The global financial services sector still faces upheaval, five years after the credit crunch decimated its ranks. But how have IT strategies changed in the years since the UK government was forced to nationalise Northern Rock?
Five years ago the early signs of trouble brewing in the financial sector emerged when Northern Rock was rescued by the government after it ran out of money. A year later, investment banking giant Lehman Brothers went into administration. The news sent the City into meltdown and took thousands of IT jobs with it.
In itself this may not have been the catalyst for the collapse of the global financial system, but it was the moment people realised the system was broken. The credit crunch had already caused problems for US mortgage lenders Fannie Mae and Freddie Mac, which had been bailed out by the US government only a week earlier, as well as Northern Rock's troubles the year before.
This triggered a number of aftershocks. IT workforces were decimated as banks either fell over or had to cut costs to avoid collapse. Huge overhauls in regulations took place as merger and acquisition (M&A) activity went into overdrive.
So four years on from Lehman's collapse, what has changed in financial services IT?
According to IT industry body Intellect, little has changed. In its report titled Biting the Bullet, Intellect said the UK finance sector's IT infrastructure is no longer fit for purpose and risks damaging the economy by creating more glitches such the recent RBS outage which resulted from software issues.
"Banks are willing to spend money on cutting-edge technology that facilitates high-frequency trading or reduces the time it takes to process a transaction in the capital markets – where every cut millisecond means more profit – but not on modernising the infrastructure that allows them to deliver better customer services, act as a catalyst for the economy or allow regulators to perform their roles," said the Intellect report.
Intellect said banks are currently spending 90% of IT budgets on managing legacy systems. The findings follow a report from analyst firm JWG Group earlier this year, which said decades of ad hoc technology investment, combined with merger and acquisition activity, has left many financial institutions with disconnected silos of information and duplicative processes.
Intellect called on the Financial Policy Committee and the forthcoming Prudential Regulatory Authority to take the lead on this issue.
Ring-fencing investment banking operations
Perhaps the most significant change for IT departments is the plan to separate the retail and investment arms of the big banks. Ring-fencing the investment units of banks will protect the retail arms from problems emanating in the high-risk investment sector. The government is forcing banks to separate their investment and retail arms by 2015.
This decision followed the Independent Banking Commission (IBC) recommendations that banks separate their retail and investment operations. The IBC report was scant on detail, but conclusions about its impact on IT have been drawn and, as well as individual systems requiring separation, entire IT operations and outsourcing agreements might face restructuring before the recommendations come into force.
Ring-fencing is seen by many in banking as less harsh than a complete separation.
Integrating IT infrastructures
The financial services sector's trouble led to a wave of mergers, acquisitions and rescues. This meant major integration of IT infrastructures.
Probably the biggest of all integration challenges is Lloyds TSB acquisition of Halifax Bank of Scotland for £12.2bn. Now known as the Lloyds banking group, the group targeted savings of £1bn per year. IT savings will contribute to the savings as the combined bank closes processing units and call centres.
The banks will also seek to make savings by integrating other aspects of their IT.
Moving to off-the-shelf software
Cash-strapped banks have also changed their buying habits when it comes to software. They are now moving from mainframes, customised applications with lots of integration and people, to off-the-shelf software.
Moving to supplied software marks a significant departure in financial services, where software is traditionally highly bespoke and created in-house. Much of it is also decades old, so moving off the shelf is more of a pioneering change than perhaps the label suggests.
For example, Nationwide is transforming into a full service bank and is implementing SAP throughout the back office and Microsoft in the front office.
Nationwide's £1bn technology investment has transformed the IT department from a development shop into an integrator.
New players in the financial services sector
Another consequence of the banking crisis in the UK has been the emergence of new banks. The dominance of so few over so much of the market has led to support for new banks.
These banks that do not have a long history in the sector and are taking a different approach to IT and operations. For example, Tesco selected an off-the-shelf core banking system from Fiserv, as it moved towards becoming a full-service retail bank.
Virgin Money is also on an IT journey as it strives to become a full-service bank, boosted by its acquisition of Northern Rock.
In 2010 another new player, Metro Bank, outsourced its entire IT infrastructure. Banks are big outsourcers but massive in-house capabilities are traditionally retained. Metro Bank opened its first three branches in London in the summer of 2010 and plans to have over 200 branches eventually.
Any major changes at banks will require significant IT planning because the finance sector is so reliant on IT. According to Gartner, banks spend about 6% of their revenue on IT. This compares with the retail and wholesale sectors that spend 1.1% of revenue on IT, utilities 2.8%, industrial manufacturing 1.8% and a sector-wide average of 3.6%.
The only sector that spends a larger proportion of revenue on IT is the software and internet sector, at 7.6%. Could banks close the gap as IT's role in post-crash banking increases? It remains to be seen whether this will prove the case, or if it will just be a short-term increase in spending, followed by a reduction in the proportion of revenue going on IT as banks become more efficient and standardised.
