. In the insurance
business, for example, the claims processes may primarily revolve around a call center, which has
attracted sufficient attention in the literature as we
will see later. But unnecessary costs can be reduced
by fraud prevention and detection, and subrogation
activities (money the firm pays out but is owed

to it by other carriers). Timely intervention can
avoid expiry of opportunities to collect dollars owed,
and more attention could be paid to even small
opportunities. There is an extensive literature in risk
and insurance journals on scoring for fraud prevention and detection, but leveraging that information in the claims process can benefit from an
operations perspective.
Another example from the insurance industry
concerns workers compensation claims, where the
process for handling workplace injury can have
long tails spanning several years before the claim
is closed. The process is complicated with interactions between the worker, the employer, medical
practitioners, hospitals, state authorities, and lawyers (both on the staff of the insurance firm and
panel counsel, i.e., lawyers who are hired on an
ad hoc basis). There are several opportunities
here (Jewell 1974) to speed up the process (and
speed up the workers return to work, which is in
the insurance firms interest), reduce costs, detect
fraud, ensure that review triggers are not overlooked, increase the utilization of staff counsel
compared with panel counsel by better scheduling
of appearances for hearings, etc. We are unaware
of any recent operations management literature in
this area.
1.2.5. Customers Sense of Well-Being Closely
Intertwined with Services. Along with the ease of
manipulating the putty at the core of the financial
services process comes the responsibility of working
with something that is so close to the customers sense
of well-being and worth. Poor operations management that results in delays, quality issues, or sloppiness can and will attract regulatory scrutiny and
unfavorable publicity, and will generate immediate
rebukes from the customer in the form of calls,
complaints, and because the account can be easily
moved around, customer attrition. At least two factors
make the detection of errors due to operational faults
and their exposure to the clients relatively easy in
financial services:
(i) the amount, frequency, and detail of communication and disclosure as required by regulation,
and
(ii) the clients heightened propensity and incentive
to check for error in something so closely linked
to their livelihood and sense of security.
Because of the above, tolerance for error is significantly lower than in other industries. For example,
faulty processes resulting in incorrect calculations of
interest amounts in savings, mortgage loan, or credit
card accounts, or in inappropriate handling of stock

dividend payments, become obvious immediately

after monthly statements are sent out.
The above customer service issues are distinct
from the perceived quality of the performance of individual customer brokerage portfolios, retirement
accounts, annuities, mutual funds, and interest accrued
in retail banking. With the plethora of information
available comparing a customers firm with others in
the same space, moving an account to the competition
is only a few clicks away. Even though performance
may depend on the economy, the stock market, investment research, and fund manager performance,
recognizing the costs (Schneider 2010) and capacity
issues (the increased transactions during market turbulence, e.g.) are important operations management
concerns that have received little attention.
1.2.6. Use of Intermediaries. This is an important
aspect of the financial services industry. In some cases
a direct-to-consumer approach is used (credit cards);
in other cases most of the customer facing work is
done by intermediaries (financial advisors, insurance
agents, annuity sales through banks, etc.); and in still
other cases the firms employees and its agents have
to collaborate with one another (insurance). Working
through an intermediary entails a set of issues not
normally seen in other services that function without
intermediaries. For example, financial product and
service design and delivery get filtered through the
prism of what the agent feels is in his or her own best
interest. At times, the relationship between the firm
and the intermediary is not exclusive, hereby adding a
layer of complexity because the customer may choose
between products from competing firms. Therefore,
what gets planned in the corporate offices of the
financial services firms and what is seen by the
customer may be quite different. The operations
management literature, to our knowledge, has not
paid attention to product and service design in such
situations, because the implications on customer
lifetime interactions with the firm go much beyond
initial pricing, product features, and the inventory of
brochures left with the agents.
1.2.7. Convergence of Operations, Finance, and
Marketing. There is probably no other industry where
this convergence is more pronounced. These functions
are supported and enabled by a healthy dose of
statistics, technology, and optimization. By focusing
only on back-office operations such as call centers,
researchers in service operations are leaving a lot on the
table. There is very little research in the service
operations literature that leverages this convergence,
which requires a choreography, as described by Voss
et al. (2008), who put it in a more limited context of
operations and marketing. For example, the client
637
acquisition process in full-service retail brokerage and

investment advisory firms begins at the corporate level,
where it draws resources from marketing, strategy,
information technology, and operations, and is ultimately implemented through the sales force of brokers/
financial advisors. Customer acquisition at a credit card
company is a competitive differentiator and a complex
process focused on direct mail campaigns. At many
large firms, the budgets for direct mail run into several
hundred million dollars annually. By focusing on the
billing mailroom, collections, call centers, and billing
call centers, researchers in service operations are working on a problem akin to quality inspectors at the end of
the production lineby then it is too late, the volumes
of mail and calls are baked in during the mailing
campaign creation, while their skills could have made
the mailings more effective and targeted (given the
minuscule response rates), resulting in fewer delinquent accounts (requiring fewer outbound collection
calls), and perhaps also fewer billing calls to inbound
call centers.
At a more sophisticated level, very few credit card
firms use contact history in mailing solicitations,
which may result in repeated mailings to chronic
non-responders. The managers developing campaign
strategies may not have the analytical background that
a researcher in service operations can bring to bear,
and the cycle time for campaign creation is typically
so long and complicated that much attention gets
expended on scoring for credit and response, file
transfers from credit bureaus and data vendors, scrubbing of data, etc. These complicated processes leave
little time to incorporate experience from a previous
mailing because a reading of the results of that mailing
takes time (prospective customers may not respond
immediately, even if they do respond), and file structures may not have been designed to carry information
about previous contacts and the response to them.
Another indication of this convergence is that the
majority of the undergraduate and MBA hiring at an
investment bank in the greater New York City area
from one of the regions business schools is in the
COOs operation, whether the student concentrations are in finance, marketing, information systems,
or operations.
The foregoing does not imply that no significant
work has been done in the research on financial
service operations, just that areas of work have had a
narrow focus. The purpose of this article and this
special issue is to begin to expand that focus and
encourage research in neglected or emerging areas in
financial service operations. We will survey existing
research next, not only where the attention is only on
financial service operations, but also where research
in service industries in general has substantial application in financial service operations. In Appendix
638

A, we provide an overview of the various operations

processes in financial services and highlight the
ones that have been addressed in operations management literature.
This survey paper is organized as follows. Sections
2 through 9 go over eight research directions that are
of interest from an operations management point of
view. The first couple of sections consider the more
general research topics, whereas the later sections go
into more specific topics and more narrowly oriented
research areas. Section 2 focuses on process and system design in financial services, while section 3
considers performance measurements and analysis.
Section 4 deals with forecasting, because forecasting
plays a major role in virtually every segment of the
financial services industry. The next section focuses
on cash and liquidity management; this section relates cash management to classic inventory theory.
Sections 6 and 7 deal with waiting line management
and personnel scheduling in retail banking and in
call centers. Even though these two topics are strongly
dependent on one another, they are treated separately;
the reason being that the techniques required for dealing with each one of these two topics happen to be
quite different from one another. Section 8 focuses
on operational risk in financial services. This area
has become very important over the last decade and
this section describes how this area relates to other
research areas in operations management, such as total quality management (TQM). Section 9 considers
product pricing and revenue management issues. The
last section, section 10, presents our conclusions and
discusses future research directions.
2. Financial Services System Design

Service systems design has attracted quite a bit of
attention in the academic literature. It is clear that
service design has to be as rigorous an activity as
product design, because the customer experiences the
service first hand, much like a product, and comes
away with impressions regarding the quality of service. Although the quality of service delivery depends
on a number of factors, such as associate training,
technology, traffic, neighborhood customer profile,
access to the service (channel access), and quality of
resource inputs, the service experience gets baked into
the process at the time of the service design itself, and
therefore a proper service design is fundamental to
the success of the customer experience.
2.1. Aspects of Service Design
Service research has usually focused on capacity management (type of customer contact, scheduling, and
deployment) and the impact of the response to variability on costs and quality. For long the nature of
customer contact has influenced service design think-
ing by creating front-office/back-office functions

(Sampson and Froehle 2006, Shostack 1984). Shostack
also pioneered the use of service blueprinting for
identifying fail points where the firm may face quality
problems. She illustrated this methodology for a discount brokerage and correctly identified that many of
the operational processes are not seen by the customer;
she then focused on the telephone communication step,
the only one with client contact. This focus on client
contact tasks, whether in the front office or in the back
office, is widespread in services research in general and
in research on financial services operations in particular.
One reason may be that service researchers have found
it necessary to motivate their work by differentiating
services from products (whether it is service marketing
vs. product marketing, or service design vs. product
design), and client contact is an obvious differentiator.
From the outset, it has been clear that service
processes are subject to a significant amount of randomness from various sources. Frei (2006) discusses
the various sources of randomness in service processes
and how firms react to them in the design of their
services. She identifies five types of variability
customer arrival variability, request variability, customer capability variability, customer effort variability,
and customer preference variability. She states that
firms design services to factor in this variability by
trying either to accommodate the variability at a higher
cost (cross training of employees, increased automation, variable staffing) or to reduce the variability with
a view to increasing efficiency rather than cost (off
peak pricing, standard option packages, combo meals).
2.2. Focus on Single Encounters
Much of the services literature, however, focuses on
single service encounters, which are common in services such as fast food. Even if a customer repeatedly
visits the same restaurant, there is not the kind of
stickiness to the relationship as can be found in
financial services. Retail banking seems to have
attracted the most attention among financial services
with respect to service design, but here again the
focus is on disparate single visits to the branch or
Automated Teller Machine (ATM), rather than as part
of a life cycle of firmcustomer interactions. Other
than meeting the branch manager when opening an
account, there is usually no other recognition of the
stage of the relationship in the delivery of service.
Perhaps this will change with time as more firms start
experimenting with their service delivery design as
Bank of America has been doing (Thomke 2003).
2.3. Descriptive vs. Prescriptive Studies of Financial
Services
Several descriptive studies have focused on retail
banking (Menor and Roth 2008, Menor et al. 2001),

substitution of labor with information technology

(Fung 2008), the use of customer feedback to improve
customer satisfaction (Krishnan et al. 1999), the use
of distribution channels (Lee et al. 2004, Xue et al.
2007), self-service technologies (such as ATMs,
pay at the pump, see Campbell and Frei 2010a, b,
Meuter et al. 2000), online banking (Hitt and
Frei 2002), and e-services in general (see Boyer et al.
2002, Ciciretti et al. 2009, Clemons et al. 2002, Furst
et al. 2002, Menor et al. 2001). These studies talk about
the types of customers who use the various different
channels and how firms have diversified their delivery of services using these new channels as newer
technologies have become available. However, they
are usually descriptive, rather than prescriptive, in
that they speak about how existing firms and customers have already adopted these technologies,
rather than what they should be doing in the future.
For example, there are few quantitative metrics to
measure a product (e.g., its complexity vis-a-vis
customer knowledge), a process (e.g., face to face vs.
automated), and proximity (on-site or off-site) to help
a manager navigate financial service operations strategies from a design standpoint based on where her
firm is now. In that sense, financial service system
design still has ways to go to catch up with product
design (product attributes, customer utility, pricing,
form and function, configuration, product development teams, etc.) and manufacturing process design
(process selection, batch/line, capacity planning,
rigid/flexible automation, scheduling, location analysis, etc.). Because batching and lot sizing issues have
been of considerable interest in the history of the
study of manufacturing processes, and because online
technologies have made the concept of batching considerably less important, it would be interesting to see
how research in service systems design unfolds in the
future. One paper with prescriptive recommendations
for service design in the property casualty insurance
industry is due to Giloni et al. (2003).
3. Financial Services Performance

Measurement and Analysis
3.1. Best Practices and Process Improvement
Many service firms are measuring success by factors
other than profitability, using such factors as customer
and employee loyalty, as measured by retention,
depth of relationship, and lifetime value (Heskett
et al. 1994). Chen and Hitt (2002), in an empirical
study on retention in the online brokerage industry,
found that ease of use, breadth of offerings, and quality reduce customer attrition. Balasubramanian et al.
(2003) find that trust is important for online transactions, because physical appearance of branches, etc.
no longer matter in such situations. Instead, perceived
639
environmental security, operational competence, and

quality of service help create trust.
In general, service quality is difficult to manage and
measure because of the variability in customer expectations, their involvement in the delivery of the
service, etc. In general, there may be two different
measures of service quality that are commonly used:
the first refers to and measures the actual service provided (e.g., customer satisfaction, resolution, etc.), the
second may refer to the availability of service capacity/personnel (e.g., service level, availability, waiting
time, etc.). The first type of quality measure is not as
nebulous in financial services where the output is
generally related to monetary outcomes. If there is an
error in the posting of a transaction, or if quarterly
returns from a mutual fund are below industry performance, there is an immediate customer reaction
and the points in the service design that caused such
failures to occur is apparent, whether it is in remittance processing or in the hiring of a fund manager.
Quality in financial services is not influenced by such
matters as the mood of the customer, as may be the
case in other services. This makes ensuring quality in
financial services more doable and one of the foci of
the research in operational risk management which
we will discuss later.
Roth and Jackson (1995) found that market intelligence and imitation of best practices can be an
effective way of improving service quality, and that
service quality is more influenced by service process
choices and the cumulative impact of investments
than by peoples capabilities. Productivity measurement in services is also a challenge (Sampson and
Froehle 2006). Bank performance as a result of process
variation has been studied by Frei et al. (1999).
This current special issue of Production and Operations Management provides some interesting new
cases of process improvement in financial services.
The paper by Apte et al. (2010), Analysis and
improvement of information-intensive services: Evidence from insurance claims handling operations,
presents a classification of information-intensive
services based on their operational characteristics;
this paper proposes an empirically grounded conceptual analysis and prescriptive frameworks that can be
used to improve the performance of information- and
customer contact-intensive services. The paper by De
Almeida Filho et al. (2010) focuses on collection processes in consumer credit. They develop a dynamic
programming model to optimize the collections process in consumer credit. Collection processes have
been the Cinderella of consumer lending research,
because psychologically lenders do not enjoy analyzing their mistakes, and also once an accounting loss is
ascribed to a defaulted loan, there had been little
incentive for senior managers to keep track of how
640

Figure 1 Typical Structure of an Asset Management Organization
Asset management
o Investment research, management,
and execution
o Sales and client relationship
management
o Product development
o Marketing
Independent internal oversight

functions
o Compliance, legal and regulatory
o Controllers
o Credit and market risk
management
o Internal audit
o Valuation oversight
Internal support teams

o Billing
o Human resources
o Operations
o Operational risk
o Performance
o Tax
o Technology
o Treasury
External service providers

o Brokerage, clearing and execution
o Custody and trust services
o Fund administrator
o Prime brokerage and financing
o Reputable auditor
o Valuation (reputable third-party
valuation firm)
much will be subsequently collected. The paper by

Buell et al. (2010) investigates why self-service
customers are more reluctant to change their service
provider. This papers primary contribution is to
investigate how satisfaction and switching costs contribute to retention among self-service customers. This
is a particularly important issue in the financial services industry where considerable investments have
been made in developing self-service distribution
channels, and migrating customers to them.
3.2. An Example of Best Practices: Asset
Management
Asset management provides an interesting example of
an area within the financial services sector that has
been receiving an increasing amount of research
attention with regard to best practices from various
operations management perspectives. The body of
research on operations management in asset management is growing, however, not always produced by
operations management researchers, but often by
those in the finance world (Black 2007, Brown et al.
2009a, b, Kundro and Feffer 2003, 2004, Stulz 2007),
who examine operational risk issues in hedge funds.
A collection of operations management research
papers in asset management can be found in a recent
book by Pinedo (2010). Alptuna et al. (2010) present a
best practices framework for the operational infrastructure and controls in asset management and argue
that it is possible to effectively implement such a
framework in organizations that enjoy a strong, principle-based governance. They examine conditions
under which the cost-effective strategy of outsourcing asset management operations can be successful
for asset managers and their clients. Figure 1, which
has been adapted from Alptuna et al. (2010), shows
the multiple constituent parts that must work together

in order for a typical asset management organization
to function effectively. Figure 2, also adapted from
Alptuna et al. (2010), lists the functions in the investment management process according to their distance
from the end client. Typically, the operations-intensive
functions reside in the middle and back offices;
accordingly, the untapped research potential of operations in asset management must be sought there. One
can create a similar framework, as shown in Figures 1
and 2, for a typical retail bank, credit card issuer,
mortgage lender, brokerage, trust bank, asset custodian, life or property/casualty insurer, among others,
none of which is less complex than an asset manager.
Outsourcing operations adds to the complexity by introducing elements of quality control for outsourced
pieces and coordination between the main organization and the third-party provider (State Street 2009).
To develop their framework, Alptuna et al. (2010)
draw heavily on asset management industry resources
on best practices, namely the Managed Funds Associations Sound Practices for Hedge Fund Managers
(2009), the Report of the Asset Managers Committee to
the Presidents Working Group on Financial Markets
(2009), the Alternative Investment Management Associations Guide to Sound Practices for European Hedge
Fund Managers (2007), and the CFA Institutes Asset
Manager Code of Professional Conduct (2009).
Schneider (2010) provides a framework for asset
management firms to analyze their costs. Arfelt (2010)
proposes an adaptation of the Lean Six Sigma framework used in automobile manufacturing for asset
management. Biggs (2010) advocates a decentralization of risk management, accountability as well as
technology and expense control in asset management
firms. Cruz (2010) argues that the focus of cost man-

Figure 2
Front
office
Middle
office
Back office
641
Investment Management Process Functions
Asset management
- Investment research
- Portfolio and risk
management
- Sales and client
relationship
management
- Product development
Investment operations
- Billing
- Cash administration
- Client data warehouse
- Client reporting
Trade execution
- Financial
Information
eXchange (FIX)
connectivity
- Trade order
management and
execution
Fund accounting
- Daily, monthly, and adhoc reporting
- General ledger
- NAV calculation
- Reconciliation
- Security pricing
Global custody
- Assets safekeeping
- Cash availability
- Failed trade
reporting
- Income/tax
reclaims
- Reconciliation
- Trade settlement
agement programs at asset management firms should

be strategic and tactical (see also Cruz and Pinedo
2009). Nordgard and Falkenberg (2010) give an IT
perspective on costs in asset management. Campbell
and Frei (2010a) examine cost structure patterns
in the asset management industry. Amihud and
Mendelson (2010) examine the effect of transaction
costs on asset management, and study their implications for portfolio construction, fund design, trade
implementation, cash and liquidity management, and
customer acquisition and development strategies.
3.3. Performance Analysis Through Data
Envelopment Analysis (DEA)
There are numerous studies on performance and productivity analyses of retail banking that are based on
DEA. DEA is a technique for evaluating productivity
measures that can be applied to service industries in
general. It compares productivity measures of different entities (e.g., bank branches) within the same
service organization (e.g., a large retail bank) to one
another. Such a comparative analysis then boils down
to the formulation of a fractional linear program. DEA
has been used in many retail banks to compare
productivity measures of the various branches with
one another. Sherman and Gold (1985), Sherman and
Ladino (1995), and Seiford and Zhu (1999) performed
such studies for US banks; Oral and Yolalan (1990)
performed such a study for a bank in Turkey; Vassiloglou and Giokas (1990), Soteriou and Zenios (1999a),
Corporate actions
processing
Data management
OTC derivatives
processing
Performance
and analytics
- Portfolio
recordkeeping
and accounting
- Reconciliation
processing
- Transaction
management
Transfer agency
- Shareholder
servicing
Zenios et al. (1999), Soteriou and Zenios (1999b), and

Athanassopoulos and Giokas (2000) for Greek banks;
Kantor and Maital (1999) for a large Mideast bank;
and Berger and Humphrey (1997) for various international financial services firms. These papers discuss
operational efficiency, profitability, quality, stock market performance, and the development of better cost
estimates for banking products via DEA. Cummins
et al. (1999) use DEA to explore the impact of
organizational form on firm performance. They compare mutual and stock property liability companies
and find that in using managerial discretion and costefficiency stock companies perform better, and in lines
of insurance with long payouts mutual companies
perform better.
Cook and Seiford (2009) present an excellent overview of the DEA developments over the past 30 years
and Cooper et al. (2007) provide a comprehensive
textbook on the subject. For a good survey and
cautionary notes on the pitfalls of improper interpretation and use of DEA results (e.g., loosely using the
results for evaluative purposes when uncontrollable
variables exist), see Metters et al. (1999). Zhu (2003)
discusses methods to solve imprecise DEA (IDEA),
where data on inputs and outputs are either bounded,
ordinal, or ratio bounded, where the original linear
programming DEA formulation can no longer be used.
Koetter (2006) discusses the stochastic frontier
analysis (SFA) as another bank efficiency analysis
framework, which contrasts to the deterministic DEA.
642

4. Forecasting
Forecasting is very important in many areas of the
financial services industry. In its most familiar form in
which it presents itself to customers and the general
public, it consists of economic and market forecasts
developed by research and strategy groups in brokerage and investment management firms. However, the
types of forecasting we discuss tend to be more internal to the firms and not visible from the outside.
4.1. Forecasting in the Management of Cash
Deposits and Credit Lines
Deposit-taking institutions (e.g., commercial banks,
savings and loan associations, and credit unions) are
interested in forecasting the future growth of their
deposits. They use this information in the process of
determining the value and pricing of their deposit
products (e.g., checking, savings, and money market
accounts, and also CDs), for assetliability management, and for capacity considerations. Of special
interest to these institutions are demand deposits,
more broadly defined as non-maturity deposits.
Demand deposits have no stated maturity and the
depositor can add to the balance without restriction,
or withdraw from on demand, i.e., without warning
or penalty. In contrast, time deposits, also known as
CDs, have a set maturity and an amount established
at inception, with penalties for early withdrawals.
Forecasting techniques have been applied to demand
deposits because of their relative non-stickiness due to
the absence of contractual penalties. A product with
similar non-stickiness is credit card loans. Jarrow and
Van Deventers (1998) model for valuing demand
deposits and credit card loans using an arbitrage-free
methodology assumes that demand deposit balances
depend only on the future evolution of interest rates;
however, it does allow for more complexity, such as
macroeconomic variables (income or unemployment),
and local market or firm-specific idiosyncratic factors.
Janosi et al. (1999) use a commercial banks demand
deposit data and aggregate data for negotiable order
of withdrawal (NOW) accounts from the Federal
Reserve to empirically investigate Jarrow and Van Deventers model. They find demand deposit balances to be
strongly autoregressive, i.e., future balances are highly
correlated with past balances. They develop regression
models, linear in the logarithm of balances, in which
past balances, interest rates, and a time trend are predictive variables. OBrien (2000) adds income to the set
of predictive variables in the regression models. Sheehan (2004) adds month-of-the-year dummy variables in
the regressions to account for calendar-specific inflows
(e.g., bonuses or tax refunds), or outflows (e.g., tax
payments). He focuses on core deposits, i.e., checking
accounts and savings accounts; distinguishes between
the behavior of total and retained deposits; and devel-
ops models for different deposit types, i.e., business and

personal checking, NOW, savings, and money market
account deposits.
Labe and Papadakis (2010) discuss a propensity
score matching model that can be used to forecast the
likelihood of Bank of Americas retail clients bringing in
new funds to the firm by subscribing to promotional
offerings of CDs. Such promotional CDs carry an
above-market premium rate for a limited period of
time. Humphrey et al. (2000) forecast the adoption of
electronic payments in the United States; they find that
one of the reasons for the slow pace of moving from
checks to electronic payments in the United States is the
customers perceived loss of float. Many electronic payment systems now address this, by allowing for
payment at the due date rather than immediately.
Revolving credit lines, or facilities, give borrowers
access to cash on demand for short-term funding needs
up to credit limits established at facility inception. Banks
typically offer these facilities to corporations with investment grade credit ratings, which have access to
cheaper sources of short-term funding, for example,
commercial paper, and do not draw significant amounts
from them except:
(i) for very brief periods of time under normal
conditions,
(ii) when severe deterioration of their financial
condition causes them to lose access to the
credit markets, and
(iii) during system-wide credit market dysfunction,
such as during the crisis of 20072009.
Banks that offer these credit facilities must set aside
adequate, but not excessive, funds to satisfy the demand for cash by facility borrowers. Duffy et al. (2005)
describe a Monte Carlo simulation model that Merrill
Lynch Bank used to forecast these demands for cash
by borrowers of their revolver portfolio. The model
uses industry data for revolver usage by borrower
credit rating, and assumes Markovian credit rating
migrations, correlated within and across industries.
Migration probabilities were provided by a major
rating agency, and correlation estimates were calculated by Merrill Lynchs risk group. The model was
used by Merrill Lynch Bank to help manage liquidity risk in its multi-billion portfolio of revolving
credit lines.
Forecasting the future behavior and profitability of
retail borrowers (e.g., for credit card loans, mortgages,
and home equity lines of credit) has become a key
component of the credit management process. Forecasting involved in a decision to grant credit to a new
borrower is known as credit scoring, and its origins
in the modern era can be found in the 1950s. A discussion of credit scoring models, including related
public policy issues, is offered by Capon (1982). Fore-

casting involved in the decisions to adjust credit access and marketing effort to existing borrowers is
known as behavioral scoring. The book by Thomas
et al. (2002) contains a comprehensive review of the
objectives, methods, and practical implementation of
credit and behavioral scoring. The formal statistical
methods used for classifying credit applicants into
good and bad risk classes is known as classification scoring. Hand and Henley (1997) review
a significant part of the large body of literature in
classification scoring. Baesens et al. (2003) examine
the performance of standard classification algorithms,
including logistic regression, discriminant analysis,
k-nearest neighbor, neural networks, and decision trees;
they also review more recently proposed ones, such as
support vector machines and least-squares support
vector machines (LS-SVM). They find LS-SVM, and
neural network classifiers, and simpler methods such as
logistic regression and linear discriminant analysis to
have good predictive power. In addition to classification scoring, other methods include:
(i) response scoring, which aims to forecast a
prospects likelihood to respond to an offer for
credit, and
(ii) balance scoring, which forecasts the prospects likelihood of carrying a balance if they
respond.
To improve the chances of acquiring and maintaining
profitable customers, offers for credit should be mailed
only to prospects with high credit, response, and balance scores. Response and balance scoring models are
typically proprietary. Trench et al. (2003) discuss a
model for optimally managing the size and pricing of
card lines of credit at Bank One. The model uses
account-level historical transaction information to select
for each cardholder, through Markov decision processes,
annual percentage rates, and credit lines that optimize
the net present value of the banks credit portfolio.
4.2. Forecasting in Securities Brokerage, Clearing,
and Execution
In the last few decades, the securities brokerage
industry has seen dramatic change. Traditional wirehouses charging fixed commissions evolved or were
replaced by diverse organizations offering full service,
discount, and online trading channels, as well as research and investment advisory services. This
evolution has introduced a variety of channel choices
for retail and institutional investors. Pricing, service
mix and quality, and human relationships are key
determinants in the channel choice decision. Firms are
interested in forecasting channel choice decisions by
clients, because they greatly impact capacity planning,
revenue, and profitability. Altschuler et al. (2002) discuss simulation models developed for Merrill Lynchs
643
retail brokerage to forecast client choice decisions on

introduction of lower-cost offerings to complement
the firms traditional full-service channel. Client
choice decision forecasts were used as inputs in the
process of determining the proper pricing for these
new offerings and for evaluating their potential
impact on firm revenue. The results of a rational economic behavior (REB) model were used as a baseline.
The REB model assumes that investors optimize their
value received by always choosing the lowest-cost
option (determined by an embedded optimization
model that was solved for each of millions of clients
and their actual portfolio holdings). The REB models
results were compared with those of a Monte Carlo
simulation model. The Monte Carlo simulation allows
for more realistic assumptions. For example, clients
decisions are impacted not only by price differentials
across channels, but also by the strength and quality
of the relationship with their financial advisor, who
represented the higher-cost options.
Labe (1994) describes an application of forecasting
the likelihood of affluent prospects becoming Merrill
Lynchs priority brokerage and investment advisory
clients (defined as clients with more than US$250,000
in assets). Merrill Lynch used discriminant analysis, a
method akin to classification scoring, to select high
quality households to target in its prospecting efforts.
The trading of securities in capital markets involves
key operational functions that include:
(i) clearing, i.e., establishing mutual obligations of
counterparties in securities and/or cash trades, as
well as guarantees of payments and deliveries,
and
(ii) settlement, i.e., transfer of titles and/or cash to
the accounts of counterparties in order to finalize transactions.
Most major markets have centralized clearing
facilities so that counterparties do not have to settle
bilaterally and assume credit risk to each other. The
central clearing organization must have robust procedures to satisfy obligations to counterparties, i.e.,
minimize the number of trades for which delivery of
securities is missed. It must also hold adequate, but
not excessive, amounts of cash to meet payments.
Forecasting the number and value of trades during a
clearing and settlement cycle can help the organization meet the above objectives; it can achieve this by
modeling the clearing and settlement operation using
stochastic simulation. A different approach is used by
de Lascurain et al. (2011): they develop a linear programming method to model the clearing and settlement
operation of the Central Securities Depository of
Mexico and evaluate the systems performance through
deterministic simulation. The models formulation in de
Lascurain et al. (2011) is a relaxation of a mixed integer
644

programming (MIP) formulation proposed by Guntzer

et al. (1998), who show that the bank clearing problem
is NP-complete. Eisenberg and Noe (2001) include
clearing and settlement in a systemic financial risk
framework.
4.3. Forecasting of Call Arrivals at Call Centers
Forecasting techniques are also used in various other
areas within the financial services sector; for example,
the forecasting of arrivals in call centers, which is a
crucial input in the personnel scheduling process
in call centers (to be discussed in a later section). To
set this in a broader context, refer to the framework of
Thompson (1998) for forecasting demand for services.
Recent papers that focus on forecasting call center
workload include a tutorial by Gans et al. (2003), a
survey by Aksin et al. (2007), and a research paper by
Aldor-Noiman et al. (2009).
The quality of historical data improves with the
passage of time because call centers become increasingly more sophisticated in capturing data with every
nuance that a modeler may find useful or interesting.
Andrews and Cunningham (1995) describe the autoregressive integrated moving average (ARIMA) forecasting models used at L.L. Beans call centers. Time
series data used to fit the models exhibit seasonality
patterns and are also influenced by variables such as
holiday and advertising interventions. Advertising
and special calendar effects are addressed by Antipov
and Meade (2002). More recently, Soyer and
Tarimcilar (2008) incorporate advertising effects by
modeling call arrivals as a modulated Poisson process
with arrival rates being driven by customer calls that
are stimulated by advertising campaigns. They use a
Bayesian modeling framework and a data set from a
call center that enables tracing calls back to specific
advertisements. In a study of Fedexs call centers,
Xu (2000) presents forecasting methodologies used
at multiple levels of the business decision-making
hierarchy, i.e., strategic, business plan, tactical, and
operational, and discusses the issues that each methodology addresses. Methods used include exponential
smoothing, ARIMA models, linear regression, and
time series decomposition.
At low granularity, call arrival data may have too
much noise. Mandelbaum et al. (2001) demonstrate
how to remove relatively unpredictable short-term
variability from data and keep only predictable variability. They achieve this by aggregating data at
higher levels of granularity, i.e., progressively moving up from minute of the hour to hour of the day
to day of the month and to month of the year. The
elegant textbook assumption that call arrivals follow a
Poisson process with a fixed rate that is known or can
be estimated does not hold in practice. Steckley et al.
(2009) show that forecast errors can be large in com-
parison to the variability expected in a Poisson

process and can have significant impact on the predictions of long-run performance; ignoring forecast
errors typically leads to overestimation of performance. Jongbloed and Koole (2001) found that the call
arrival data they had been analyzing had a variance
much greater than the mean, and therefore did not
appear to be samples of Poisson distributed random
variables. They addressed this overdispersion by
proposing a Poisson mixture model, i.e., a Poisson
model with an arrival rate that is not fixed but random following a certain stochastic process. Brown
et al. (2005) found data from a different call center that
also followed a Poisson distribution with a variable
arrival rate; the arrival rates were also serially correlated from day to day. The prediction model proposed
includes the previous days call volume as an autoregressive term. High intra-day correlations were
found by Avramidis et al. (2004), who developed
models in which the call arrival rate is a random
variable correlated across time intervals of the same
day. Steckley et al. (2004) and Mehrotra et al. (2010)
examine the correlation of call volumes at later periods of a day to call volumes experienced earlier in the
day for the purpose of updating workload schedules.
Methods to approximate non-homogeneous Poisson processes often attempt to estimate the arrival rate
by breaking up the data set into smaller intervals.
Henderson (2003) demonstrates how a heuristic that
assumes a piecewise constant arrival rate over time
intervals with a length that shrinks as the volume
of data grows produces good arrival rate function
estimates. Massey et al. (1996) fit piecewise linear rate
functions to approximate a general time-inhomogeneous Poisson process. Weinberg et al. (2007) forecast
an inhomogeneous Poisson process using a Bayesian
framework, whereby from a set of prior distributions
they estimate the parameters of the posterior distribution through a Monte Carlo Markov Chain
model. They forecast arrival rates in short intervals
of 1560 minutes of a day of the week as the product
of a days forecast volume times the proportion of
calls arriving during an interval; they also allow for a
random error term.
Shen and Huang (2005, 2008a, b) developed models
for inter-day forecasting and intra-day updating of
call center arrivals using singular value decomposition. Their approach resulted in a significant dimensionality reduction. In a recent empirical study, Taylor
(2008) compared the performance of several univariate time series methods for forecasting intra-day call
arrivals. Methods tested included seasonal autoregressive and exponential smoothing models, and the
dynamic harmonic regression of Tych et al. (2002).
Results indicate that different methods perform best
under different lead times and call volumes levels.

Forecasting other aspects of a call center with a

significant potential for future research include, for
example, waiting times of calls in queues, see Whitt
(1999a, b) and Armony and Maglaras (2004).
5. Inventory and Cash Management

5.1. Cash Inventory Management Under
Deterministic and Stochastic Demand
Organizations, households, and individuals need cash
to meet their liquidity needs. In the era of checks and
electronic transactions, an amount of cash does not
have to be in physical currency, but may correspond
only to a value in an account that has been set up for
this purpose. To meet short-term liquidity needs, cash
must be held in a riskless form, where its value does
not fluctuate and is available on demand, but earns
little or no interest. Treasury bills and checking
accounts are considered riskless. Cash not needed to
meet short-term liquidity needs can be invested in
risky assets whereby it may earn higher returns, but
its value may be subject to significant fluctuations and
uncertainty, and could become wholly or partially
unrecoverable. Depending on the type of risky asset,
its value may or may not be quickly recoverable and
realizable at a modest cost (as with a public equity
that is listed in a major stock exchange). Determining
the value of certain types of risky assets (e.g., private
equity, real estate, some hedge funds, and assetbacked fixed income securities) may require specialized valuation services, which could involve
significant time and cost. Risky assets can also be
subject to default, in which case all or part of the value
becomes permanently unrecoverable.
Researchers have produced over the last few decades
a significant body of work by applying the principles of
inventory theory to cash management. We review the
cash management literature from its beginnings so
we can put later work in context, and we have not
identified an earlier comprehensive review that accomplishes this purpose. Whistler (1967) discussed a
stochastic inventory model for rented equipment that
was formulated as a dynamic program; this work
served as a model for the cash management problem.
One of the early works produced an elegant result that
became known as the BaumolTobin economic model
of the transactions demand for money, independently
developed by Baumol (1952) and Tobin (1956).
The model assumes a deterministic, constant rate of
demand for cash. It calculates the optimal lot sizes of
the risky asset to be converted to cash, or the optimal
numbers of such conversions, in the presence of transaction and interest costs. Tobins version requires an
integer number of transactions and therefore approximates reality more closely than Baumols, which allows
that variable to be continuous.
645
The concept of transactions demand for money,

addressed by the BaumolTobin model, is related to,
but subtly different from, precautionary demand for
cash that applies to unforeseen expenditures, opportunities for advantageous purchases, and uncertainty
in receipts. Whalen (1966) developed a model with a
structure strikingly similar to the BaumolTobin
model, capturing the stochastic nature of precautionary demand for cash. Sprenkle (1969) and Akerlof and
Milbourne (1978) observed that the BaumolTobin
model tends to under-predict demand for money,
partly because it fails to capture the stochastic nature
of precautionary demand for cash. Sprenkles paper
elicited a response by Orr (1974), which in turn
prompted a counter-response by Sprenkle (1977).
Robichek et al. (1965) propose a deterministic shortterm financing model that incorporates a great degree
of realistic detail involved in the financial officers
decision-making process, which they formulate and
solve as a linear program. They include a discussion
on model extensions for solving the financing problem under uncertainty. Sethi and Thompson (1970)
proposed models based on mathematical control theory, in which demand for cash is deterministic but
does vary with time. In an extension of the Sethi
Thompson model, Bensoussan et al. (2009) allow the
demand for cash to be satisfied by dividends and
uncertain capital gains of the risky asset, stock.
In what became known as the MillerOrr model
for cash management, Miller and Orr (1966) extended
the BaumolTobin model by assuming the demand for
cash to be stochastic. The cash balance can fluctuate
randomly between a lower and an upper bound
according to a Bernoulli process, and transactions take
place when it starts moving out of this range; units of
the risky asset are converted into cash at the lower
bound, and bought with the excess cash at the upper
bound. Transaction costs were assumed fixed,
i.e., independent of transaction size. In a critique of
the MillerOrr model, Weitzman (1968) finds it to be
robust, i.e., general results do not change much
when the underlying assumptions are modified.
Eppen and Fama (1968, 1969, 1971) proposed cash
balance models that are embedded in a Markovian
framework. In one of their papers, Eppen and Fama
(1969) presented a stochastic model, formulated as a
dynamic program, with transaction costs proportional
to transaction sizes. Changes in the cash balance can
follow any discrete and bounded probability distribution. In another one of their papers, Eppen and Fama
(1968) developed a general stochastic model that
allowed costs to have a fixed as well as a variable component. They showed how to find optimal policies for
the infinite-horizon problem using linear programming.
In their third paper, Eppen and Fama (1971) proposed a
stochastic model with two risky assets, namely bonds
646

and stock; the stock is more risky but has a higher

expected return. They also discussed using bonds
(the intermediate-risk asset) as a buffer between cash
and the more risky asset. Taking a similar approach,
Daellenbach (1971) proposed a stochastic cash balance
model using two sources of short-term funds. Girgis
(1968) and Neave (1970) presented models with both
fixed and proportional costs and examined conditions
for policies to be optimal under different assumptions.
Hausman and Sanchez-Bell (1975) and Vickson (1985)
developed models for firms facing a compensatingbalance requirement specified as an average balance
over a number of days.
Continuous-time formulations of the cash management problem were based on the works of Antelman
and Savage (1965), and Bather (1966), who used a
Wiener process to generate a stochastic demand in
their inventory problem formulations. Their approach
was extended to cash management by Vial (1972),
whose continuous-time formulation had fixed and
proportional transaction costs, and linear holding and
penalty costs, and determined the form of the optimal
policy (assuming one exists). Constantinides (1976)
extended the model by allowing positive and negative
cash balances, determined the parameters of the
optimal policy, and discussed properties of the
optimal solution. Constantinides and Richard (1978)
formulated a continuous-time, infinite-horizon,
discounted-cost cash management model with fixed
and proportional transaction costs, linear holding and
penalty costs, and the Wiener process as the
demand-generating mechanism. They proved that there
always exists an optimal policy for the cash management problem, and that this policy is of a simple form.
Smith (1989) developed a continuous-time model with
a stochastic, time-varying interest rate.
5.2. Supply Chain Management of Physical
Currency
Physical cash, i.e., paper currency and coins, remains
an important component of the transactions volume
even in economies that have experienced a significant
growth in checks, credit, debit and smart cards, and
electronic transactions. Advantages of cash include
ease of use, anonymity, and finality; it does not
require a bank account; it protects privacy by leaving
no transaction records; and it eliminates the need to
receive statements and pay bills. Disadvantages
of cash include ease of tax evasion, support of an
underground economy, risk of loss through theft or
damage, ability to counterfeit, and unsuitability for
online transactions.
Central banks provide cash to depository institutions, which in turn circulate it in the economy. There
are studies on paper currency circulation in various
countries. For example, Fase (1981) and Boeschoten
and Fase (1992) present studies by the Dutch central

bank on the demand for banknotes in the Netherlands
before the introduction of the Euro. Ladany (1997)
developed a discrete dynamic programming model to
determine optimal (minimum cost) ordering policies
for banknotes by Israels central bank. Massoud (2005)
presents a dynamic cost minimizing note inventory
model to determine optimal banknote order size and
frequency for a typical central bank.
The production and distribution of banknotes, and
the required infrastructure and processes, have also
been studied. Fase et al. (1979) discuss a numerical
planning model for the banknotes operations at a
central bank, with examples from pre-Euro Netherlands. Bauer et al. (2000) develop optimization models
for determining the least-cost configuration of the US
Federal Reserves currency processing sites given the
trade-off between economies of scale in processing
and transportation costs. In a study of costs and economies of scale of the US Federal Reserves currency
operations, Bohn et al. (2001) find that the Federal
Reserve is not a natural monopoly. Opening currency
operations to market competition and charging fees
and penalties for some services provided for free by
the Federal Reserve at that time could lead to more
efficient allocation of resources.
The movement of physical cash among central
banks, depository institutions, and the public must be
studied as a closed-loop supply chain (see, e.g.,
Dekker et al. 2004). It involves the recirculation of
used notes back into the system (reverse logistics),
together with a flow of new notes from the central
bank to the public through depository institutions
(forward logistics). The two movements are so intertwined that they cannot be decoupled. Rajamani et al.
(2006) study the cash supply chain structure in the
United States, analyze it as a closed-loop supply
chain, and describe the cash flow management system
used by US banks. They also discuss the new cash
recirculation policies adopted by the Federal Reserve
to discourage banks overuse of its cash processing
services, and encourage increased recirculation at the
depository institution level. Among the practices to be
discouraged was cross shipping, i.e., shipping used
currency to the Federal Reserve and ordering it in the
same denominations in the same week. To compare
and contrast new and old Federal Reserve policies for
currency recirculation, Geismar et al. (2007) introduce
models that explain the flow of currency between the
Federal Reserve and banks under both sets of guidelines. They present a detailed analysis that provides
optimal policies for managing the flow of currency
between banks and the Federal Reserve, and analyze
banks responses to the new guidelines to help the
Federal Reserve understand their implications.
Dawande et al. (2010) examine the conditions that

can induce depository institutions to respond in socially optimal ways according to the new Federal
Reserve guidelines. Mehrotra et al. (2010), which is a
paper in this special issue of Production and Operations
Management, address the problem of obtaining efficient cash management operating policies for
depository institutions under the new Federal Reserve guidelines. The mixed-integer programming
model developed for this purpose seeks to find
good operating policies, if such exist, to quantify
the monetary impact on a depository institution operating according to the new guidelines. Another
objective was to analyze to what extent the new
guidelines can discourage cross shipping and stimulate currency recirculation at the depository
institution level. Mehrotra et al. (2010a) study pricing
and logistics schemes for services such as fit-sorting
and transportation that can be offered by third-party
providers as a result of the Federal Reserves new
policies.
5.3. Other Cash Management Applications in
Banking and Securities Brokerage
US banks are required to keep on reserve a minimum
percentage (currently 10%) of deposits in client transaction accounts (demand deposits and other
checkable deposits) at the Federal Reserve. Until very
recently, banks had a strong incentive to keep funds
on reserve at a minimum, because these funds were
earning no interest. Even after the 2006 Financial Services Regulatory Relief Act became law, authorizing
payment of interest on reserves held at the Federal
Reserve, banks prefer to have funds available for their
own use rather than have them locked up on reserve.
Money market deposit accounts (MMDA) with checking allow banks to reduce the amounts on reserve at
the Federal Reserve by keeping deposits in MMDA
accounts and transferring to a companion checking
account only the amounts needed for transactions.
Only up to six transfers (sweeps) per month are
allowed from an MMDA to a checking account, and a
clients number and amount of transactions in the
days remaining in a month is unknown. Therefore, the
size and timing of the first five sweeps must be carefully calculated to avoid a sixth sweep, which will
move the remaining MMDA balance into the checking
account. Banks have been using heuristic algorithms
to plan the first five sweeps. This specialized inventory problem has been examined by Nair and
Anderson (2008), who propose a stochastic dynamic
programming model to optimize retail account
sweeps. The stochastic dynamic programming model
developed by Nair and Hatzakis (2010) introduces
cushions added to the minimum sweep amounts. It
determines the optimal cushion sizes to ensure
that sufficient funds are available in the transaction
647
account in order to cover potential future transactions

and avoid the need for a sixth sweep.
The impact of the sequence of transaction postings
on account balances and resultant fees for insufficient
funds, similar to the cost of stock-outs in inventory
management, has been studied by Apte et al. (2004).
They investigate how overdraft fees and nonsufficient funds (NSF) fees interact in such situations.
Brokerage houses make loans to investors who want
to use leverage, i.e., to invest funds in excess of their
own capital in risky assets, and can pledge securities
that they own as collateral. In a simple application of
this practice, known as margin lending, the brokerage
extends a margin loan to a client of up to the value
of equity securities held in the clients portfolio. The
client can use the loaned funds to buy more equity
securities. Calculating the minimum value required in
a clients account for a margin loan can become complex in accounts holding different types of securities
including equities, bonds, and derivatives, all with
different margin requirements. The complexity increases even more with the presence of long and short
positions and various derivative strategies practiced
by clients. Rudd and Schroeder (1982) presented a
simple transportation model formulation for calculating the minimum margin, which represented an
improvement over the heuristics used in practice. A
significant body of subsequent work has been published on this problem, especially by Timkovsky and
collaborators, which is more related to portfolio strategies and hedging. We believe that the approach in the
paper by Fiterman and Timkovsky (2001), which is
based on 01 knapsack formulations, is methodologically the most relevant to mention in this overview.
6. Waiting Line Management in Retail

Banks and in Call Centers
6.1. Queueing Environments and Modeling
Assumptions
In financial services, in particular in retail banking,
retail brokerage, and retail asset management (pension funds, etc.), queueing is a common phenomenon
that has been analyzed thoroughly. Queueing occurs
in the branches of retail banks with the tellers being
the servers, at banks of ATM machines with the
machines being the servers, and in call centers, where
the operators and/or the automated voice response
units are the servers. These diverse queueing environments turn out to be fairly different from one
another, in particular with regard to the following
characteristics:
(i) the information that is available to the customer and the information that is available to
the service system,
648

(ii) the flexibility of the service system with regard

to adjustments in the number of servers
dependent on the demand,
(iii) the order of magnitude of the number of servers.
Even though in the academic literature the arrival
processes in queueing systems are usually assumed to
be stationary (time-homogeneous) Poisson processes,
arrival processes in practice are more appropriately
modeled as non-homogeneous Poisson processes. Over
the last couple of decades, some research has been done
on queues that are subject to non-homogeneous Poisson
inputs (see, e.g., Massey et al. 1996). The more theoretical research in queueing has also focused on various
aspects of customer behavior in queue, in particular
abandonment, balking, and reneging. For example,
Zohar et al. (2002) have modeled the adaptive behavior of impatient customers and Whitt (2006) developed
fluid models for many-server queues with abandonment. In all three queueing environments described
above, the psychology of the customers in the queue
also plays a major role. A significant amount of research
has been done on this topic, see Larson (1987), Katz et al.
(1991), and Bitran et al. (2008). As it turns out, reducing
wait times may not always be the best approach in all
service encounters. For example, in restaurants and
salons, longer service time may be perceived as better
service. In many cases, customers do not like waiting,
but when it comes their turn to be served, would like
the service to take longer. In still others, for example, in
grocery checkout lines, customers want a businesslike
pace for both waiting and service. The latter category,
which we may call dispassionate services, are more common in financial service situations, though the former,
which we may call hedonic services, are also presentfor
example, when a customer visits their mortgage broker
or insurance agent, they would not like to be rushed. In
the following subsections, we consider the various
different queueing environments in more detail.
6.2. Waiting Lines in Retail Bank Branches and at

ATMs
The more traditional queues in financial services
are those in bank branches feeding the tellers. Such
a queue is typically a single line with a number of
servers in parallel. There are clearly no priorities in
such a queue and the discipline is just first come first
served. Such a queueing system is typically modeled
as an M/M/s system and is discussed in many standard queueing texts. One important aspect of this
type of queueing in a branch is that management
usually can adjust the number of available tellers
fairly easily as a function of customer demand and
time of day. (This gives rise to many personnel scheduling issues that will be discussed in the next section.)
In the early 1980s retail banks began to make extensive use of ATMs. The ATMs at a branch of a bank
behave quite differently from the human tellers. In
contrast to a teller environment, the number of ATMs
at a branch is fixed and cannot be adjusted as a
function of customer demand. However, the teller
environment and the ATM environment do have
some similarities. In both environments, a customer
can observe the length of the queue and can, therefore,
estimate the amount of time (s)he has to wait. In
neither the teller environment, nor the ATM environment, can the bank adopt a priority system that would
ensure that more valuable customers have a shorter
wait. Kolesar (1984) did an early analysis of a branch
with two ATM machines and collected service time
data as well as arrival time data. However, it became
clear very quickly that a bank of ATMs is capable of
collecting some very specific data automatically (e.g.,
customer service times and machine idle times), but
cannot keep track of certain other data (e.g., queue
lengths, customer waiting times). Larson (1990), therefore, developed the so-called queue inference engine,
which basically provides a procedure for estimating
the expected waiting times of customers, given the
service times recorded at the ATMs as well as the
machine idle times.
6.3. Waiting Lines in Call Centers
Since the late 1980s, banks have started to invest
heavily in call center technologies. All major retail
banks now operate large call centers on a 24/7 basis.
Call centers have therefore been the subject of extensive research studies, see the survey papers by Pinedo
et al. (2000), Gans et al. (2003), and Aksin et al. (2007).
The queueing system in a call center is actually quite
different from the queueing systems in a teller environment or in an ATM environment; there are a
number of major differences. First, a customer now
has no direct information with regard to the queue
length and cannot estimate his waiting time; he must
rely entirely on the information the service system
provides him. On the other hand, the service organization in a call center has detailed knowledge concerning the customers who are waiting in queue. The
institution knows of each customer his or her identity
and how valuable (s)he is to the bank. The bank can
now put the customers in separate virtual queues
with different priority levels. This new capability has
made the application of priority queueing systems
suddenly very important; well-known results in
queueing theory have now suddenly become more
applicable, see Kleinrock (1976). Second, the call
centers are in another aspect quite different from the
teller and the ATM environments. The number
of servers in either a teller environment or an ATM
environment may typically be, say, at most 20,

whereas the number of operators in a call center may

typically be in the hundreds or even in the thousands.
In the analysis of call center queues, it is now possible
to apply limit theorems with respect to the number of
operators, see Halfin and Whitt (1981) and Reed
(2009). Third, the banks have detailed information
with regard to the skills of each one of its operators in
a call center (language skills, product knowledge,
etc.). This enables the bank to apply skills-based-routing to the calls that are coming in, see Gans and Zhou
(2003) and Mehrotra et al. (2009).
In call centers, typically, an enormous amount of
statistical data is available that is collected automatically, see Mandelbaum et al. (2001) and Brown et al.
(2005). The data that are collected automatically are
much more extensive than the data that are collected
in an ATM environment. It includes the waiting times
of the customers, the queue length at each point in
time, the proportion of customers that experience no
wait at all, and so on.
Lately, many other aspects of queueing in call centers have become the subject of research. This special
issue of Production and Operations Management as well
as another recent special issue contain several such
rmeci and Aksin (2010) focus
papers. For example, O
on the effects of cross selling on the management of
the queues in call centers. They focus on the operational implications of cross selling in terms of capacity
usage and value generation. Chevalier and Van den
Schrieck (2008), and Barth et al. (2010) consider hierarchical call centers that consist of multiple levels
(stages) with a time-dependent overflow from one
level to the next. For example, at the first stage, the
front office, the customers receive the basic services;
a fraction of the served customers requires more specialized services that are provided by the back office.
Van Dijk and Van der Sluis (2008) and Meester et al.
(2010) consider the service network configuration
problem. Meester et al. (2010) analyze networks of
geographically dispersed call centers that vary in service and revenue-generation capabilities, as well as in
costs. Optimally configuring a service network in this
context requires managers to balance the competing
considerations of costs (including applicable discounts) and anticipated revenues. Given the large
scale of call center operations in financial services
firms, the service network configuration problem is
important and economically significant. The approach
by Meester and colleagues integrates decision problems involving call distribution, staffing, and
scheduling in a hierarchical manner (previously, these
decision problems were addressed separately).
Even though most call center research has focused
on inbound call centers, a limited amount of research
has also been done on outbound call centers. Rising
delinquencies and the importance of telemarketing
649
has increased the need for outbound calling from

call centers. Outbound calling is quite different from
inbound calling, because the scheduling of calls is
done by the call center rather than the call center
being at the mercy of its customers. This presents
unique challenges and opportunities. Bollapragada
and Nair (2010) focus in this environment on
improvements in contact rates of appropriate parties.
7. Personnel Scheduling in Retail

Banks and in Call Centers
7.1. Preliminaries and General Research Directions
An enormous amount of work has been done on
workforce (shift) scheduling in manufacturing. However, workforce scheduling in manufacturing is quite
different from workforce scheduling in services
industries. The workforce scheduling process in manufacturing has to adapt itself to inventory
considerations and is typically a fairly regular and
stable process. In contrast to manufacturing industries, workforce scheduling in the service industries
has to adapt itself to a fluctuating customer demand,
which in practice is often based on non-homogeneous
Poisson customer arrival processes. In practice, adapting the number of tellers or operators to the demand
process can be done through an internal pool of flexible workers, or through a partnership with a labor
supply agency (see Larson and Pinker 2000).
As the assignment of tellers and the hiring of
operators depend so strongly on anticipated customer
demand, a significant amount of research has focused
on probabilistic modeling of arrival processes, on statistical analyses of arrival processes, and on customer
demand forecasting in order to accomplish a proper
staffing. For probabilistic modeling of customer
arrival processes, see Stolletz (2003), Ridley et al.
(2004), Avramidis et al. (2004), and Jongbloed and
Koole (2001). For statistical analyses of customer
arrival data, see Brown et al. (2005) and Robbins
et al. (2006). For customer demand forecasting, see
Weinberg et al. (2007) and Shen and Huang (2008a, b).
From a research perspective, the personnel scheduling problem has been tackled via a number of
different approaches, namely, simulation, stochastic
modeling, optimization modeling, and artificial intelligence. The application areas considered included the
scheduling of bank tellers as well as the scheduling of
the operators in call centers. Slepicka and Sporer
(1981), Hammond and Mahesh (1995), and Mehrotra
and Fama (2003) used simulation to schedule bank
tellers and call center operators. Thompson (1993)
studied the impact of having multiple periods with
different demands on determining the employee requirements in each segment of the schedule; see also
Chen and Henderson (2001). Green et al. (2007) and
650

Feldman et al. (2008) have addressed the problem from

a stochastic point of view and have developed staffing
rules based on queueing theory. So et al. (2003) use
better staff scheduling and team reconfiguration to
improve check processing in the Federal Reserve Bank.
7.2. Optimization Models for Call Center Staffing

Many researchers have considered this problem from
an optimization point of view. An optimization model
to determine the optimal staffing levels and call routing can take a more aggregate form or a more detailed
form. Bassamboo et al. (2005) consider a model with m
customer classes and r agent pools. They develop a
linear program-based method to obtain optimal
staffing levels as well as call routing. Not surprisingly, a significant amount of work has also been done
on the more detailed optimization of the various possible shift structures (including even lunch breaks and
coffee breaks). In large call centers, there are many
different types of shifts that can be scheduled. A shift
is characterized by the days of the week, the starting
times at the beginning of the day, the ending time at
the end of the day, as well as the timings of the lunch
breaks and coffee breaks. Gawande (1996) (see also
Pinedo 2009) solved this staffing problem in two
stages. In the first stage of the approach, the so-called
solid-tour scheduling problem is solved. (A solid tour
represents a shift without any breaks; a solid tour is
only characterized by the starting time at the beginning of the day and by the ending time at the end of
the day.) There are scores of different solid tours
available (each one with a different starting time and
ending time). The demand process (the non-homogeneous arrival process) usually can be forecast with a
reasonable amount of accuracy. The first stage of the
problem is to find the number of personnel to hire in
each solid tour such that the total number of people
available in each time interval fits the demand curve
as accurately as possible. This problem leads to an
integer programming formulation of a special structure that actually can be solved in polynomial time.
After it has been determined in the first stage what the
actual number of people in each solid tour is, the
placement of the breaks is done in the second stage.
Typically, the break placement problem is a very hard
problem, and is usually dealt with through a heuristic.
Gans et al. (2009) applied parametric stochastic
programming to workforce scheduling in call centers.
Gurvich et al. (2010) have developed a chance constrained optimization approach to deal with uncertain
demand forecasts. Brazier et al. (1999) applied an
artificial intelligence technique, namely co-operative
multi-agent scheduling, on the workforce scheduling
in call centers; their work was done in collaboration
with the Rabobank in the Netherlands. Harrison and
Zeevi (2005) developed a staffing method for large call

centers based on stochastic fluid models.
Nowadays another aspect of personnel management in call centers has become important, namely
call routing. As the clients may have many different
demands and the operators may have many different
skill sets, call routing has gained a significant amount
of interest, see Mehrotra et al. (2009) and Bhulai et al.
(2008). Optimal call routing typically has to be considered in conjunction with the optimal cross training
of the operators, see Robbins et al. (2007).
7.3. Miscellaneous Issues Concerning Workforce
Scheduling in Financial Services
Very little research has been done on workforce
scheduling in other segments of the financial services
industry. It is clear that workforce scheduling is also
important in trading departments or at trading desks
(equity trading, foreign exchange trading, or currency
trading). Such departments have to keep track of information on trades, such as the number of trades
done per day for each trader, amounts per trade and
total, and trades impact with regard to risk limits of
each trader or the entire desk. Automated systems
exist for recording such information, but operational
risk mitigation practices necessitate the involvement
of skilled personnel in populating and reviewing of
the data. In the case of a broker/dealer, relevant
pieces of information may include the commission
charged for each trade, whether the firm acted in a
capacity of principal or agent, and trading venue (e.g.,
an exchange, a dark pool, or an electronic communication network). Institutional and retail brokerage
and asset management firms need to maintain
databases with account-level, client-level, and relationship-level information. Typically such information
is taken from forms filled out by clients on hard copy
or electronically, and/or from legal agreements signed
by the client and the firm. Skilled personnel must
perform the back-office tasks of reviewing documents,
and populating the appropriate fields through user
interfaces of databases. Given the regulatory implications of errors in this process (e.g., Sarbanes-Oxley 404
compliance), the personnel assigned to such tasks
must have received a rigorous specialized training. A
factor that may add complexity to workforce scheduling is the emerging trend of outsourcing such
back-office tasks, especially to offshore locations in
Asia or Europe. In offshore outsourcing, time-zone
differences and high turnover of trained professionals
can be serious issues to contend with.
As stated earlier, workforce scheduling and waiting
line management are strongly interconnected. A
larger and better trained workforce clearly results in
a better queueing performance. However, workforce
scheduling is also strongly connected to operational

risk. A larger and better trained workforce clearly

results in a lower level of operational risk (especially
in trading departments, where human errors can have
a very significant impact on the financial performance
of the institution). This topic will be discussed in more
detail in the next section on operational risk.
8. Operational Risk Management

8.1. Types of Operational Failures
Operational risk in financial services started to receive
attention from the banking community as well as from
the academic community in the mid-1990s. Operational
risk has since then typically been defined as the risk
resulting from inadequate or failed internal processes,
people, and systems, or from external events (Basel
Committee 2003). It covers product life cycle and execution, product performance, information management
and data security, business disruption, human resources and reputation (see, e.g., the General Electric
Annual Report 2009, available at www.ge.com). Failures
concerning internal processes can be due to transactions
errors (some due to product design), or inadequate
operational controls (lack of oversight). Information system failures can be caused by programming errors or
computer crashes. Failures concerning people may be
due to incompetence or inadequately trained employees, or due to fraud. Actually, since the mid-1990s a
number of events have taken place in financial services
that can be classified as rogue trading. This type of
event has turned out to be quite serious because just one
such an event can bring down a financial services firm,
see Cruz (2002), Elsinger et al. (2006), Chernobai et al.
(2007), Cheng et al. (2007), and Jarrow (2008).
8.2. Relationships between Operational Risk and
Other Research Areas
It has become clear over the last decade that the management of operational risk in finance is very closely
related to other research areas in operations management, operations research, and statistics. Most of the
methodological research in operational risk has focused on probabilistic as well as statistical aspects of
operational risk, for example, extreme value theory
(EVT) (see Chernobai et al. 2007). The areas of importance include the following:
(i) Process design and process mapping,
(ii) Reliability theory,
(iii) TQM, and
(iv) EVT.
The area of process design and process mapping is
very important for the management of operational
risk. As discussed in earlier sections of this paper,
Shostack (1984) focuses on process mapping in the
651
service industries and, in particular, process mapping

in financial services. Process mapping also includes
an identification of all potential failure points. This
area of study is closely related to the research area of
reliability theory.
The area of reliability theory is very much concerned with system and process design issues,
including concepts such as optimal redundancies.
This area of research originated in the aviation industry; see the classic work by Barlow and Proschan
(1975) on reliability theory. One major issue in financial services is the issue of determining the amount of
backups and the amount of parallel processing and
checking that have to be designed into the processes
and procedures. Reliability theory has always had a
major impact on process design.
Procedures that are common in TQM turn out to be
very useful for the management of operational risk,
for example, Six Sigma (see Cruz and Pinedo 2008).
However, it has become clear that there are important
similarities as well as differences between TQM in the
manufacturing industries and operational risk management in financial services. One important difference
is that TQM in manufacturing (typically referred to as
Six Sigma) is based on statistical properties of the Normal (Gaussian distribution), because any parameter
that is being measured may have an equal probability
of having a deviation in one direction as in the other.
However, in operational risk management the analysis
of operational risk events focuses mainly on the outliers, i.e., the catastrophic events. For that reason,
the distributions used are different from the Normal;
they may be, for example, the Lognormal, or the Fat
Tail Lognormal.
The statistical analysis often focuses on the occurrences of rare, catastrophic events, because financial
services in general are quite concerned about being hit
by such rare catastrophic events. It is for this reason
that EVT has become such an important research direction, see De Haan and Ferreira (2006). EVT is based
on a limit theorem that is due to Gnedenko; this limit
theorem specifies the distribution of the maximum of
a series of independent and identically distributed
(i.i.d.) random variables. These extreme value distributions include the Weibull, Frechet, and Gumbel
distributions. They typically have three parameters,
namely one that specifies the mean, one that specifies
the variance, and a third one that specifies the fatness
of the tail. The need for being able to parameterize the
fatness of the tail is based on the fact that the tail affects
the probabilities of catastrophic events occurring.
8.3. Operational Risk in Specific Financial Sectors

There are several sectors of the financial services
industry that have received a significant amount of
652

attention with regard to their exposure to operational

risk, namely,
(i) Retail financial services (banking, brokerage,
credit cards),
(ii) Trading (equities, bonds, foreign exchange),
(iii) Asset management (retail, institutional).
There are several types of operational risk events that
are common in retail financial services. They include
security breaches, fraud, and systems breakdowns.
Security breaches in retail financial services often
involve clients personal information such as bank account numbers and social security numbers. Such
events can seriously damage an institutions reputation, bringing about punitive regulatory sanctions, and,
in some well-known instances, becoming the basis for
class-action lawsuits. There has been an extensive body
of research in the literature that has focused on understanding the risk of information security (see Bagchi
and Udo 2003, Dhillon 2004, Hong et al. 2003, Straub
and Welke 1998, Whitman 2004). Garg et al. (2003) have
made an attempt to quantify the financial impact of
information security breaches. Fraud as a cause of an
operational risk event is a major issue in the credit card
business. An enormous amount of work has been done
on credit card fraud detection, mainly by researchers in
artificial intelligence and data mining; see, for example,
Chan et al. (1999). Upgrades and consolidations of information systems may be major causes of operational
risk events associated with systems breakdowns.
Operational risk events in trading may be due to
human errors, rogue trading (i.e., either unauthorized
trades or illegal trades), or system breakdowns. A
number of such events have occurred in the last two
decades with catastrophic consequences for the institutions involved. Several rogue traders have caused
their institutions billions of dollars in losses, see
Netter and Poulsen (2003).
Asset management has also been one of the areas
within the financial services sector that have recently
received a significant amount of research attention as
far as operational risk is concerned. During the financial crisis of 20072009, some of the most catastrophic
losses suffered by investors resulted from failures to
properly address operational risk, for example, in the
fraud perpetrated by Bernard Madoff (see Arvedlund
2009). Operational risk can be effectively addressed
by implementing robust operational infrastructures
and controls in organizations that enjoy strong
governance, as presented by Alptuna et al. (2010).
Operational risk is most salient in the loosely regulated domain of hedge funds. Several studies have
shown that many of the hedge funds that have gone
under had major identifiable operational issues (e.g.,
Kundro and Feffer 2003, 2004). Brown et al. (2009a)
propose a quantitative operational risk score o for
hedge funds that can be calculated from data in hedge

fund databases. The purpose of the o score is to identify problematic funds in a manner similar to Altmans z score, which predicts corporate bankruptcies,
and can be used as a supplement for qualitative due
diligence on hedge funds. In a subsequent study the
same authors, Brown et al. (2009b), examine a comprehensive sample of due diligence reports on hedge
funds and find that misrepresentation, as well as not
using a major auditing firm and third-party valuation,
are key components of operational risk and leading
indicators of future fund failure.
8.4. Other Research Directions

There are a number of other important research directions that already have received some research
attention and that deserve more attention in the future. First, how can we analyze the trade-offs between
operational costs (productivity) and operational risk?
In the manufacturing and in the services literature,
some articles have appeared that discuss the tradeoffs between costs and productivity on the one hand
and quality on the other hand; see, for example, Jones
(1988) and Kekre et al. (2009). However, this issue has
not received much attention yet as far as the financial
services industry is concerned. Second, a fair amount
of research has been done with regard to mitigation
of operational risk. The financial services industry
has thoroughly studied what the aviation industry has
been doing with regard to operational risk, see Cruz
and Pinedo (2008). In particular they have considered
near-miss management practices of operational risk,
see Muermann and Oktem (2002). Two more recent
approaches for mitigating operational risk include insurance (in particular with regard to rogue traders,
see Jarrow et al. 2010) and securitization (e.g., catastrophe bonds), see Cruz (2002). However, these issues
concerning mitigation require more study. Third, it
has been observed that there is a significant interplay
between operational risk, market risk, and credit risk.
For example, when the markets are very volatile, it
is more likely that human errors may be made or
systems may crash. These correlations have to be
analyzed in more detail in the future.
The growing body of research on operational risk in
financial services presents interesting cross-fertilization
opportunities for operations management researchers,
given the increasing visibility of operational risk and
the potential losses in financial services. For banks, the
Basel Capital Accord in a recent revision began to
require risk capital to be reserved for potential
loss resulting from operational risk. Wei (2006) developed models based on Bayesian credibility theory
to quantify operational risk for firm-specific capital
adequacy calculations.

9. Pricing and Revenue Management

9.1. Pricing of Financial Services: Background and
Academic Research
Financial services organizations expend serious efforts
and resources on pricing and revenue management.
Applications are diverse; they include the setting of:
(i) interest rates (APR) on deposits and credit
products,
(ii) trading commissions,
(iii) custody fees,
(iv) investment advisory fees,
(v) fund fees (which for hedge funds can be a
function of assets and performance), and
(vi) insurance policy premia.
Pricing and revenue management are intertwined
with many operations management functions in large
financial services firms, because pricing strongly
affects consumer demand for products and services,
and customer attrition. Complicated pricing mechanisms can increase the volume of billing questions to
call centers. All of these can have significant implications on how these products and services are best
delivered (e.g., capacity issues, quality issues) as well
as on cash (inventory) management.
In addition to market mechanisms, pricing in financial services may be driven by other factors or
constraints that may complicate or simplify it. For example, usury laws specify maximum interest rates to be
charged for lending to consumers or businesses by
banks, credit cards, or pawn shops. Insurance regulations vary by jurisdiction. Fees in open-ended mutual
funds offered to US investors are governed by the Investment Company Act of 1940. The Employee
Retirement Income Security Act of 1974 (ERISA), which
regulates US pension plans, specifies that plan trustees
and investment advisors are considered fiduciaries
who should act in the best interests of plan participants.
Among the duties of fiduciaries is to ensure that the
plan pays reasonable investment expenses, including
fund, advisory, and custody fees, and trading commissions. Preferred pricing provisions, known as Most
Favored Nation (MFN) clauses, are typically included
in investment management agreements of pension
plans governed by ERISA in the United States and by
similar laws elsewhere. By the fiduciary standard of
ERISA, transactions in accounts that hold plan assets
must reflect the best value for the services received.
Such services include execution of trades, research, investment advice, and anything else that may be paid
through these transaction costs.
A body of literature exists in economics and finance
on some aspects of pricing in financial services, and
vendors offer pricing services and software, but little
academic research with an operations management
653
orientation has been published. In the rest of this section, we discuss the economic foundations of price
formation and attempt to link them to research in
finance on pricing practices specific to insurance,
credit, and hedge funds. We also review the meager
operations management literature on pricing in financial services, examine the challenges faced by
researchers, and propose links to other research that
might help remedy some of the issues.
9.2. Theory of Incentives and Informational Issues
in Pricing of Financial Services
By the neoclassical economic assumption of rational
individual behavior in perfect market competition,
prices for financial products and services should be
formed by:
(i) firms efforts to maximize profit, i.e., revenue
minus cost, and
(ii) consumers desire to maximize their utility
when faced with exogenous prices.
In this elegant model, information is perfectly known
and shared by all economic agents. In a setting that
more closely approximates reality, information is incomplete and asymmetrically shared, making price
formation a more complex process. The theory of incentives addresses the informational issues that arise in
the principalagent economic relationship. In such a
relationship, a principal delegates a set of tasks to an
agent who possesses special competencies to perform
the tasks and the two may have conflicting interests.
Informational issues present in a principalagent relationship include:
(i) moral hazard, whereby the agent has private information that can be used to take actions to
serve its interests; such actions may work
against the interests of the principal, who has
to assume some of these actions adverse consequences, and
(ii) adverse selection, where an agent uses private
information about its own characteristics to gain
advantage in selecting a contract offered by the
principal.
Non-verifiability is a third issue that may arise when
the principal and the agent share information that
cannot be verified by a third party, for example, a
court of law. The related free-rider problem refers to
asymmetric sharing of benefits and costs in resource
usage among economic agents. The principalagent
model addresses the design of contracts with appropriate incentives to best align the interests of principal
and agent in the presence of the informational issues
of moral hazard, adverse selection, and non-verifiability.
Laffont and Martimort (2002) focus on the situation of
654

a principal dealing with a single agent, to whom the

principal offers a take-it-or-leave-it contract without
negotiation. Their book begins with a review of the
literature on incentives in economic thought since
Smith (1776) examined incentives in agriculture, and
Hume (1740) explicitly defined the free-rider problem.
Contract negotiations can be addressed by game theory; Camerer (2003) wrote a very accessible text on
behavioral game theory in which he cites all relevant
literature. The text by Tirole (1988) contains thorough
discussions on price formation.
Moral hazard and adverse selection are responsible
for anomalies in insurance and credit product pricing.
Akerlof (1970) noted that aggregate risk in segments
of the insured population will be an increasing function of insurance premium paid. This is the case
because private knowledge of individuals state of
health, drinking or smoking habits, driving behavior,
stability of employment, etc., leads them to accept
or reject higher premia offered for health, life, automobile, or mortgage insurance. The same holds true
for credit, as Stiglitz and Weiss (1981) noted. Higher
interest rates offered would be a lot more likely to be
accepted by borrowers whose private self-assessment
of their default probability is high. These borrowers
would then become even more likely to default because of the high credit cost burden. Insurance and
credit are therefore rationed, because there is no price
high enough to be profitable with certain customers.
That means, as Rothschild and Stiglitz (1976) found,
that equilibria in competitive insurance markets under imperfect and asymmetric information needed to
be specified by both price and quantity of contracts
offered. Stiglitz (1977) examined differences in the role
of imperfect information in insurance pricing under a
monopoly regime compared with perfect competition.
9.3. Pricing in Asset Management, Securities
Trading and Brokerage, and Credit Cards
Pricing in the asset management industry consists
primarily of fees charged on a clients assets under
management (AUM) in investment vehicles such as
mutual funds, hedge funds, or separately managed
accounts (SMAs). Fees can be
(i) fixed, regardless of AUM,
(ii) asset-based, i.e., a percentage of AUM, or
(iii) performance-based, i.e., dependent on AUMs
return.
Pricing structures reflect costs of different vehicles,
are formed in the process of bringing investor demand into equilibrium with each vehicles capacity,
and attempt to address the principalagent issues between investor (principal) and investment manager
(agent). Capacity of an investment vehicle refers to:
(i) operational infrastructure, which tends to be more

sophisticated and expensive for hedge funds
than for mutual funds, and has additional complexities for SMAs, and
(ii) implementation, whereby profitable opportunities become scarcer as investment vehicles
become larger; and the effectiveness of execution
of a vehicles investment strategies depends to a
large degree on the market liquidity of the securities traded by the investment manager in the
vehicles portfolio.
Mutual funds and similarly managed SMAs typically charge asset-based fees on a calendar basis. As
assets grow due to good performance and inflows of
new funds resulting from this good performance, the
manager gets rewarded for skill and effort. As securities traded by mutual funds are typically liquid,
implementation capacity is rarely an issue. In contrast,
hedge funds and like-managed SMAs often face capacity constraints that limit their size due to diminishing
returns to scale, which makes the asset-based fee an
inadequate incentive for hedge fund managers. Hedge
fund pricing, therefore, constitutes a more representative application of the principalagent model because it
must use more complete incentive mechanisms to minimize informational issues between fund manager
(agent) and investor (principal). A typical pricing structure for hedge funds may consist of
(i) a base (or management) fee, which can be a percentage of AUM paid on a calendar schedule,
and covers operating costs of the fund, and
(ii) an incentive (or performance) fee, which allows
the manager to keep a share of the value created
for the investor during agreed-on time intervals,
to ensure that the interests of the two parties are
aligned.
The manager earns an incentive fee if value is created for the investor according to an agreed-on metric
usually based on either monetary units or rates of
return (see Bailey 1990). Typically, incentive fee
arrangements have asymmetric payoffs, i.e., they
reward gains and do not penalize losses. However,
they often require that an investments value be at or
above a historical maximum, called a high water mark
(HWM), before an incentive fee becomes payable to
the manager. This implies that prior losses, if any,
must have been recovered. Earning high incentive
fees depends on fund manager skill; hedge funds with
highly skilled managers have higher revenues. Such
hedge funds can afford the higher expense of setting
up and maintaining a robust operational infrastructure and control framework, as discussed by Alptuna
et al. (2010). Incentive fees are also common in private
equity, where they are typically known as carried

interest and paid by investors on the liquidation of a

partnership and distribution of proceeds.
A new rule adopted by the Securities and Exchange
Commission under Section 205 of the Investment
Advisers Act of 1940 permitted the use of performance fees by registered investment advisers. Several
published articles then examined performance fee
schemes, with emphasis on inherent moral hazard
and its mitigation. Record and Tynan (1987) described
incentive fee arrangements, and examined the basic
issues involved. Davanzo and Nesbitt (1987) analyzed
incentive fee structures and their impact to the business of investment management. Kritzman (1987)
proposed ways to deal with moral hazard issues,
and to reward the managers skill rather than investment style or chance; these issues were also addressed
by Grinblatt and Titman (1987). Grinold and Rudd
(1987) added another perspective by examining fee
structures that would be appropriate for the investor
and for the manager according to the latters investment skills. Bailey (1990) demonstrated that incentive
fee metrics based on value added in monetary units
serve investors interests better than metrics based on
rates of return. Lynch and Musto (1997) examined
how incentive fees compare with asset-based fees,
especially in extracting value-creating effort by the
manager. Anson (2001) valued the call option implicit
in incentive fees by BlackScholes analysis. The nonlinear optionality in incentive fees was found by
Li and Tiwari (2009) to be optimal even for mutual
funds. Golec and Starks (2004) examined the reduction in risk levels of mutual funds after the option-like
incentive fee option was prohibited by an act of Congress in 1971.
More recent works have studied the role of HWMs
in incentive fee contracts. In a seminal paper, Goetzmann et al. (2003) valued incentive fee contracts with
HWMs using models with closed-form solutions. Anson (2001) and Lee et al. (2004) examine the free-rider
problem in hedge funds that offer all investors the
same HWM: late investors can avoid paying incentive
fees if they enter after losses suffered by earlier investors. This issue was addressed in practice by
offering investors a different HWM based on their
time of entry.
Pricing for security transactions is determined in a
deregulated and competitive market. It has been experiencing a downward trend driven by the dramatic
cost reductions brought by technological innovations
such as electronic trading (see Bortoli et al. 2004,
Levecq and Weber 2002, Stoll 2006, 2008, Weber 1999,
2006). Transaction commissions typically pay for the
costs of brokerage, clearing and execution, trading,
research, and investment advice before the brokerage
firm can make a profit. Economies of scale are very
important, because a brokerages operational infra-
655
structure requires a very high capital investment and

is costly to operate. Generally, institutions have access
to lower pricing than individual investors. A pricing
application for brokerage commissions and investment advisory fees was studied by Altschuler et al.
(2002). They developed models to determine appropriate commission rates for a new discount brokerage
channel, and asset-based fees for advice and unlimited trading in full-service accounts introduced by
Merrill Lynch. Among the issues to contend with were
adverse selection, which might prompt full-service
clients without a strong relationship with their financial advisors to select the low-cost discount channel.
Another known issue is moral hazard, when an advisor might not be committing much effort to a clients
portfolio after the account was converted to the assetbased annual fee.
Credit card pricing and line management were
studied together by Trench et al. (2003). They built a
Markovian model to select the optimal APR and credit
line for each individual cardholder based on historical
behavior with the goal to maximize Bank Ones
profitability. Offering an attractive APR and a large
credit line to entice a cardholder to transfer a balance
presented the moral hazard issue of the client taking
advantage of the offer and then defaulting, which the
model successfully addressed. In his book, Phillips
(2005) discusses consumer loan and insurance pricing.
He expands on it in a more recent book (Phillips 2010)
that also includes a chapter by Caufield (2010), who
examines pricing for consumer credit, including credit
cards, mortgages, and auto loans. In his book, Thomas
(2009) discusses the use of risk-based pricing in consumer credit. Wuebker et al. (2008) also wrote a book
on pricing in financial services.
9.4. Revenue Management in Financial Services:

Challenges and Opportunities
Revenue management principles can be applied to
financial services pricing with some adaptation. The
framework can address key considerations, such as
rationing in credit and insurance (see, e.g., Akerlof
1970, Phillips 2010, Stiglitz and Weiss 1981). Evidence
of rationing is reflected in protecting capacity for airline fare classes (Talluri and Van Ryzin 2005). Another
key consideration is consumer behavior (Talluri
and Van Ryzin 2004). Some revenue management
concepts, for example, capacity, can be quite different
in financial services than in the transportation and
hospitality industries. It can also be idiosyncratic to
each financial product, for example, a CD vs. a mutual
fund, or a hedge fund. Boyd (2008) discussed the
challenges faced by pricing researchers. Identification
problems exist (see Koopmans 1949, Manski 1995) that
make it hard to build demand curves from data and
656

therefore figure out demand elasticities, which are key

to pricing. These problems are especially acute in industries where sales and client relationship persons
have a lot of information on customers, including demand and price elasticities. Such information remains
private and not centrally shared, as is often the case in
some areas of financial services. For example, firms
have databases with prices of closed sales but no information on prices of refused offers; the latter
remains in the field. Remedies have been proposed
and can be considered, such as Goniks (1978), which
Chen (2005) analyzed and compared with a set of linear contracts. Tools used by Athey and Haile (2002)
may also be considered.
10. Concluding Remarks and Future

Research Directions
In this paper, we have attempted to present an overview of operations management in the financial
services industry, and tried to make the case that this
industry has several unique characteristics that demand attention separate from research in services in
general. We have identified a number of specific characteristics that make financial services unique as far as
product design and service delivery are concerned,
requiring an interdisciplinary approach. In Appendix
A, we provide an overview table of the various operational processes in financial services and highlight
the ones that have attracted attention in operations
management literature. From the table in Appendix
A, it becomes immediately clear that many processes
in the financial services industries have received scant
research attention from the operational point of view
and that there are several areas that are worthy of
research efforts in the future. These include each step
in the financial product and service life cycle as well
as in the customer relationship life cycle.
Much work remains to be done on the design of
financial products so that they are
(i) easier to understand for the customer (resulting in fewer calls to call centers),
(ii) easier to use (better online and face-to-face
interactions, with less waiting),
(iii) less prone to operational risks induced by
human errors,
(iv) easier to forecast and arrange the necessary
operational resources for, and
(v) able to take advantage of pricing and revenue
management opportunities.
Service designs need to recognize the fact that
financial services are relatively sticky, involve
long-term relationships with customers, and are at
the same time prone to attrition due to poor performance or frustrating service encounters. Anecdotal
evidence suggests that it is six times more expensive

to acquire a new client than to service an existing one,
making operations a really important factor in financial services.
As described in this paper, there is an extensive literature on traditional service operations research
topics such as waiting lines, forecasting, and personnel scheduling that are applicable to financial services
as well. Inventory models have been successfully applied to cash and currency management. Operational
risk management is an emerging area that is attracting
quite a lot of attention lately. We expect researchers to
branch out and address other non-traditional operational issues in financial services, some of which we
have highlighted here. Many of these are likely to be
cross-disciplinary, interfacing information technology,
marketing, finance, and statistics.
Another area with a potentially significant payoff is
the optimization of execution costs in securities trading. Amihud and Mendelson (2010) and Goldstein
et al. (2009) examine transaction costs in recent studies,
and Bertsimas and Lo (1998) develop trading strategies that optimize the execution of equity transactions.
A significant body of work exists in algorithmic trading,
market microstructure, and the search for liquidity in
securities markets (see, e.g., OHara 1998). Operations
management researchers can examine the problem and
develop solutions by synthesizing elements from this
diverse set of disciplines and points of view.
Another interesting area of research could be the
integration of the various objectives for improving
operations in financial services in which interactions
among components can be viewed and modeled
holistically. For example, most financial services are
quite keen on improving the productivity of their processes. However, one has to keep in mind that there are
strong relationships between the productivity of the
processes, the operational risk encountered in these
processes, and the quality of the services delivered to
the clients. When one reduces headcount, productivity
may indeed go up; however, the operational risk may
increase and the quality of service may go down. It is of
great interest to the financial services industry that
these interdependencies are well understood.
Pricing and revenue management of financial
services could be an area that is ripe for academic
research with a potential short-term payoff that may
be large. Operations management researchers could
leverage related work in economics, finance, and may
adapt revenue management principles to develop
novel pricing methodologies for financial services.
Operations management research may also be key
in enabling visionary ideas for reforming corporate
governance. In the principalagent relationship between corporate shareholders and management,
proxy voting is the most important tool available to
657
shareholders for ensuring that management acts

according to their interests. This tool is seldom effective due to shareholder apathy and obstacles to voting
through institutional ownership of shares. Holton
(2006) proposed proxy aggregation mechanisms, such
as a proxy exchange, that could make the process
more effective in improving corporate governance.
Such mechanisms would ensure that the voting of
proxies is handled by informed entities acting in the
best interests of shareholders, with thorough knowledge of the issues to be voted on. Implementation
of proxy aggregation mechanisms is almost certainly

expected to face complex logistical issues, which operations management can examine and address.
Acknowledgments
The authors thank five anonymous referees, an editor, and
other readers for constructive comments that helped revise
an earlier version of the paper. The presentation, content,
flow, and readability of the paper has benefited as a result.
The views expressed in this paper are those of the authors
and do not necessarily reflect those of Goldman Sachs.
Appendix A: Operations Management Processes in Financial Services

Operational processes
Process realm
Retail banking
Acquisition/origination
Campaign management
Current customer portfolio

management
Cash, currency, and deposit
management
Strategic processes
Delinquent customer
management
Collections
Product design
Service/process
design
Account type
Branch location and
offerings and design rationalization
Deposit product operations Teller, ATM, and online operations Recovery operations
Outsourcing / insourcing
Retail loan origination
Treasury operations
ATM location planning
Risk management
Capacity issues
Credit, liquidity, operational
Technology issues
Anti-money laundering surveillance

Commercial
lending
Loan syndication
Credit agreement maintenance
Defaulted borrower
management
Credit facility
offerings
Credit facility design
Lending operations
Loan syndicate management
Recovery operations
Revolver, term,
bridge, letter of
credit, etc.
Syndicated loan offerings
Credit risk management
Risk management
Credit, liquidity,
operational
Capacity issues
Technology issues
Insurance
Acquisition planning
Policy maintenance
Past due account

handling
Product design
Product offerings
Solicitation management
Claims investigation and

processing
Recovery operations
Insurance policy
types
Application processing
Workers comp case tracking
Annuity products
Capacity issues
Underwriting
Property disposal
(auto auctions, etc.)
Technology issues
Risk management
Operational
Credit cards
Campaign creation and

management
Statement operations
Collections
Card offerings
management
Facilities location
Remittance processing
Recovery operations
APR, credit line,

rewards
Processing and call

centers
Plastic printing and

mailing operations
Call center management
Merchant acquisition Outsourcing/insourcing

operations
Plastic printing and

mailing operations
Private label cards
Risk management
Capacity issues
Technology issues
Credit, operational
Continued
658
Appendix A (Continued)
Operational processes
Process realm
Mortgage
banking
Acquisition/origination
Strategic processes
Current customer portfolio

management
Delinquent customer
management
Product design
Mortgage origination
Mortgage servicing operations
Collections
Product offerings
Facilities location
Securitization
Remittance processing
Foreclosure management
Term, APR
Processing and call

centers
Secondary market
operations
Call center management
Recovery operations
Risk management
Outsourcing/insourcing
Capacity issues
Credit, operational
Brokerage/
investment
advisory
Service/process
design
Client prospecting
Client at risk handling
Technology issues
Collections operations
Cold calling, referrals
Client litigation
Delinquent margin accounts
Anti-money laundering
Commission management
Recovery operations
Account offerings
management
Multichannel design and

pricing
Capacity issues
Margin lending
Technology issues
Trust services
Trading platform design
Channel choice and

coordination
Risk management
Credit, operational
Asset
management
Investment manager
due diligence
Pricing structures
Collections operations
New product/fund
design
Organization design
Pricing structures
Custodian operations
Recovery operations
Share class/series
management
Location of sales and

client relationship
management
New account setup

processes
Fund administration
Operational risk
management
Fund accounting
Capacity issues
Valuation operations
Infrastructure,
implementation
Operational risk management
Technology issues
Processes in bold have been addressed in operations management literature.
Processes in italics have received less attention in the operations management literature.
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PRODUCTION AND OPERATIONS MANAGEMENT

Vol. 19, No. 6, NovemberDecember 2010, pp. 633664

Operations in Financial ServicesAn Overview

Key words: financial services; banking; asset management; processes; operations

insurance (other than health), credit cards, mortgage

1.1. Importance of Financial Services

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

Employment within Financial Services

Title within financial services

Non-depository credit intermediation

Activities related to credit intermediation

Vice President, Operations, Operations Manager, Financial Operations

Securities and commodity contracts

Securities and commodity exchanges

Other financial investment activities

Agencies, brokerages, and other

Insurance and employee benefit funds

Other investment pools and funds

Brokerage operations, Improve customer service, resolves customer issues,

Monetary authorities-central bank

Depository credit intermediation

Source: Bureau of Labor Statistics, stat.bls.gov/oes/home.htm, May 2008.

Even though services account for about 84% of the

Source: Monster.com jobs listings during the week of March 8, 2009.

the services economy, we wish to explore whether

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

bond, or stock certificates, much of the transactions are

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

cohorts, the largest ones, were in fact dependent on

activities (money the firm pays out but is owed

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

dividend payments, become obvious immediately

acquisition process in full-service retail brokerage and

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

A, we provide an overview of the various operations

2. Financial Services System Design

ing by creating front-office/back-office functions

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

substitution of labor with information technology

3. Financial Services Performance

environmental security, operational competence, and

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

Figure 1 Typical Structure of an Asset Management Organization

Independent internal oversight

Internal support teams

External service providers

much will be subsequently collected. The paper by

the multiple constituent parts that must work together

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

Investment Management Process Functions

agement programs at asset management firms should

Zenios et al. (1999), Soteriou and Zenios (1999b), and

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

ops models for different deposit types, i.e., business and

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

retail brokerage to forecast client choice decisions on

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

programming (MIP) formulation proposed by Guntzer

parison to the variability expected in a Poisson

Hatzakis, Nair, and Pinedo: Operations in Financial ServicesAn Overview

Forecasting other aspects of a call center with a

5. Inventory and Cash Management

The concept of transactions demand for money,