Time to cough up the IT hairball

These remain challenging times for bankers, and equally challenging times for banking IT chiefs. Since the onset of the credit crunch, an industry that had grown accustomed to consistent growth and fat profits has been forced to adjust to a more austere financial climate.

This shift in fortunes has prompted major changes in the business thinking and strategy in all corners of the banking industry and nowhere more so than in the IT departments of the top-tier banking community.

Of course, there is nothing very new about IT bearing the brunt of business change, particularly in today's digitally driven banking industry, and particularly when change is being driven by a toughening, ever more competitive business environment.

Sheltered status

IT's status as the chief source of improved productivity and savings has tended to shelter it from the worst of any restructuring that has accompanied previous business downturns, and this occasion has been no exception.

According to Celent, a US-based analyst of financial IT services, global IT spending by financial-services companies dipped 2.5% in 2009 as firms cut development budgets and froze spending, but 2010 is already showing signs of a rebound.

This year, assuming there are no more major traumas lurking in the wings, Celent expects financial IT spending growth to reach 2.9% and then to accelerate to achieve 4.9% between 2010 and 2012.

By the standards of an industry still widely held to be in a depressed state, this is impressive growth. But it is no surprise to banking IT specialists such as Daniel Benton, managing director for technology in financial services at Accenture, the global consultancy, or Likhit Wagle, IBM's global leader for banking and financial markets. After all, IT investment will be critical for business survival.

"These days, IT is usually not just about 15% of a bank's cost base," says Mr Benton. "It is also usually the principal enabler for driving cost out of the 85% that is left."

Not business as usual

Both Mr Benton and Mr Wagle believe that, unlike previous banking downturns, the recent crisis is more than just a temporary blip that will be followed by a return to 'business as usual'. This time the business climate change is set to be more profound, forcing banks to make similarly profound changes to their business strategies and, of course, to the information systems that they need to support them.

"It seems that a lot of the banking industry has already returned to a level of profitability, but a lot of [banking] people believe this is a temporary phenomenon," says Mr Wagle. "Investment bankers are afraid that it [the recovery] will collapse when the stimulus is removed."

Meanwhile, in the retail banking sector there are similar fears that what appear to be good prospects for growth are showing fewer signs of translating into healthy profits. Whereas before the crisis a 'good bank' in Europe would expect to realise a 25% return on equity (RoE), today the average is closer to 6%, says Mr Benton. "Fundamentally," he says, "this suggests that the old [business] model doesn't work very well."

If banks are to survive in the long term, says Mr Benton, they must find a way of returning RoE to somewhere between 10% and 15%, and this is unlikely to be achieved solely by cost-cutting.

Instead, says Mr Wagle, banks must find ways of efficiently exploiting new opportunities, such as the booming markets of Brazil, Russia, India and China (BRIC), where some players are known to be adding new retail account holders at an incredible rate of 2 million a month. Banks operating in more mature markets such as Europe must do better at maximising profit from the customers they already have.

Mr Wagle says: "Banks such as Barclays [or any other US or European retail bank] need to be a lot more agile than they have been in the past. They need to be a lot better at launching new products and cross-selling to discover new sources of revenue. What they cannot do is just ratchet up the fees. The market is now so much more competitive than before."

Translating these ambitions into new IT systems and practice can be done and is already being done in myriad different ways. For instance, the unification of banking channels to produce a consistent set of services across ATM networks, the internet, TV and telephone networks continues be a key customer-service focus for many banks.

Innovative analytics, particularly using larger data warehouses set against larger server grids, are driving investment at other banks, while others are still exploring innovative ways of exploiting new categories of mobile platform such as Apple's iPad and Google's Android smartphone environment. Of course, still more banks are attempting to drive service innovation through all of these different technologies.

The point is not that banks are continuing to experiment with new technologies, but that their motivation for doing so is changing. "Before the credit crunch, people were investing in technology to sell as many products as they could," says Nick Brewer, vice-president of the retail banking division at US financial technology provider SunGard.

"They were interested in market share and customer acquisition so that they could bundle things up and sell them on to other people. What they did not have was a view of customer profitability. Now they are not worried about market share - they want to make a profit."

The observation that IT is there to drive profit is not just relevant to customer-facing systems. Banks have two other categories of core asset: their capital and their staff. These too are now being subjected to IT-driven investments that are focused on producing business benefits that will have a direct impact on the bottom line. Mr Brewer believes that most banks now recognise the virtue of taking a more structured and focused view of IT investment, and that they are likely to accelerate their deployment of new systems as result.

Legacy IT complexity

However, there is one structural IT problem that the post-crisis shift to profit-focused technology deployment is now bringing into sharp relief: the fact that the great majority of banks do not have a single enabling IT infrastructure. Instead, they have a collection of separate IT infrastructure investments that may occasionally complement each other, but which are more usually found to be incompatible and wasteful duplications of each other.

This is the legacy of decades of incomplete system consolidation following mergers and acquisitions, and a perennially 'siloed' assembly of IT resources that are the consequences of too many investments driven by the interests of a single line of business and comparatively little commitment to genuinely corporate systems architecture. Now that banks are emphasising speed to market and streamlined resource efficiency, they are discovering that the biggest obstacle to achieving this goal is the intractable nature of their existing IT investment.

Indeed, it is difficult to exaggerate the scale and complexity of the banks' legacy IT challenge and, whenever it is discussed, it tends to inspire some colourful turns of phrase. Mr Benton, for instance, calls it the "legacy hairball", capturing the sense of a deep-seated problem that has accumulated over time. Mr Brewer talks about the "tar-baby": a problem that becomes more intractable the more it is struggled with. Bart Nartar, senior analyst at Celent, stresses the potentially "ruinous and prohibitive cost" of tearing up 50 years of systems and application software investment.

Risk of migration

However, the most compelling reason that banks have found for constantly deferring any decision to 'cough up the hairball' is the sheer risk involved in attempting to jump from existing systems to new ones. "For any large bank with a very large and complex IT legacy, the cost and risk of migrating away is great. It is like undergoing a heart and lung transplant while you are still awake and working," says Mr Wagle.

But it may be that the time has finally come to attempt this tricky operation, or else risk being overtaken by the growing number of nimbler, more cost-efficient competitors that have no legacy confining them to their own operational past. If that is the case, then even the credit crunch may be said to have a silver lining.