Back in 2004, a management consulting major studied IT systems at over 20 large global companies and delivered this simple diagnosis – diseconomies of complexity. “Diseconomies” is the operative word here, especially because it is often said that complexity is the natural byproduct of sophistication. Today’s smartphones pack in as much complexity as the systems that power the Mars Curiosity rover without compromising the sophistication required to destroy pigs or process payments.
IT complexity, with or without sophistication in attendance, erodes enterprise economic value. And this is the challenge facing banking, one of the most IT-centric industries in the world. Estimates underscore the savings, of up to 50% and 30% on application and total IT costs respectively, that banks can derive from reducing complexity.
Currently, up to 90% of IT budgets in banking are frittered away on just stemming this hemorrhage. While banks continue to channel a significant chunk of their technology investments into restoring the status quo, the quo, to paraphrase Laurence J. Peter, has irreversibly altered its status.
Take customers, for instance. Loyalty is passé; promiscuity is in. Even as banks continue to invest in customer engagement and experience, more and more customers are moving beyond their traditional one-bank relationships into developing multiple financial affiliations, while nearly three-quarters of all banking customers have attrition on their mind. The table’s stakes for retention and trust have also increased significantly; customers are now benchmarking their banking experience against that provided by lifestyle categories, like retail, for example. Digitally empowered customers are demanding a financial experience that is custom-fit for their convenience, circumstance and aspirations, regardless of channel, device or transaction.
As banks race to cope with fickle uncompromising customers, a new breed of competition, with business models crafted around contemporary customer expectations, disruptive innovation and cutting-edge technology, is slowly but surely making inroads into traditional banking turf. Even as mainstream financial institutions remain engaged in a race against IT complexity to stay in place, these new entrants are pushing the boundaries of technological possibilities in banking. Today, concepts like Square, Passbook and Wallet are nibbling away at the fringes of the banking ecosystem, but they represent a real threat of disruption to the entire process of banking. In contrast, banks themselves cite their current technology systems as the biggest hurdle to innovation.
Even within the traditional banking space, emerging technologies are enabling smaller players to acquire capabilities without having to break the bank in the process. These smaller players are already proving to be more nimble and agile than their colossal counterparts, who, just to provide one metric for perspective, take twice as long to take new offers to market than their much smaller peers. Technologies like Social, Mobility, Analytics and Cloud, are disrupting the traditional banking model by leveling the playing field.
Heightened regulatory oversight following the events of 2008 is amplifying the challenge for banks already grappling with potentially disruptive developments on multiple fronts. The pressures of shrinking fee incomes and cost inflating consumer protection regulations, further exacerbated by capital and liquidity mandates, are severely stressing banks’ compliance structures, not to mention their balance sheets. If all pending regulations were retrospectively applied to European banks, their collective ROE in 2010 would have been 6% instead of the actual 10%. In the new regulatory regime, banks are also expected to deliver information at a much more granular level and in ever shorter time frames, which only increases their compliance burden.
To top all of this, a volatile global economy only adds to the overall mood of uncertainty in the banking sector. In comparison to pre-2008 levels, profitability has almost halved, cost to income ratio is raging at around 60% and the slowdown seems to be seeping from developed economies into emerging markets. The constantly morphing macroeconomic landscape only makes it more challenging for banks striving to make proactive bets for growth and profitability.
Looking back at the intensity of change, across every node of the banking value chain, it becomes abundantly clear that nothing short of a complete transformation will equip the sector with the capabilities required to compete in the radically new norm. But any effort to effect a comprehensive transformation of banking will have to start by addressing the diseconomies of complexity that currently plague banking systems. Simplifying the banking platform, therefore, becomes a critical step in the process of banking transformation.
Now, the case for banking platform simplification is easily made – it enables the agility to respond to rapidly changing market dynamics, reduces costs so banks may compete more effectively, helps build customer-centric banking models and fast tracks innovation. But paradoxically, the case for platform simplification is fraught with complexity.
Banking platform simplification involves large-scale, multi-year efforts that are extremely time and capital intensive. But the banking ecosystem is evolving so rapidly that expecting banks to wait for years to reap the benefits of simplification can hardly be justified. Then again, it is for the same reason that banks simply cannot afford to defer simplification any longer.
There is however one approach to simplification that addresses both the time and the capital constraints that the sector is currently faced with. Today, banks have the option of choosing a process of progressive, componentised simplification and transformation that can be adapted to the investment and rollout requirements suited to specific contexts. This process allows banks to choose the sequence of component deployment based on their business priorities while mitigating business continuity risk, easing transitioning management and simplifying the transformation journey. Progressive transformation also drastically reduces the time required to realise the benefits of simplification. Most importantly, even as the componentised approach simplifies technology architecture from the inside it creates a sophisticated platform that is primed to accommodate the next evolution in banking technologies to enable banks to build competitive advantage.
By Haragopal Mangipudi, Senior Vice President and Global Head of Finacle at Infosys