Banks running modern, third-party systems are significantly more profitable than banks running legacy systems
Temenos (SIX: TEMN), the market-leading provider of mission-critical solutions to the financial services industry, today announces the publication of its new paper “Restoring Profitability in the Digital Age”, written jointly with Deloitte. The paper, which is an update to “Bridging the Profitability Gap”, takes a fresh look at the banking industry and the trend in profitability. It finds that, five years on from the banking crisis, bank profitability is still materially below historical averages. It also finds that banks that have modernized their legacy IT systems enjoy much better profitability. Lastly, it illustrates the reasons why IT renewal is set to accelerate, including the increasing digitization of the industry.
The report finds that banking profitability remains materially below pre-crisis levels and has not improved in the past two years, despite improving macroeconomic conditions. The structural changes that initially drove down RoE – tougher regulation, changing customer behaviour and more intense competition – persist and, in fact, have been exacerbated by the digitization of the industry.
The paper finds that system renewal can have a material impact on profitability. Over the past five years, banks using third-party banking applications have enjoyed on average a 19% higher return on assets (RoA), a 28% higher Return on Equity (RoE) and a 6.5 percentage point lower cost-to-income ratio than banks running legacy applications. Temenos customers have even better profitability metrics, showing for instance a 42% higher RoE than banks using legacy systems. This data offers a compelling reason for adopting third party core banking software for improving profitability.
However, in addition to restoring profitability, there are many reasons to expect system renewal to accelerate from here. The continuing R&D investment by software vendors and expanding partner ecosystems provide banks with more options than ever to move to modern core banking software in a low risk manner. Furthermore, there is growing pressure from external stakeholders, such as investors and regulators, for banks to reduce the cost and risk of running legacy systems. Nonetheless, a more significant reason for needing to address legacy systems stems from the digitization of banking, which is simultaneously handing more power to customers and opening up the industry to more competition from non-traditional financial services companies.
Chris McGinnis, Head of Strategy at Temenos, said: “Core system replacement can have a very material impact on banks’ profitability and so constitutes a key lever in helping to restore the industry to pre-crisis levels of returns. Furthermore, the need to address ageing IT systems stems from more than just a desire to improve profits: legacy systems represent a systemic risk to the industry and a major barrier to innovation in an increasingly competitive marketplace. Those that do not keep up with ‘new’ banking will lose out to new competitors, both non-traditional players and banks who break ranks with the status quo. Transforming core banking systems is a necessity of survival.”
Patrick Laurent, Partner at Deloitte, commented: “The banking industry is undergoing significant structural change in areas such as regulation and digitization that will require a structural answer if returns of equity are to be restored to pre-crisis levels. That structural answer is technology modernization. Nonetheless, banks have remained reluctant to take on the risk of core replacement. In this report, we make again the case for system renewal, but we also highlight the lessons that the industry is learning in terms of adapting its systems and in terms of formulating best practices around implementations that are enabling faster time-to-value with lower risk-to-value. As such, we predict an acceleration in core renewal projects in the coming years.”