The public has only recently gained an insight into the all-encompassing nature of the technology that underpins all banks, and indeed the entire financial system, through a demonstration of what happens when this stops working.
Despite the problems caused by instances of systems failure during 2012, there is a silver lining. For the first time the public’s assumption that banks “just worked” was challenged and a light shone on the 90 per cent of the technology iceberg below the waterline.
This usually invisible infrastructure is the myriad complex technology systems that every function within every bank is built upon, from assessing loan applications, to detecting money laundering, to making payments into accounts. Simply put, when this technology doesn’t work, the bank doesn’t work and the public wants to know why.
It is widely acknowledged that the technology infrastructure across the financial system is exceptionally complex, to the point where it no longer serves many banks – it hinders them.
Over the years, systems have been built on top of other systems to implement a constant stream of necessary changes, driven by regulatory, customer and market demands. As this technology estate has grown, so has its complexity and this has limited banks’ ability to serve both their customers and the wider economy.
This complexity inhibits data – the lifeblood of the financial system – to flow to where it is needed to make decisions on anything from lending, to risk exposure, to the reduction of financial crime.
Addressing infrastructure deficiencies is a large and difficult task, but one that needs addressing nonetheless
It is this over-complexity that means banks do not truly know their own operations and customers, regulators cannot hope to undertake their supervisory roles effectively if the data they receive does not reflect banks’ true exposures, and all business change is impeded by systems that cannot be adapted without significant cost, risk and disruption.
While the financial crisis demonstrated banks’ inability to extract and analyse data relating to their exposures, events of 2012 – such as systems failures, rogue trading and money laundering – have all been irrefutably attributed to failures of a technology infrastructure that has not been modernised as banks’ operations have expanded over the last few decades.
Intellect, the trade association for the UK technology industry, estimates that approximately 80 per cent of banks’ technology budgets can be attributed to “keeping the lights on” across their complex and inefficient technology infrastructure. Only about 4 per cent is spent on non-regulatory driven innovation to improve the way the bank operates or customer experience. Here lies a future challenge for the established banks in the UK.
In the longer term, there is a significant challenge to these banks from disruptive, non-traditional entrants to the retail banking sector. To compete, banks need to become more agile so they can better understand market dynamics and anticipate customer needs, and design, introduce or modify products and services in a timely manner.
At the current rate and speed, banks cannot offer customers what they want today, let alone in five or ten years. For instance, the next generation of bank users may never go into a branch and may see any number of digital wallets as their main bank account, transferring large portions of their salaries to these services on a monthly basis.
Similarly, new entrants that are more adept at using data to judge credit risk will be able to supply finance to small businesses that warranted it, a function that many banks are currently simply not able to undertake. If this were to happen, where would revenue streams for the high street bank come from? It is foreseeable that, if established banks are unable to adapt quickly enough and improve their ability to “know their customers”, they may merely become a utility that processes transactions.
However, it is not to say that banks do not want to change; of course they want to know their customers better, maintain their market relevance, reduce the risks they face and improve their operational efficiency.
If banks were to start afresh tomorrow, it is unlikely they would design their technology infrastructure to replicate their current state. Yet starting again by ripping out and replacing these systems is not feasible, both in terms of the disruption it would cause to the continuous provision of economically critical banking services and the scale of the up-front cost this would require.
Addressing these infrastructure deficiencies is a large and difficult task, but one that needs addressing nonetheless. The longer it’s left, the less viable the banks’ businesses become, and the larger, more difficult and expensive this unavoidable task gets. So an incremental approach is required. However, first there needs to be the will to change, a significant barrier to which is a perennial requirement to deliver dividends to banks’ shareholders.
As leading economist John Kay recently concluded, market short-termism has played a role in many of the recent deficiencies of the financial system – a case in point being a lack of focus on this technology infrastructure during the “boom years”. It may have been essential for the bank to function effectively, but renovating complex and ageing systems was not deemed to be a priority for many banks, as it did not deliver an immediate return on investment.
It’s not just the public that has “enjoyed” a moment of clarity in recent months either. Shareholders have also awoken to the realisation that the vehicle for their investment may not be as stable as it once was, even though share prices are generally recovering from the shock wave of the financial crisis.
In the longer term, banks’ abilities to improve their margins in the face of encroaching regulation, protect their market share from new, more agile entrants, and mitigate the threat of operational risks, such as systems failures, rogue trading, money laundering, cyber attacks, and so on, are not as certain as they once were.
This should concern shareholders to the point where they allow the banks to untie a hand from behind their backs, and make the necessary changes to safeguard the longer-term interests of customers, the economy and their own investment.
Ben Wilson is associate director, financial services programmes, at Intellect, the trade association for the UK technology industry, where he focuses on the growing regulatory challenges and commercial opportunities within the financial services sector.