Is software eating the banking industry?

This morning, I took part in a fireside chat at the Goldman Sachs European Financials Conference. We discussed the potential for technology to lower costs and raise productivity.

How can technology help drive down bank IT costs?

1. Reducing hardware and software maintenance costs. Modern systems are better architected, with broader capabilities, than the legacy systems they replace, helping to consolidate the number of software applications banks run whilst reducing infrastructure overheads.

2. Extracting IT economies of scale. As banks grow, IT costs should fall relative to income. But banks have struggled to realize IT economies of scale, as legacy systems are too complex to integrate (in the case of M&A) or scale to support organic growth. Modern systems provide a scalable platform for improving productivity as demonstrated by the experiences of Temenos customers like Bank of Shanghai and EFG

3. Greater straight through processing. Automation of processes helps to reduce the number of back office and IT staff needed, but also helps to reduce errors. Automation also leads to faster fulfilment of customer interactions, critical to satisfying customer expectations in an increasingly digital world (technology giants like Amazon and Google run at 99%+ STP, a level banks will need to reach as well)

4. Lowering the cost of compliance. It is relatively easy for banks to quickly and simply implement most new rules and regulations on integrated and highly parametrised modern systems. Where a third-party packaged system is used, the provider can leverage the economics of packaged software to develop new modules for compliance which can be made available to all customers at zero marginal cost

5. Better risk management and operational control. Modern systems have very robust workflows, to ensure segregation of duties for example, or to keep detailed audit records. They also provide comprehensive and real time information about the business to help management to make better informed and faster decisions.In terms of risk management, modern technology helps by giving better data, a greater insight into customers’ circumstances that goes way beyond standard credit checks.

Can banks continue to defer technology renewal?

Time is definitely running out. In another blog, I suggested that many banks were underestimating the pace of exponential change and needed to act quicker.

The challenge is two-fold.

The first is opportunity cost. Maintaining legacy systems takes up 76% of banks’ budgets, leaving little to invest in meaningful enhancements that consumers demand and that market leaders deliver.

Secondly, if banks don’t modernize legacy systems, they won’t have a platform to deliver seamless and rich customer experiences. Customers – of all types – want their financial services providers to become trusted advisors, helping them to make better financial and commercial decisions, giving them advice, finding ways for them to save money, introducing them to trusted partners and so on. For banks to be able to successfully play this role as ‘infomediaries’, they will need real-time capabilities (offers, publishing, etc ) that simply aren’t possible with legacy infrastructure

How much more efficient can banks become with IT renewal?

Temenos produces a report every year with Deloitte that compares KPIs of banks running modern core banking systems vs. those running legacy systems. It shows a significant and sustained differential in performance (a 6.5pp lower cost to income on average over a 5 year period).

Obviously, the report can’t establish causation, but the correlation is extremely strong (it holds across every year, every region, every type of bank, etc) and certainly this kind of differential in performance is representative of the cases where we can prove causation.

Is IT cost/total cost still a meaningful efficiency metric?

In future, people will focus much less on IT costs relative to total costs. As the industry digitizes, IT costs will necessarily rise relative to other costs. Technology will become an even more important source of competitive advantage and a higher ratio of IT costs to total costs might even come to be seen as a good thing.

Instead, people will focus more on where  IT costs are invested. Investors, management and other stakeholders will concentrate on KPIs like how much of a bank’s IT budget is spent maintaining systems vs. developing or acquiring new capabilities.

Will banks be able to realize significant savings themselves or will they rely more on third parties?

Banks can realise massive savings by adopting modern third-party systems, irrespective of how the software is deployed. However, much bigger savings can be made if banks use shared infrastructure. A recent report by IDC looking at Microsoft SQL found that it was over 50% less expensive to run the database in the Azure cloud.

Therefore, more and more banks will turn to the cloud. Not necessarily the public cloud but private and community clouds in order to take advantage of  lower costs; they’ll be obliged to as significant parts of the banking value chain commoditise, forcing transactions to be processed at the lowest unit costs.

Nonetheless, we don’t predict a more significant move to bureaus and business process outsourcers because this would entail banks giving up too much of their capability to differentiate in the front office; to launch new products quickly, to differentiate their channel experience, etc.

Is technology modernization becoming less risky?

Today, things have moved on quite a lot. Most systems are open i.e. they can run on most technologies, so banks can continue to leverage their existing platforms if they choose to. In addition, a lot of the big SIs like Accenture and Capgemini have built practices, so there is more expertise around mission critical banking technology. Lastly, the systems have been more and more componentized, meaning progressive renovation is now possible – replacing a bank’s IT estate bit by bit, reducing risk and time to value.

Will technology displace the labour force?

Some jobs in banking will inevitably be replaced by technology over time. There are many studies looking at the kinds of jobs most susceptible to automation and, unsurprisingly, many of these are in banking (tellers, for instance).

But ultimately technology is an enabler. It will enable bankers to do their jobs better, with better information, fewer mistakes and better customer outcomes. For example, while there is a valuable place for roboanalyzers, they won’t replace, but empower, the best wealth managers.

Do banks give adequate disclosure of IT spending?

If you look through a typical bank annual report, you’ll see some information about how the bank accounts for IT costs, some information about what IT costs the bank has recognised as assets on the balance sheet, but that’s about it. Given IT costs are typically around 15% of total costs and given the growing importance of technology in establishing competitive advantage, this level of disclosure is completely inadequate. Investors and other stakeholders should be demanding much more disclosure about where the money is going, banks’ IT strategy and roadmap.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s