The worst of the industry budget cuts may be over, but what lessons have banks learnt from the financial crisis regarding how they pay for their IT and the way they manage the relationship with their IT vendors? Writer Nik Pratt

For many years, the relationship between banks and their technology vendors has been richly rewarding and mutually satisfactory. The banks have had bloated IT budgets that the vendor community has been only too happy to relieve them of in return for all manner of systems and services. Indeed, for some years, the financial services industry has accounted for 20% to 25% of global IT expenditure, making financial services firms, second only to the public sector, a primary target of software vendors. But the recent financial crisis has put this long-standing relationship under strain.

The banking sector has, of course, embarked on cost-cutting exercises on several occasions during the past 20 years, at which times vendors would traditionally resort to selling the long-term value of electronic automation and straight-through-processing - unglamorous programmes that bring the undisputed benefits of increased efficiency, with a sizeable chunk of upfront investment. The recessionary malaise of the past 18 months, however, has proved to be more long-lasting and in many ways transformative than the blips of the recent past, and both banks and their vendors have had to seek out new approaches for distributing, consuming and paying for IT.

"The recent global financial crisis has had a huge impact on IT throughout 2008 and 2009," says Bryan Cruickshank, a global leader for technology advisory at consultancy KPMG. "Investment has been frozen or limited and focus has been inward-looking; minimising cost and making efficiency savings wherever possible. But as the market emerges from recession, so it evolves," he adds.

Indeed, evidence from both bankers and vendors alike suggests that budgetary pressures have in many respects borne a more dynamic and flexible IT delivery and pricing environment, as well as strengthening the relationship between banks and their vendors. But whether or not this relationship will stand the test of time, especially as the market picks up, is another matter.

Postpone and prolong

At one major European bank, the reaction to the financial crisis and shrinking IT budgets has generally been one of 'postpone and prolong', reports the organisation's chief information officer, who agreed to comment under the condition of anonymity. The discretionary budget every bank allocates for business changes or new development projects have been revisited and, where possible, each business unit has been contacted to see if it still wants to continue with these projects. Of course, every bank department has felt the budgetary repercussions of the financial crisis, so the IT department's efforts to encourage postponements was relatively straightforward, he says.

"None of the work was cancelled but where possible we delayed projects for a year or so. And where the projects continued we stretched them over a longer period, so what was planned to last 18 months would last two or even three years, which allowed us to spread the cost of each project and also to reduce our headcount by shedding a few contractors."

The bank has also deferred expenditure on hardware, he continues. "We run a very strict four-year lifecycle here which means that every year a quarter of desktop PCs and laptops are replaced. We deliberately delayed that last year which saved us the cost of 400 new machines. And we also took a holiday on the servicing we get from the hardware vendors, which saved us a bit more money."

There have been no changes to the procurement process as such, says the IT chief, but the bank's major vendors were all asked to share the pain. "We were at the point of agreeing new contracts with many of our vendors so this gave us the opportunity to ask them what they could do to help us out. With other vendors there was no natural break in the contract, but fortunately we have a lot of long-standing relationships so approaching them was easy enough to do."

The bank did not lay down explicit conditions as to what changes the vendors should make to their pricing structure, but a certain amount of 'guidance' led the majority to reduce their fees and licensing arrangements by 10% to 15%, he adds. Were any vendors able to offer more creative solutions to the budget tightening problems? "Most vendors have been caught in the crossfire as well and we did not want to damage these relationships," he says.

A test too far?

This is all well and good, but these relationships will now be further tested when, as the worst of the financial crisis is deemed to be over and licensing agreements come up for renewal, vendors will be looking to return to previous costs or even charge an increased amount for new technology. Has the goodwill between the bank and its vendors endured this testing time?

"Generally speaking the relationships are still good and we have not seen any long-term damage from the changes we put in place over the past two years, but some vendors are sticking their heels in when it comes to new contracts," the IT chief says. The biggest change he has seen is a more serious approach to account meetings, using them as a basis for meaningful discussions rather than simply meeting up four times a year because it is a condition of the contract.

"They are more willing to open up their books to us and to share their future plans with us. They are outlining their strategy for the next 12 to 24 months and they want to know whether this is a direction we would also like to go in - so it is a far more engaging relationship," he says.

And this is a welcome shift, he adds. "In many ways, the financial crisis has been a force for good - at least in terms of the relationship between banks and their vendors. We had perhaps become complacent and were taking things for granted, but the past 18 months have forced us to think of new ways of dealing with each other in a more co-operative way.

"We all went into the financial crisis together and hopefully we will all come out of it together. But the test will be whether these changes are embedded into the way we do things and if they are still in place several years down the line when, hopefully, market conditions will have improved. We can be quite quick to forget the lessons of the past."

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Adam Honoré, a research director at US-based consulting firm Aite Group

Backing your product

Adam Honoré, a research director at US-based consulting firm Aite Group, agrees that the past two years have in some ways proved useful for IT chiefs, in that they were able to pressure their vendors for either a reduction in prices or the provision of extra consulting services or resources in exchange for the same price. And while banks' budgets may have returned to more promising levels, a number of banks have still found ways to retain discounts, he says.

"We have seen a trend towards inverse pricing models where, as banks are moving into new asset classes, they are asking vendors if they can pay an initial portion of the total cost for the system until they can tell whether they will make money from the venture," he adds.

This model might involve paying 20% of the software's list price until the bank is in full production. It is an approach that works well for the customer in that it is able to hold back on paying large initial sums which therefore makes it easier to build a business case. And, says Mr Honoré, it works well for the good vendors because by agreeing to this model they are backing their product by assuming it will prove successful and enable the bank to generate revenue.

Budgetary constraints for technology spending have been particularly severe in banks' trading departments and the technology providers operating in this space have endured tougher times than most. "We knew that budget cuts were going on but it was business as usual for us in 2008. But then in early 2009 things really started to slow down," says Tom Driscoll, managing director of Charles River, a developer of order management systems for banks, brokers and investment managers. "We saw massive cuts across the front and middle office and in some cases those cuts went down to the bone."

Mr Driscoll says that a consequence of these cuts was a change to the process of selecting and choosing systems, most noticeably for the front-office applications used by the dealing desks. As the major money-makers, tech-savvy traders have always had a big say in the machines that they use, so high-performance and ease-of-use were always the most sought-after qualities. But in 2009 the chief financial officers and chief operating officers began to get more involved in the IT procurement process, reports Mr Driscoll. "They instigated a rationalisation of systems, including the desktops of traders and this changed the way they interact - often for the better," he adds.

For example, rather than separate order and execution management systems, traders realised that there are considerable benefits to having more consolidated trading data residing in a single system. They also began to take more interest in new technology models such as Software as a Service (SaaS) and cloud computing, recognising the advantage of a hosted environment where data feeds directly to the traders' systems rather than relying on batch data feeds.

"Of course, when conditions return to normal, traders will once again have a say in what systems they get," says Mr Driscoll. "But by that time I think the technology in SaaS models would have advanced to the point that traders will see it as a large plus in terms of quality of data and a compelling return on investment argument."

To this extent, new approaches in pricing IT reflect not merely recessionary pressures but a changing conceptualisation of how IT may be both distributed and consumed, particularly given that one of the key benefits associated with the rise of SaaS and the ever-present cloud is the absence of upfront licences and, more importantly, ongoing maintenance costs that have traditionally sucked up vast chunks of the banking IT budget. Indeed, SaaS and cloud models generally allow the user to adopt a pay-as-you-go model, a consumption and pricing model once entirely alien to the world of package-dominated corporate IT.

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Mark Gunning, group retail banking director at core banking system provider Temenos

Retail reaction

On the retail side of banks' operations, during the past two years the 'postpone and prolong' approach to IT spending has been strongly in evidence. "Since the financial crisis we have seen a delay in spending rather than a reduction of budgets and now we're seeing a reasonable return to investment in new projects," says Mark Gunning, group retail banking director at core banking system provider Temenos.

Mr Gunning says there has been relatively little change in what his customers are asking for in terms of licensing or pricing structures. As such, there are only certain systems that are currently subject to more flexible pricing or SaaS delivery and pricing models, with core systems, such as those provided by Temenos, remaining relatively untouched.

"We have seen a small demand for a rental pricing structure from the smaller players and start-ups but the nature of core banking system replacements means that there is little demand for a pricing structure based on consumption or pay-as-you-go," says Mr Gunning.

More noticeable has been the banks' increasingly attentive approach to the procurement process. And although this trend has been long-term and predates the financial crisis, the budgetary constraints of 2009 helped bring this aspect into even sharper focus. "The selection of core banking systems is always a big event and banks' procurement departments are becoming more prominent in the process," says Mr Gunning.

The total cost of ownership is also becoming more important to banks, he continues, so those involved in the procurement process are looking more closely at the underlying technology and platforms, the operating system that the software runs on and whether there is any open-source technology involved, which would allow the bank more control over software development. These are all trends that are to be expected at a time of frugality, but as bankers begin to talk about the green shoots of recovery and technology vendors prepare to unveil the latest product suites that were kept under wraps until budgets loosened, the true test of this relationship between banks and their vendors is only just beginning.

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