When I spoke at the Goldman Sachs financial services conference last Wednesday, we got into a good discussion about how little insight investors are given into bank IT spending (one audience member described it as a "black box").
Given that IT today represents around 15% of costs at a typical universal bank and given the growing importance of technology to building and maintaining competitive advantage in an increasingly digitized industry, this situation must change. Investors and other bank stakeholders should be demanding more disclosure on where the money goes as well as banks' strategy and roadmap for the future.
Until that happens, however, investors will have to build for themselves a picture of banks' IT capabilities and their readiness to take advantage (or withstand) exponential technology change, rapidly changing customer behaviour and a new competitive environment.
To help with this information gathering exercise, another audience member asked me what key questions he should ask bank executives about IT. I gave a few ideas then, but here is a list of 12 good questions and a short explanation of why each is relevant to an investor in banking stocks:
1. How much does the bank spend on IT annually?
A bit of an obvious one, but it's not disclosed today and is an essential starting point.
2. What is the bank's ratio of maintenance spend to enhancements?
(Celent estimates that 76.3% of banks' IT budgets go on maintaining existing systems which is self-evidently too high if banks are keep up with the speed of change)
3. What is the ratio of IT and back office staff to total employees?
This will give a measure of how efficient the bank's back office processing is and, by extension, an idea of the split between spend on transaction processing and other back office capabilities vs. everything else (which is more likely to result in better customer experiences)?
4. What percentage of transactions are straight through (i.e. don't involve any human intervention)?
This clearly is a measure of process automation, but it has wider import. One of the fundamental characteristics of a good online experience is speed of response and fulfilment. To keep up with the tech giants, bank would need Straight Through Processing ('STP') levels of 99%+
5. How many services are not only straight through but also real time?
STP just eliminates human intervention, it does not stop services being provided through bulk/batch – i.e. collated throughout the day and processed in one go, typically overnight. Since in most countries, clearing and processing is not real-time, not all services can be real-time. But banks will need real-time capabilities to deliver the rich online experience we envisage they'll have to offer to stay relevant (see below). Banks should simultaneously be building real-time capabilities across all services and lobbying for single immediate payments in their domestic markets.
6. What is the bank's strategy for leveraging its data to better service, cross-sell and retain its customers?
Data is banks' most valuable competitive asset and yet so few either capitalise on it today or have a clear strategy for capitalising on it in the future. As I have written before, leveraging data will require a strategy that encompasses a range of factors, such as personnel, technology and mindset
7. What is the strategy for open banking (creating an online marketplace offering both the bank's and third party products)?
The banking value chain is splitting: new players are offering discrete services (e.g. TransferWise for FX, Lending Club for unsecured credit) and non-banks are trying to offer front-end capabilities that threaten to disintermediate the banks. To successfully compete, banks will need to become more open. They'll need to offer third-party banking services (e.g FX, remittances) where these are cheaper or offer better convenience as well as third-party non-banking services like legal services if they are to ensure that they remain customers' principal gateway into banking.
8. How agile is the bank in terms of speed to launch new products and apps?
This will give an indication of how responsive a bank can be to fast-changing competition. How quickly can it launch a new product? How quickly can it launch an app?
9. How is the bank fostering innovation? (e.g. involvement with start-ups)?
Developing an innovative culture will be key for banks to generate new ideas and accelerate the pace at which they are able to bring these to fruition. The most innovative companies are those that cast the widest net for ideas. Is the bank involved with the start-up community? Does it run hackathons? Does it crowdsource innovation? Does it open up its platform to third-party developers? When it is incubating innovative ideas, can the teams involved operate with different conditions (e.g. more autonomy, fewer KPIs)?
10. How is the bank preparing for the explosion of interactions with increasing digitization and the internet of things?
Barclays, since it introduced its highly successful mobile banking app Pingit, has seen the number of interactions rise from roughly 2 per month to more than 30 per month. This phenomenon has been observed in other industries such as travel and book retailing, but is likely to grow exponentially as more and more devices connect to the internet (e.g a smart printer will order its own ink, querying your bank account). Are banks ready for this explosion in look-to-book (i.e. number of times customers access their accounts in a given time period without necessarily executing any transaction), which requires bank to operate at a different scale and also to drive down costs (since the extra interactions likely come with no commensurate increase in income)?
11. Are there any services that can't be delivered through all channels?
That is not to say that all services have to be available on all channels, but that any service can be delivered on all channels and all channels can distribute any service. GAFA (Google, Apple, Facebook, Amazon) have this capacity today.
12. What is the strategy for managing online security, mitigating risk and potential associated reputational damage?
Our banking relationships are moving online and banks are gathering and analysing more information about us, which needs to kept secure.
The end game
Our view is that the only way banks prevent themselves from disintermediated over the medium term is by offering what we term experience-driven banking (and which we have tried to depict in the graphic below). To deliver this will require positive responses to all of the questions above.