The demands of competition and regulation mean banks need to be poised for action. Their core systems must be able to evolve with industry changes, says CSC’s Anita Bradshaw.

Core banking systems lie at the heart of retail banks yet are seldom considered glamorous. However, these familiar – generally reviled– workhorses can hold the key to competitive advantage, and are often the engine for some of the most exciting developments in banking.

During the past few years, retail banking has seen something of a revolution. Functionality has changed beyond recognition in many markets, and delivery mechanisms have proliferated. Consumers have been bombarded with different types of product, and banks have been competing with each other not only in terms of price and quality, but also time-to-market of new products.

Many markets are over-banked and the levels of competition in some areas have been intense. With competition has come not just innovation, but also attempts by banks to cut back-office expenses, often by cutting staff numbers, training budgets and allowing experience to dissipate. Customer service is often directly hit by such measures, and complaints increase where changes are visible to customers.

Regulation has responded to some of the more gross customer abuses that have been reported as service levels come under threat. Regulators have become more powerful during the last decade and have extended their sphere of activity, responding to a variety of scandals in both the retail and wholesale markets. Banks are being forced to introduce controls in a range of areas.

Standing out

Functionality is a key competitive differentiator. Since the first telephone banks came into existence, banks have realised that they need to differentiate their products by offering new service levels. Banks that were able to offer new methods of delivery and new products were able to gain competitive advantage and turn it into market share.

The product development process requires creative effort, or, for those banks that are not market leaders in innovation, the ability to replicate competing products with accuracy and speed. Most significant is the time-to-market in either case. Barring explicit industrial espionage, the first to produce a new product offering has some time advantage before the product is copied and competitors defend their market shares.

Avoiding pitfalls

New business opportunities, more than anything else, reveal the true characteristics of the underlying core systems.

Product development efforts often fail, for a number of well-established reasons. A product development team must often create the infrastructure for asubtly new process alongside the existing operation. Communications between operations staff and product development unit are crucial to a good result, but may be fraught with problems. Operations are generally tasked with keeping costs low and maintaining efficiency, and may resent any time spent with the product development team. The type of staff employed in these two areas may differ so much that they cannot work together effectively without firm and effective management.

The product development team may be viewed as “not living in the real world” as they strive to create new ways of working. There may also be structural reasons for failure, with the entire business process being split between different business silos – very common in banks, given the trends for management reorganisation along specific lines during the last decade in particular – and change may be difficult or even impossible to manage in these circumstances.

Customer demands

However, failure to understand customer needs and behaviour properly is probably the most common reason for failure. Often this phenomenon is caused by the most obvious failing: lack of knowledge and direct experience with customers.

Over the years, retail customers have become more and more sensitive to service level issues as they realise that they have a choice of provider. Service levels are crucial to customer perceptions, and customers that have already shifted provider once are often more sensitive.

Clearly management has to establish a balance with the product development team, keeping them close enough to both the customer and the operations staff, while bridging the different cultures that these extremes often represent.

Product development requires an ability to think outside established parameters. A good example would be the introduction of the euro, destroying much of the difference between ‘domestic’ and ‘international’ that banks have built up over the years. Yet few banks have bridged this gap.

Regulation costs

Regulation is designed, usually with good intent, to protect vulnerable groups in society. Regulation should create stability and certainty, but generally has the unwanted effect of increasing costs. Banks are currently attempting to surmount the various challenges of the Basel II regulations, being the authorities’ response to the increasing awareness of risk in business and the systemic risks that banks – the most highly leveraged of all institutions – pose to society, both consumer and corporate.

Most people believe that business is exposed to more and more multifarious risks today than has been the case in the past. Humans are poor judges of risk, being both emotional and over-optimistic where their own abilities are concerned. People express genuine concern about public transport conditions after relatively infrequent, if horrific, accidents while indulging themselves in numerous far riskier pursuits without even realising or acknowledging the inconsistency of their views. Regulators have to act because they perceive that bank employees generally apply the same logic to their professional duties, and because they can see how consequences of relatively small lapses of judgement can extend quickly in the modern world.

Global trends

The global nature of bank business and the linkage of payment systems through mechanisms such as continuous linked settlement (CLS) means that liquidity shortages can spread rapidly with potentially disastrous consequences. Contagion can affect innocent competitors of stricken organisations, and with the increasing size and global reach of many banks, some form of monitoring and control seems desirable.

Regulation for banks is not just a matter of local variants on the Basel II theme; many banks will also be exposed to requirements under the US’ Sarbanes-Oxley Act. There is also national legislation on a similar theme of tightening internal audit and control mechanisms. In the UK, for example, the Companies Bill will tighten regulation in a number of areas, and may end up becoming the UK’s own Sarbanes-Oxley variation. On an even shorter time scale, there are international accounting requirements to be met in many major markets.

Key features

Core banking systems have to respond to these challenges, and the extent to which different applications can do so effectively is likely to be the major competitive differentiator of the next few years in this sector. Not all systems are alike in this respect, and it is worth analysing the features that will make the difference. Of these features, real time processing, flexibility and reusability of business rules will stand out.

All the regulatory requirements can be viewed as empty exercises in compliance, or they can be built into an exercise to generate competitive advantage. If a bank can build a more responsive risk monitoring and mitigating system that can help management anticipate crises, and respond quicker to external conditions, the resulting lowering of volatility in its results should promote greater investor confidence and facilitate a virtuous circle as capital becomes more readily available.

Risk management techniques comprise a set of tools for the general manager to help prevent certain types of failure. Risk managers should have basic alert mechanisms to speed up response, and reporting mechanisms to express different types of risk in a way that enables comparison. Overlaid on such mechanisms are techniques such as scenario analysis, but generally these rely on outputs, in the same way as management reporting. Data collection and manipulation will be required beneath such reporting mechanisms to allow monitoring over appropriate timescales.

Of course, the appropriate timescale will vary according to the type of risk. Some credit risks need to be measured in real time; some operational risks develop slowly over long periods, to cite but two examples. All will require some form of measurement of “near misses” to be fully effective and allow accurate prediction of future trends. Accounting regulations require the same approach to some degree, in that consistency is important. One requirement of Sarbanes-Oxley is also for timely reporting.

Reporting mechanisms

A core banking system lies at the lowest level of this pyramid, and must provide the data to feed and run the models and reporting mechanisms. However, the process is rarely simple. In many cases the lack of co-ordination between business and IT becomes apparent when one has to consider how to create these new reporting mechanisms. Often IT operations concentrate on technical monitoring, and disregards the parameters which drive its most important customer – the business.

Risk management disciplines provide the incentive to address this problem, and bridge the gaps between the two disciplines. Organisations that are forward-thinking will devise ways to revisit the ideal of creating an IT organisation aligned to the objectives of the business while devising their regulatory responses. Others will no doubt fail in this challenge, as similar initiatives have failed before.

The key to success in such ventures is disarmingly simple. Creating a responsive system requires good quality, accurate and timely data in the first place. Real-time transaction reporting is provided by only a few core banking systems, but, for those banks that have had the foresight to invest in this initially disruptive technology, will now pay dividends.

Instead of being a “nice to have” or seen as an enhancement with no clear business case, real-time systems will prove their worth. Few banks have seen fit to make such visionary investments, and there are few suppliers who have foreseen the advent of real time advantage, and many of them have fallen by the wayside.

Time is money

The retail market must surely follow. Today, money launderers work on time scales of a few hours from start to finish of an operation, knowing that batch processing within banks is not generally equal to the task. A few banks have seen at first hand the damage that publicity surrounding money laundering operations can do to their market capitalisation, and more will find this out over time. Not only can real time transaction processing support anti-money laundering technology that is equal to the task, but it can produce competitive advantage in basic cash management technology, and has led to massive competitive advantage for some banks in the corporate cash management market.

The efforts of many banks seeking to implement real time nostro account reconciliation bear witness to the importance of underlying core system responsiveness. The limitations of hardware platform cannot be used as an excuse since leading real time systems such as Hogan are now available on a variety of platforms. Supplemented by flexible architectures and supported by good analysis of the underlying processes, there are some obvious leaders in this field which will result in clear blue water between successful banks of the future, and those who will be outrun over a short distance.

Risk model

Some aspects of Basel II requirements can be managed using “soft” measures such as scorecards but other require the provision of vast quantities of data. To date, few banks have succeeded in implementing full risk management systems incorporating all the different Basel II risk categories into a complete risk model that spans the entire organisation.

As banks attempt to create these new systems, at significant cost in both monetary and resources terms, they often ignore the components that already exist within their back offices, generally as a result of poor communications and understanding of the underlying business processes. There is a great deal of irony in the risks that many banks are likely to run in order to install risk reporting and mitigation mechanisms.

Regulatory requirements are one aspect of future challenges which banks have to meet. Non-traditional competitors are another. The strategic threat of non-bank financial institutions to existing retail franchises should not be underestimated. There are cases on record of non-banks developing franchises at the expense of incumbents who have limits on their speed of response. The only response to this type of threat is to move quickly, to invest in new functionality ahead of the opposition, and not to become complacent in any way. The choices should be clear, but many banks fail to meet these challenges head on.

History is littered with the names of banks which did not make the grade, and there will always be casualties. The survivors will be those that invest in technology that supports innovation.

Anita Bradshaw is senior industry expect, financial services at CSC

 In association with CSC

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter