Nexus of innovation?

Walk through the City of London on any given weekday and the smell of money is everywhere: the buildings are ostentatious, the offices palatial, the business suits expensive, the bar bills long. Such emblems are symptomatic of the “high-cost mentality” that runs through the whole financial services sector, says Ken Emerson, head of IT for British Airways Pension Fund, in which big rewards and a culture of excess have justified a near limitless spend on services such as IT.

And the levels of spend are truly eye-popping. Financial services research house Celent reports that in the first 10 months of 2006 alone the global financial services industry chalked up total IT costs of some $318 billion. To put that in perspective, analyst house IDC estimates that $1.16 trillion was spent globally on IT by both businesses and consumers during the whole of 2006, putting the financial services industry’s share at around 30%.

And that’s not all. A recent scorecard issued by the UK’s Department of Trade and Industry found (perhaps somewhat embarrassingly for the IT industry) that a mere five UK banks spent a combined total of £705 million on R&D between 2005 and 2006, compared with the £932 million invested by a total of 119 UK software companies. Not bad for an industry whose raison d’etre is to make money, not software.

In the light of such numbers, it is not surprising that the financial services industry, and in particular the banking sector (which accounts for 50% of the entire industry’s expenditure, according to Celent), has traditionally been celebrated as a nexus of IT innovation, serving as an exemplar to more technologically conservative peers. This notion became ingrained during the 1980s, when ‘Big Bang’ deregulation spurred an explosion of IT investment and underscored the link between the application of cutting-edge technology and huge paybacks.

Today, though, that profile is being called into question. According to Emerson, the notion of the financial services industry as a hub of IT innovation is outdated, if not “a bit of a myth”. While in the 1980s and 1990s the industry served as a testing bed for wave after wave of new technologies that other industries could barely afford and rarely justify, this practice owed less to the spirit of innovation and more to the industry’s uniquely compelling argument for vast IT expenditure, argues Paul Simmons, equities business manager at UBS Bank and a former IT manager at the organisation. This argument, he says, is predicated on the sheer scale of risk that characterises the industry’s operations.

When one trade or financial instrument can be worth tens if not hundreds of millions of pounds, a seemingly tiny error can have devastating results, Simmons points out. Just ask Mizuho Securities. The Japanese firm nearly went bust in 2005 after a trainee trader miss-input an order. Lacking a fail-safe mechanism, the Tokyo Stock Exchange – which has since switched suppliers – was unable to cancel the trade immediately, costing Mizuho a painful $225 million. In other cases, operational errors have caused entire indexes to dip.

As such examples demonstrate, the risk exposure to the market and the economy at large is huge if the technology that underpins transactions fails, or the technology processes are inadequate. “So the bottom line,” says Simmons, “is that financial services companies can justify a lot on the basis that they’ve got to be due diligent, that they’ve got to make the investment.” Because this expenditure is so visible, he continues “there’s a perception that financial services is at the leading edge of technology. But I don’t believe that is the case.”

Application glut

During the heady days of the dot-com era, the industry was particularly profligate. Wielding bloated IT budgets in an over-buoyant market, the finance houses bought in and built up a raft of systems and applications that were, more often than not, unnecessary. When the bubble burst, recalls Murat Sonmez, executive vice president of global field operations at business integration and process management software company Tibco, the industry was hard-hit. As IT expenditure lost momentum, many projects were never able to realise their strategic value, but finance organisations were, nonetheless, saddled with the spoils of their over-consumption.

At one global investment house, for example, “hundreds if not thousands” of products now jostle along side one another, says its principal. What’s more, these products compete for attention against the bank’s in-house built systems too. Similarly, reveals Bob Carlson, former global head of IT and telecommunications at HSBC, the banking giant’s application count, at the height of the dot-com boom, stood at no less than 50,000, supported by 100 data centres globally.

Dealing with such high levels of complexity has been burdensome. Furthermore, it has not been helped by the industry’s enduring hunger for highly ambitious mergers and acquisitions, not least because the industry’s ability to digest inherited IT has often been weak.

“Integration is always the biggest challenge for us,” says an investment bank chief. And, according to Emerson, he is hardly alone in this predicament. In many instances, organisations have acquired “ancient systems,” some of which can be up to 30 years old. These often-mission critical platforms cannot simply be decommissioned or refreshed, as the risk of tampering with such outmoded applications and systems – shrouded, as they are, in layers of maintenance code – is outweighed by the requirement to simply keep them alive. Attempting to rationalise such infrastructures has cost the industry tens of billions, and yet, claims Emerson, the rate of failure remains extremely high. “I’ve yet to see any player who’s put in a major system and rationalised their business successfully,” he adds. As a result, note analysts at Celent, financial institutions are running systems that are “too obsolete, too slow and inflexible”.

Behind the curve

WHILE many other consumer-facing industries have devoted significant resources to enhancing their interaction with customers in recent years, the retail banks and building societies have – in most cases – lost ground. Now, says the Economist Intelligence Unit (EIU), the banking sector has been forced to undergo a major rethink of its technology, as its failure to use IT strategically will cost it dear.

Having closed a fifth of local branches between 1995 and 2003, the retail banking sector had hoped to push the majority of customers online. But the strategy has been met with only marginal success, thereby depriving the banks of the traditional opportunity to cross- and up-sell products to customers within the environment of the local branch.

While other retail outlets have used sophisticated customer relationship management strategies to devise more personalised services and enhance brand loyalty, the banks have sat back and focused purely on efficiencies – and even these efforts have proved lacklustre, says the EIU. Automation of simple transactions, such as cash and cheque deposits and withdrawals, for example, is still behind the curve.

According to NCR, a manufacturer of cash machines and banking technology, more than 50% of transactions that are currently being handled by tellers at most bank branches could be moved to self-service points.

Furthermore, finds the EIU, banks routinely fail to deploy leading-edge technologies proven to enhance customer service, such as RFID, which allows organisations to quickly identify customers and better service their needs. IP networks have been similarly neglected. Of the 190 retail banking executives interviewed by the EIU, a mere 28% said that their banks either had, or planned, to implement, technologies allowing remote working via Internet or video links within the next few years.

“The banks don’t get that it’s a retail outlet, adopting retail technologies,” says Emile Sanchez, managing director of BT Global Services Finance Industry Solutions. “They are treating every channel individually and they are not experiencing the most recent technologies because they are stuck into a model with central applications and legacy.

They need to think differently. They are far behind other retailers, and the consumer expects more.”

A dubious legacy

All in all, it seems, the financial services industry – after nearly three decades of vigorous IT activity – has inherited something of a dubious legacy. Such is the current burden of its IT infrastructure, says Christopher Lyons, a consultant and co-founder of online bank Cahoot, the finance sector has become “a prisoner of the technological developments it has made”.

This becomes particularly clear when examining the breakdown of IT budgets for 2006. According to Celent, a chunky 75% of IT expenditure in 2006 was dedicated to maintenance, and while budgets have for the most part increased this year, this predominance of legacy systems is showing no signs of going away.

In the insurance sector, for example, 96% of respondents to PricewaterhouseCoopers Financial Services Survey of December 2006 cited replacement of old mainframe systems as the primary reason for new capital expenditure going forward.

Meanwhile, the margin devoted to technological innovation remains, in the words of the global technology director at a leading investment bank, “disappointingly small”. The company’s now slim efforts dedicated to developing new technologies are largely performed “with the same [aging] toolkit that we’re [already] using,” he adds.

As Emerson observes, in such complex IT environments “the aggravation and the risk” of making significant changes or pursuing new developments is often simply too great. For the business, it is often easier – if not preferable – to bury its head in the sand, he continues. “That’s why a lot of system projects are not that successful or not even undertaken. Unless you’re a highly structured, organised place, and a lot financial institutions are not, you do not have the capacity or ability to change systems,” he says.

And even when such aging systems fail to meet compliance obligations, in many instances, it is less of a risk to the business to continue to pay fines for certain operational errors than it is to rip out and replace established if inefficient systems. That is evident from the Financial Services Authority’s website, which names and shames recidivist finance houses for systems failures or related errors on a daily basis.

Within this climate, adds UBS’s Simmons, the vast majority of IT projects are run on a 12 month basis or less. “Therefore if you cannot deliver a return on investment within 12 months, it doesn’t happen,” he says. Such a short-term focus has inhibited the industry’s ability to push technology boundaries, and often restricted any delivered benefits to a specific part of the organisation. “One very common thing you find is that the benefits are only there for the stakeholders or people approving the budget. But there are other areas not involved in the approval of the project that might actually have a cost,” he says.  

Small wonder, therefore, that 73% of UK IT directors within the industry feel their departments are failing to deliver better business results, according to specialist research house Vanson Bourne. No longer on the front line of innovation, IT managers are largely forced to ‘fight fires’, while in-house development teams now take their lead from smaller niche players. No doubt the financial services sector will work through its legacy problems over the next half decade. But until then, the reputation it once had for being an early adopter, a cutting edge developer of new technology, needs some revision.

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