IT in Financial Services: Modernising – innovate or hibernate?

IT in Financial Services: Modernising – innovate or hibernate?
By Peter Redshaw, research vice president at Gartner

Published: June 2 2008 12:45 | Last updated: June 2 2008 12:45

The IT department in a financial services institution (FSI) is a difficult place to be right now. Just as it’s being asked to do more than ever – enabling more personalisation, faster time-to-market, greater agility and tighter compliance and risk management – the sub-prime crisis erupts and its IT budget gets slashed. So the emphasis shifts to efficiency and how it can run ever larger volumes of electronic transactions, for less money, on a creaking infrastructure of legacy applications. Inevitably, the prospect of modernising that old IT portfolio is raised again.

The problem is that there is so much of it and it is all tangled together in a Gordian knot of home-built IT. For many years, the conventional approach in this industry has been to chip away at it a little bit at a time. That approach can work in other industries, such as manufacturing, retail or utilities, where they may eventually rationalise and consolidate their IT portfolios.

However, the trouble with an FSI and its intangible assets is that IT is at the very core of everything it does and part of every customer contact. It is what defines its products and processes, the customer experience, the communications and distribution. Increasingly it is how it innovates. Hence, the tendency is for the IT portfolio at a bank to swell faster than any chief information officer (CIO) can chip away at it and the legacy application set remains stubbornly rooted in its operations.

The alternative “big-bang” approach to IT modernisation is usually dismissed as too risky. IT tends to be even more conservative than the trading or asset management activities it supports. But the barriers to modernising IT at an FSI are mostly nothing to do with IT – the barriers are to do with people, culture, politics, bureaucracy, and so forth. It is much more about project management issues, job security and incentivisation – how many CIOs are sufficiently encouraged to take on risk or to break up their own empires?

Making subtle tweaks to the IT portfolio achieves very little and certainly isn’t going to make a trailing bank suddenly competitive. If a CIO is saddled with a risk-averse culture and a heavily regulated industry (that insists on the banking equivalent of emission controls and crash safety tests), is it really worth modernising IT at all? After all, most banks are still making lots of money, even after the impact of the credit crunch.

IT modernisation needs to address two key issues: one is that simply running-the-bank soaks up about 70 per cent of the IT budget at a typical FSI, and the other is that poor IT hits profitability. High operating expenses mean that very little IT budget is left for innovation, and that means differentiation is being eroded. Poor IT means that product margins are also getting squeezed and that customers show less loyalty, which diminishes the bottom line.

What a CIO needs to do to turn this around is to develop much more sophisticated financial models for calculating the economic value added to the FSI, replacing the current models for calculating the return on investment that technology X offers over technology Y. They need to be able to see if a big-bang approach would radically reduce their cost/income ratio or transform their return on equity. Without a radical boost to shareholder value, why change?

The net result of this would be to polarise the current continuum into two opposite camps – the dichotomy of “innovate or hibernate”. The innovate camp is at the leading edge of technology and embraces the big-bang approach, while the hibernate camp adopts the ultra-conservative approach that avoids IT change until absolutely necessary.

Innovate has developed accurate cost-benefit models that link IT changes to business metrics, so that it can quantify benefits and justify the radical transformations it encourages. Meanwhile, hibernate concentrates on using the “oil-can” by keeping its systems running for the absolute minimum cost (maybe through offshore outsourcing) while building up a war-chest of cash with the money it saves. Ultimately this must be a short-to-medium term approach; hibernators must constantly monitor the market and be prepared to buy up small, smart, innovative FSIs (that may have had the luxury of a green-field start) and then use them as incubators. The hibernator can then gradually migrate its customers and its data over to its protégé once the local contextualisation and scalability is in place.

These are not easy options – the innovators must find the tools needed for more sophisticated financial modelling of IT and the hibernators must efficiently manage global sourcing and spot their potential acquisitions. The vital thing is to avoid the worst-case scenario which for an FSI is to sit in the middle between these two extremes. The in-betweeners will fritter away their IT budget on incremental modernisation for little gain. Far from being fast followers – as they might like to think of themselves – they will be ditherers and laggards.
Copyright The Financial Times Limited 2008