Barriers to entry in banking are falling

A recent paper by UBS analysts, ‘Big banks and the bigtech, fintech & digibank incursion’, reports that challenger banks are launching with an advantage over incumbent firms due to their use of cloud-enabled banking systems, limiting their IT-related cash burn.

The concept behind cloud-enabled banks and capital market firms has always been straightforward: freedom from fixed-cost legacy technology allows them to compete more effectively and flexibly as costs rise and margins fall.

The UBS report analysed 49 big banks and found that their IT assets have more than doubled since 2010, leaving total intangible IT assets at US$70bn by the end of last year, up from US$32 billion in 2010. In other words, banks are sustaining barriers to their own growth.

For capital markets-focused banks, this growing tech stack creates a host of problems when operating within an extremely cost-focused environment. Profitability of business areas which require balance sheet commitment has fallen considerably since 2010, while more historically-profitable businesses, such as FX, struggle after the first half of 2019, when many currencies traded in a tight range. The fixed costs for processing and administrative work in the middle and back office add to the burden.

Consider a traditional risk management system, which provides coverage of a fixed range of risks and has pre-set connections to other systems, set up in the proprietary data centre and the corresponding disaster recovery data centre. Gaps in the system’s functionality – either by asset class, risk type or reporting function – require integration via other systems or by customising the platform. The system also must be integrated with the databases used by business lines, and then out to the databases required for risk and compliance.

In this scenario, both reskilling and hiring new people to look after each element of the tech stack is in the hands of the bank, as is the management of change when market practice or market rules evolve. Temporary addition of team members to work on upgrades, licensing to database vendors and ongoing maintenance expenses all add to the total cost of ownership.

The advantages of more modern approaches are marked. Deployment of technology in the cloud removes a host of problems.

Firstly, the technology is hosted, developed and maintained by a team that with expertise in how the system works, how it can be adapted and how it can be integrated with other systems. Those teams do not have to be mirrored within the bank in order to develop and improve, because they can collaborate with the firm’s internal experts in order to build what is required.

Secondly, cloud-based systems use development methodologies such as Agile and DevOps, designed to incorporate user feedback during the development process in order to minimise any gaps between design, development and deployment. As a result, the outcome is a far better technology tool set, more closely aligned with user needs and expectations.

Thirdly, and crucially, control of the cloud model is now firmly in the hands of the bank, which means concerns around privacy and access have been fully addressed by service providers. For example, data can be moved between remote systems across jurisdictions through masking, in order to address the risk of information being viewed outside of its original jurisdiction, while still allowing the data to be analysed. The developers who build systems are only able to support them through strict permission controls, which mitigate the risk of fraudulent or erroneous activity, putting power in the hands of the bank while retaining the edge that is a benefit of using the most knowledgeable developers to handle upgrades, new functionality and integrations.

The barriers to entry in banking are falling; banks stuck sustaining barriers to growth only will cede an advantage to their rivals.

November 21, 2019

Amrik Thethi