China's banks face up to their technological challenge

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If there is one characteristic that defines and differentiates the Chinese banking system it is one of immense scale. Behemoths such as Industrial and Commercial Bank of China (ICBC) and Agricultural Bank of China (ABC) boast colossal customer bases comprising hundreds of millions of customers, the likes of which have never been seen in developed markets. And this is just the start. For China's banking sector, extensive economic growth is bringing with it the opportunity to acquire even more new customers and expand into fresh products, regions and businesses. But technology heads at some of the country's financial institutions would be forgiven for casting a concerned eye over their IT systems and wondering if they are equal to the demands that ambitious modernisation and expansion programmes will place on them.

This rapidly changing banking landscape is generating new and varied technology requirements. From catering for the disparate demands posed by China's vast geographical and economic diversity, to focusing on long-neglected areas such as risk and operations - and in some cases even constructing decade-long IT strategies - more is being asked of chief technical officers (CTOs) than ever before.

Growing pains

Although fears that the Chinese economy is cooling have been voiced in recent months, growth is still robust. An International Monetary Fund (IMF) report released in July suggested that the world's most populous country is on course to realise 10.5% economic expansion in 2010, its biggest increase in three years. Despite some ongoing concerns regarding asset quality, Chinese financial institutions have emerged from the crisis in comparatively rude health and are now scrambling to keep up with, and in some instances overtake, the rest of the country's economy.

As a result, technology departments are facing what Ye Yousheng, CTO at China's third biggest bank, ABC, sees as his biggest challenge - ensuring that IT keeps pace with the development of the business as a whole. This may be more easily summed up than accomplished, however, especially given the complex, sprawling nature of the Chinese banking sector itself.

Mr Ye identifies a number of specific issues faced by technology heads at Chinese financial institutions, the most simple, and perhaps the greatest, being the sheer size of the wide-ranging domestic market. "There is a geographical disparity in China," he says. "It is so big that there are different levels of economic maturity in different regions. This poses highly varied demands on a banking service and catering for it is a huge IT challenge."

The influx of a newly moneyed middle class in China is placing fresh burdens on banking technology, as firms diversify their products and services. "China is in the development stage but we have seen the rise of the well-off, so the banking sector has to think of the different demands from each segment," says Mr Ye. Wealthier customers are certainly on the rise: 50 million people join what analysts have defined as China's middle class every year, which is projected to make up roughly half of China's urban population by 2025, according to research from McKinsey Global Institute.

The general move away from state-prescribed size and operational requirements in the banking sector provides yet another technology headache. Mr Ye adds: "Things are more market-driven now, so the focus is increasingly on risk and performance. That has been an area of weakness in the past but there is now a much bigger focus on making banking IT solutions more risk-orientated, as well as paying more attention to cost and performance."

Ye Yousheng, CTO at China's third biggest bank, ABC

Ten-year itch

There is a clear appetite to overcome these issues, however. The degree of ambition among Chinese banks is demonstrated by the future IT plans of a trio of IBM's clients, says Rohitha Perera, a partner in IBM Global Business Services. "With all three clients (one of which has more than 200 million accounts), we are creating a strategic blueprint for the next decade," he says. "That in itself is interesting because in a lot of Western banks the strategic blueprint is two years. The reason for this approach is that with the combination of central planning and the free-market dynamics going on, by 2020 they want to be world-class financial services organisations."

Consequently, financial institutions are pouring money into technology, and spending - which was hardly impacted by the crisis - is now forecast to reach $11.3bn by 2011, according to financial research and consulting firm Celent.

Demand for fresh IT infrastructure is coming from an unparalleled array of institutions, ranging from the so-called 'big four' state-owned commercial banks to a number of joint stock commercial banks, more than 100 city commercial banks, many more tiny rural credit co-operatives and, now, a number of foreign subsidiaries.

Despite some common drivers, each type of institution has very different IT requirements, and there are clear differences between the way in which China's first-tier institutions approach technology when compared with smaller firms. This is in part due to the incredible volume of accounts and customers they deal with - something the banks themselves cannot always avoid even if they wished to. "Chinese banks, particularly the big ones, provide something of a social welfare service; the bank is obligated to open an account for anyone who comes in," says ABC's Mr Ye. "This makes account numbers even higher than they would be otherwise and means it is hard to control numbers." He adds that banks are unable to impose fees entirely at will, as upper limits are set by governmental mandates. "There is a lot of business, a lot of free business and huge transaction volumes."

Jost Hoppermann, vice-president, principal analyst with technology and market research firm Forrester

Core values

The banking heavyweights have the most mature systems, the biggest IT footprint and conduct more in-house development than smaller institutions, says Michael Araneta, associate consulting and research director with market research and analysis firm IDC Financial Insights' Asia-Pacific business. But unlike some of their Western counterparts, Chinese banks are increasingly happy to take off-the-shelf packages when it comes to replacing outmoded legacy architecture.

In the US and western Europe, banks traditionally rely on proprietary core banking systems, with only the odd exception, such as Deutsche Bank, braving third-party technology. Conversely, even the largest of Chinese banks - including Bank of China, which runs a core system provided by Tata Consultancy Services - are happy to install core systems provided by external software vendors, according to Jost Hoppermann, vice-president, principal analyst with technology and market research firm Forrester. Off-the-shelf core platform sales, for example, are very much on the up in mainland China, and the market accounts for as much as 25% of the entire Asia-Pacific region's banking platform deals, according to Forrester data. "In China, even large and very large banks, as well as those that are somewhat smaller by Chinese standards, are all using off-the-shelf systems for their headquarters' installations and international subsidiaries," he says. "These numbers are pretty unique as far as this kind of contract pattern is concerned."

One of the reasons for this, according to ABC's Mr Ye is that Chinese banks benefit from international vendors' wider market knowledge, along with their technology services. "This trend is mainly motivated by the learning process," he says. "By working with different firms, we can learn more about different management technologies and have access to international expertise."

Despite the benefits, however, ABC was not prepared to surrender all responsibility for constructing its core operations. Instead, it chose to build the platform itself but to use reference architecture and process and data models from core banking system provider Temenos as the basis to supply services for its 350 million customers.

Although somewhat atypical, Mr Hoppermann draws parallels between this approach and more usual installations, which for a first-tier bank would usually include extensive customisation to comply with Chinese banking norms and standards. He adds that both of these approaches are symptomatic of a general trend towards componentisation in core systems. "While we certainly have different approaches today - such as solving the question internally, customising a third-party solution or buying a blueprint - these are only indicators that off-the-shelf banking platforms need a lot of flexibility."

Come the revolution

After the four first-tier institutions, China's joint-stock banks are next in the financial hierarchy. While they tend to be significantly smaller (usually with an asset size of about one-quarter that of their state-owned siblings, according to Celent), they are experiencing a higher rate of growth and their IT systems are relatively mature, according to Hua Zhang, an analyst in Celent's Asia Research group. A similar situation is found in the smaller city commercial banks, he says, many of which have taken advantage of the favourable financial climate to begin programmes of mergers and acquisitions.

The demand for new products and services has, in part, impelled something of an IT revolution among these smaller institutions, says Mr Araneta. But while they share many of the same goals as their bigger peers, they will be running on tighter budgets and, as a result, when picking a technology vendor, price will often be a decisive factor. "Among the smaller banks, cost is a far bigger consideration, and we often see them choosing second-tier technology providers," says Mr Araneta.

The next layer of firms - the policy banks, postal savings banks, rural banks and credit co-operatives - often have much weaker IT systems, says Mr Zhang. Indeed, when contacted, a spokesperson for Chengdu Rural Commercial Bank - China's fifth largest institution of its type - declined to comment because they felt the bank would not "represent the mainstream of China's banking industry", given that it did not currently even have an operational enterprise e-mail system. However, Mr Zhang predicts that as banking reform continues, these institutions will become important players in the banking technology landscape.

A mobile population

Despite major differences in terms of scale, Chinese banks, like their counterparts in other emerging markets such as India, are delving into channels found to be less mature in developed markets. "As with other emerging countries, mobile is very hot in China, and banks need systems with these kinds of capabilities," says Mr Hoppermann. China is currently leading the world in the uptake of mobile finance, and 77% of consumers use their phones to conduct financial transactions, according to advisory group KPMG.

IBM's Mr Perera also anticipates huge growth in mobile banking capabilities, as well as in traditional service channels. In fact, service as a whole is where he expects Chinese banks to concentrate much of their IT efforts. "Service quality in some of the branches in China is very high and what they are looking at very closely is the need to balance control of what happens in a branch, both in terms of how a branch manager controls it and in how the corporation understands what is really happening across its vast branch network," he says.

From a risk and governance perspective, this is essential to ensure a corporation is growing in a controlled way. However, ensuring a uniform service quality across branches is also key, Mr Perera says. While that may seem obvious from a brand and customer experience point of view, it is crucial nonetheless, and for every tier of institution, he says. "It is important for the national banks in servicing core clients who move between cities and expect a consistency of service, it's important for the

second-tier institutions who you could argue will compete on pure service quality, and it is certainly important for the city and provincial banks looking to grow out of their city or province."

Michael Araneta, associate consulting and research director, IDC Financial Insights' Asia-Pacific business

Cracking the market

For banking technology vendors, both domestic and foreign, the business opportunities presented by these myriad technology requirements are both extensive and potentially lucrative. Chinese installations are likely to be large in terms of scalability, or at least planned scalability, and are often used to provide prestige-boosting benchmarks regarding numbers of transactions.

Local firms such as Longtop or Yucheng Technologies are well established in the market, but foreign vendors are also keen to get involved. However, most non-domestic vendors will admit that penetrating the Chinese market has not always been easy and that attempts to do so have had a rather chequered history.

Domestic companies will have inherent advantages when compared with global firms, particularly in China's often reticent banking climate, says Mr Araneta. He notes that specialised knowledge, local ties and relationships, and even perceived confidentiality are given as reasons cited by banks for working with local technology vendors.

It might be tempting to put the problems faced by international technology firms in the Chinese banking sector down to cultural and operational differences, and indeed many vendors do. But the root may lie in basic economics rather than distrust of the capability of outside providers, according to Mr Araneta. He says: "In a lot of cases, decisions are based on pricing, and foreign technology providers tend to have higher unit prices." He also notes that while non-domestic players are often willing to make their pricing closer to local averages, they may still present a premium. This is something the international vendors themselves are only too aware of.

"There is a high degree of cost sensitivity when bidding for business in China," says Chris Longden, Temenos's regional director for Asia-Pacific. "If you look at Japan, for example, banks tend not to be very cost-sensitive. The focus is on quality, quality, quality, and the cost is secondary. It isn't that they don't care about quality in China but they certainly do care about cost. The negotiation process can be pretty painful."

The solution to Western technology vendors' problems may lie with creating ties to firms already operating in the region. "Foreign players have to look for local partners to be really successful in the market," says Mr Araneta. "For foreign technology providers, length of experience is most essential. To be successful you need to be familiar with the Chinese market."

To achieve this, firms are integrating themselves rather more closely into the market by creating joint ventures with, or even acquiring, local firms to create a more locally aligned platform. The biggest area of cash handling equipment and software provider Talaris' Chinese operations, for example, involves producing parts for mainland China ATM manufacturers, such as GRG Banking Equipment and Eastcom Finance, which are major suppliers to Chinese banks. An approach that Ben Thorpe, head of Talaris' Asia-Pacific operations, feels has put the firm in good stead.

"It gives us a degree of credibility with banks because they already use our technology, even if it isn't branded as ours," he says. "We have three offices in China but can't be everywhere, so we're taking quite a common approach by partnering with strong local companies that have established relationships, good business models, the right kind of people and an understanding of the challenges a Western company faces trying to do business in the [Chinese] market."

Away from the established vendors, systems are available from other quarters, too. China Industrial Bank (CIB), for example, has developed what it calls an 'inter-bank service system', which provides IT outsourcing to small and medium-sized banks (SMBs) that find constructing their own IT systems prohibitively expensive. This has now been deployed in SMBs all over China, CIB officials say, and is finding particular favour among those involved in micro-credit in rural areas.

But wherever banks get their IT systems from, they are likely to play an increasingly important role in both everyday operations and revenue generation. Looking to the future, ABC's Mr Ye expects the technology path taken by his department to typify much of the development within the Chinese banking sector, particularly when it comes to integration with, and importance to, the business as a whole. "The general trend in IT will be for technology to work closer with the business department. We expect IT packages to cover a far greater depth and breadth of the business," he says.