A changing nordic banking it sourcing landscape


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Nordic banks are pressured by high competition, changing customer service expectations and increased regulation. Thus they are adopting new sourcing models for their IT systems.

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A changing nordic banking it sourcing landscape

  1. 1. The changing IT sourcing landscape of Nordic banking Executive Summary Stricter regulative requirements, in parallel with increased cost pressure and competition in banking, set challenges for banking IT systems and their maintenance. At the same time global banking software vendors are entering the Nordic IT market, jointly with global service providers. We expects that the Nordic banking IT services market will reform remarkably in the next 5 years. Introduction The Nordic banking market has remained largely unchanged since the aftermath of the last Nordic financial crisis in the late 1980s. During the coming decade we are likely to see major changes to the IT sourcing landscape of this market. In particular the Nordic banks will experience that three drivers affect the way they manage their IT: - - - Their local Nordic IT service providers will increasingly struggle to deliver cost efficient solutions that satisfy customer needs, Stricter regulations will force banks to reduce IT and other costs to meet tight capital requirements, while the challenges of implementing other regulations will continue to drive IT projects and costs up, Emerging technologies paired with increasingly tech savvy clients will increase the pressure on innovation and time to market of new solutions and support for new devices and channels. The results of these drivers are likely to spur the entry of global software and IT service providers and the emergence of new service models, including “Platform as a Service” (PaaS”) and also potentially “Banking as a Service” (“BaaS”) models. Nordic banks have traditionally been conservative in their choice of IT service providers, but they now face strong incentives to reassess their risk-benefit analysis and consider new solutions when they build strategic sourcing partnerships for the future. 1 What is happening in other regions? There seems to be a globally rising trend amongst the banks’ IT departments to move from old home grown legacy systems to package software systems in their core banking and other IT systems. The drivers for these changes are rooted in the need to comply with increasing number of new regulations, cost pressures and need to remain competitive in the market where the margins are being squeezed from all directions. The rate of migration and renewal projects starting and ongoing varies between different regions and between banks in different size categories. Despite the fact that the European banks have been battling with the aftermath of the 20082009 financial crisis (or perhaps because of it?) there has been increasing trend towards moving away from traditional home-grown legacy IT solutions. A few examples of European banks that have moved or are moving all or parts of their IT to a new platform are Frankfurter Bankgesellschaft, Norddeutsche Landesbank Luxembourg S.A, Rothschild Bank AG, Amsterdam Trade, Société Générale, Barclays, Danske Bank, European Credit Management Limited (ECM), and BNP Paribas Securities Services. Local Nordic IT Service Providers under Fire The weaknesses of Nordic banks’ IT solutions have lately been exposed on several occasions. In particular in the Norwegian market where IT service providers have been criticized for serious internet banking issues. Furthermore, local IT service providers dominating the market keep losing their general competitiveness as large global IT service providers continue to enter the market, using well established offshore models that offer higher quality at a lower cost. Higher capitalization requirements and increased competition increase the cost pressure and require the banks to improve their sales effectiveness and in essence provide more services with same or less A Point of View to the Nordic Banking IT Outsourcing Landscape | October 2013
  2. 2. resources. This requires more process support from the banking IT systems, in particular in the front office, to enable more automation, self-service, omni-channel support and increasingly 1-2-1 targeted campaigns and offers. All this needs to be in place while IT spend is reduced. Cost/quality pressure opens the market to new providers of software as well as IT and BPO services. Providers such as FIS, Misys and Temenos can leverage global business models offering economies of scale, international partnerships providing skills, and access to offshore centers enabling very competitive pricing. Software vendors (or the banks themselves) will be able to opt to set-up innovative new delivery models such as e.g. Banking- as-a-Service (BaaS) through partnering with IT outsourcing service providers. These new models, if accepted by the market, may prove to be very competitive. Smaller Banks Seek Alternative Delivery Models In particular the smaller banks are likely to look for new solutions and new IT service providers compared to what they have used previously. The smaller Nordic banks often utilize a Platform-as-a Service model with local vendors, who are providing application maintenance and development on their old legacy systems. However, this is in the current set-up a very expensive model. These legacy systems are largely outdated, inflexible, with significant limitations on scalability, and architecturally unable to adapt to the modern omni-channel bank. All this is resulting in rigid and slow IT development processes for the banks, which is intolerable in the long run. The smaller banks will also find it increasingly difficult to absorb the high capital expenditure related to their current IT service contracts and license agreements. Larger banks have a significantly stronger ability to absorb such costs. They also tend to utilize slightly different models and keep more IT in-house as they have the size to justify their own application maintenance and development centers. The larger banks have also, to a larger extent, outsourced and/or 2 offshored their IT application/infrastructure to larger service providers. This does not mean, however, that they could not further improve their cost/quality ratio by improving their IT sourcing. However, the changes for the larger banks are likely to be less dramatic even if they opt to continue with their existing models and relationships, and only opt to leverage some of the benefits of an increasingly competitive IT service provider landscape. Tighter Regulations Drive Cost Focus A number of new regulations with the aim to enforce higher capital requirements are being implemented. The most important international ones are BASEL III (global) and Capital Requirements Directive IV (CRD IV) within EU/EEC, and a key principle of these regulations is harmonization across borders. Still, the relative success of the Nordic countries in withstanding the negative effects of the current financial crisis may lead to even stricter requirements being implemented here under the assumption that banks that operate in growing or stable markets have a stronger ability to absorb such regulations. On top of the increased capital requirements a number of other regulations are currently being implemented. These will also be costly for the banks as they require changes to systems and processes. Tighter regulative requirements thereby drive cost focus in three dimensions. 1) Regulation goes across the IT and process stack. Regulative changes need to be reflected in IT security, data availability and consolidation, reporting, business processes, product offering and product specifications. These changes are often costly to implement. In particular, the costs are high for those actors in the Nordic market that have a high degree of rigid legacy IT systems, but the numerous restrictions regarding organization and process (strict labor laws, limited access to skills, etc.) are impacting all banks, 2) Non-compliance impacts the bottom line. The costs of non-compliance with the new regulations can be extremely A Point of View to the Nordic Banking IT Sourcing Landscape | October 2013
  3. 3. high. So far, Nordic banks have generally managed to steer clear of the fines other global banks, such as Standard Chartered, RBS, UBS and several other major banks, have received for their inability to comply with the regulations, 3) Compliance demands reduced expenditure. Increased capital requirement is a regulation by itself – and higher degree of capital in a competitive market will be hard to achieve without reduced capital expenditure. There is a long list of upcoming regulatory and compliance related changes that will impact the banking IT system in coming years and we expect still more to come. Some of the biggest on-going projects are: Single Euro Payment Area (SEPA), FINREP reporting standard changes, PCI DSS (data security standard for improved card holder protection), Foreign Account Tax Compliance Act (FATCA) compliance, EMIR (European Market Infrastructure Regulation, MiFIR (Markets in Financial Instruments Regulation) and MiFID II (Markets in Financial Instruments Directive). In order to efficiently keep costs down while ensuring compliance, the Nordic banks need to partner with organizations that have the necessary knowledge of the applicable regulations, the tools to enable compliance and, not the least, the ability to rapidly implement the required changes to the processes and IT systems in a cost efficient manner. This will be very difficult to do without the economies of scale and skills base that only large global players have access to. Increased cost focus is also likely to affect the efforts banks put on attracting and retaining the “right” customers in order to squeeze better margins out of their customer base. Hence, demands for data availability, data consolidation and reporting do not only become a compliance and KYC concern, but also a major driver for strategy, client segmentation, 360 view of the customer, targeted marketing, and other CRM improvements. This furthermore drives the 3 need for seamless integration and standardization of information technology across functions and increases the pressure to phase out fragmented legacy environments. Another aspect of the regulations currently being implemented, that favors the global software and service providers, is the fact that regulations, in addition to being complex, are increasingly harmonized on a global and/or pan-European scale. Only a large global organization is able to benefit from sharing the workload across regions and offering the solutions to a large number of customers, each taking a limited share of the costs of the changes needed in the solutions to remain compliant. The smaller local players will be disadvantaged as the costs of upkeep of skills and understanding for each regulation as well as effort in updating software and IT to meet new requirements is spread across only a handful of small customers. Previously these small local players benefitted from their expertise in specific local regulations that often escaped the larger players focus, but this strength is now quickly eroding. As with other cost/quality challenges the regulations are likely to have the most impact on smaller banks as they do not have the size and capital to absorb the necessary IT system changes using their current models. Hence, regulative changes will be a driver for them to choose new IT service delivery models that enable a shift from capital expenditure to operational expenditure. Customers Drive the Innovation Agenda New technologies and a new generation of tech savvy customers provide both opportunities as well as threats to the Nordic banks. The ones that manage to utilize the new technologies and meet the high and ever changing needs and expectations of these customers will be able to offer new and better suited products and hence expand their customer base. However, in order to be successful the banks will need to pursue the right strategies, identify the right trends and emerging technologies, build the right image and services and quickly go to market while A Point of View to the Nordic Banking IT Sourcing Landscape | October 2013
  4. 4. continuously innovating new solutions that prepare them for the next generation of changes. Those, who fail in this, will find their market share dwindling and being taken over by their more successful rivals as well as new non-traditional banking players emerging with superior products and nimble operations. In order to succeed the banks will need to rely on IT service providers and technology solutions that provide the agility and time-tomarket that enables them to swiftly reply to changing customer demands. Or else, their profits will be weighted down by their costly and outdated IT service providers. Customer needs will impact the banks in several ways: - - - 4 Seamless omni-channel banking: Customers expect that they will receive same level of service independent of which channel they use. Furthermore, they expect that they can start a process with a bank through one channel and complete the same process through a different channel. In order to satisfy this need the banks need to have fully integrated and efficient IT enabling information to be seamlessly shared across channels, processes and solutions. Complete relationship overview: Customers expect their banks to have a complete overview of the relationship they have with the bank, including services they currently have, history over both product use and communication with regard to solutions and offerings. This requires a complete log of customer interaction independent of which channel is and has been used. Increased service level expectations: Banks performance and service levels are now also compared to the experience that customers have with other non-bank services. For example, when using a tablet application from a bank, the user will compare the user friendliness and functionality of the application not only to the - applications of other banks, but also other service providers, be it the online retailers, utility providers, public services providers or the local cinema. Hence, the creativity and service provided by these industries will raise the bar of expectations also for banking customers. Ability to provide customized offers and products: Banks are put under increasing pressure to understand their customers and not only to meet the customer needs, but also to understand which customers to target, attract and retain. This requires the banks to collect, analyze and feed into the customer service processes the information to make these decisions quickly and accurately for each customer. And this information needs to be available across all channels and the decision made and action taken based on it. Also, the decisions need to be made according to the same principles and information independent of who makes it and through which channel. This requires highly sophisticated analytical capabilities that analyze the customer data and transactions, create insights from them, and thereby, enable process automation and feeding of actionable insight into the operative processes across channels. The solution: Look to global software and IT service providers In order to face these challenges Nordic banks will be forced to reinvent their business models and, as part of it, their IT sourcing models. The formula to survival will be to form partnerships with software and IT service providers that can offer the right quality of service and skills at a competitive price level. Forming such partnerships with both software providers as well as IT service providers will enable a completely new business model and a stronger focus on core activities. There are several variants available for the partnership A Point of View to the Nordic Banking IT Sourcing Landscape | October 2013
  5. 5. models that offer potential for adjustments based on the individual bank’s preferences with regards to risk appetite, control and fee model. behind in a market with a rapidly changing competitive landscape. The key advantages of forming closer partnerships with the software and IT service providers, potentially establishing such PaaS models, are: While larger banks might make the shift from traditional local IT service providers to larger global ones the smaller banks are likely to go even further, considering completely new service models, such as “Banking as a Service” (BaaS) models. - - - Operational and IT cost reduction - as well as reduced cost of remaining compliant - through economies of scale, Increased agility and improved cost/price -ratio through transaction based pricing models, Quicker time-to-market through access to large vendors’ innovation capabilities, availability of required skills and scalability of resources. The large global IT service providers already score significantly higher than the smaller local players on client satisfactioni and they have the ability to provide a cost/quality ratio that is difficult for smaller players to achieve. The global players also benefit from the international harmonization that is increasingly taking place within banking regulations. With determination and the right partnering they can build stronger delivery models that provide superior benefits to their clients and enable them to capture significant market share. PaaS model variants already exist, for example in Finland where Samlink provides this service, though the services provided are based on an ageing legacy system. Both software and service providers seem ready for this change and they are increasingly partnering to deliver PaaS implementations and services of core banking solutions. The question is whether the previously risk averse Nordic banks are willing to replace their long standing local IT service providers with new global players forming a new model of partnership. However, with the current development the potential benefits are quickly outgrowing both costs and risks. Therefore, the Nordic banks should take the leap of faith sooner rather than later. Those that hesitate for too long, risk being left 5 Investigate the “Banking as a Service” Model A BaaS model that provides a shift away from the current capital expenditure intensive solutions will bring in numerous benefits:     Old legacy platforms can be replaced by up-to-date packaged software that is further developed and serviced by a large software provider that also sells the same solution to other smaller banks. Time-to-market will be reduced in making changes in business models or responding to new customer needs, since new services and product offerings will be easier and quicker to launch using the features provided by the modern solutions. Furthermore, fees can be paid for example in a form of transactional costs or in some form of pay-as-yougo licensing further limiting the capital expenditure and providing a completely different agility tying costs to revenue, operations and transaction volumes. Finally, tighter relationships with global software and service providers offer even small banks with a network of knowledge and competency that they otherwise will struggle to obtain. Current local IT service providers offering the more traditional PaaS (platform as a service) solutions are facing significant challenges in reinventing themselves to meet the BaaS model requirements and in facing the competitive pressures created by the new comers to the Nordic IT market. The traditional local IT vendors need to renew their legacy platforms in a quick pace. A Point of View to the Nordic Banking IT Sourcing Landscape | October 2013
  6. 6. Realistically, this can be done only by replacing the current legacy system with a global packaged banking product. But this generates several complications for the vendors. To mention just a few:    The sheer renewal project size is easily beyond vendors capabilities, skills and financial resources, Their financial model will change, because in the new model a large portion of the customer revenue will flow through as product licenses to a 3rd party software vendor, Working as a system integrator of a global packaged software product (as opposed to being a software developer of a custom software) is a specific competence, and the system integrator needs to constantly generate added value both for their customer and their software vendor partner, or risk becoming obsolete in the equation. Beware of the Challenges Banks need to consider if the chosen software product solution(s) can evolve in accordance with requirements, such as extend of the provided functionalities, availability of and access to required competencies, continued compliance with changing regulations, in the future. In order to support the bank’s strategic intent and aspirations, the bank’s IT department needs to carefully evaluate the available software options against the bank’s business needs and TCO of each option. Most of the leading banking software providers offer products that are at least “good enough” to meet the typical banking requirements. But that may not be enough to generate competitive advantage over local competitors, or the price that the bank has to pay to get the advantage, may exceed the potential ROI. In addition, the fit with the existing application architecture and rest of the infrastructure needs to be validated. As the Nordic banking market is a small market, any, however small, local 6 customizations in a global product are done on a need basis, usually initiated by a system integrator working for a particular customer and built further upon afterwards by the software product company. It is thus important for the bank to verify that its selected global vendor(s) partner with a local vendor(s) or establish enough local presence to create the localized version complying with the local regulations. In general, bank should review the strategic and cultural fit with the software and IT service partner candidates. Projects related to renewing or migrating banking systems are typically long and somewhat risky, therefore, there is no need to add further complexity to the project management due to mismatch in values or ways of working. Banks’ IT departments have a good opportunity to evaluate the cooperation and fit with the software and partner candidates during the RFI and RFP processes. Another risk to consider is the need for data conversion from the legacy systems, conversion testing and integration, which are making the migration to a new platform complicated. These activities can prove to be quite challenging due to the nature of disintegrated legacy systems, their inherent data structure and the quality of the data accumulated over the years. All these are resulting in complexity of extracting coherent data sets for data conversion and migration purposes. New (packaged software) platforms have generally stricter business rules than the legacy systems have had. For example packaged systems may require fixed collateral for a loan, whereas older systems might have loan and collateral data distributed across separate systems with weak or no data links between them. These kinds of conflicts in the business rules are likely to significantly complicate the automated export of data during migration to a new platform. Hence, fixing misalignment between business rules in old and new systems will require significant amount of manual work effort in restructuring and cleaning the data sets. However, usually the migration needs to be done in a fairly short time window, possibly overnight. This A Point of View to the Nordic Banking IT Sourcing Landscape | October 2013
  7. 7. renders time-consuming manual labor to an unfeasible option. Therefore, banks are advised to lean on the best practices and data conversion tools that their vendors can provide. These best practices and tools may include e.g. automated data extraction and data cleansing or running the old system and the new system in parallel for a period of time. The preparations for the data conversion need to be started as early as possible, since it is likely to form the critical path in the migration project due to the careful planning, control and testing it requires. What does all this mean? Nordic banks, especially the smaller banks, are facing increasing cost pressure due to   Increased regulations of the financial industry, and Changing customer expectations. These pressures require the banks to rethink their IT cost structure and sourcing strategies. Banks’ current IT departments and/or local IT service providers with their legacy platforms are even struggling to meet the regulatory requirements and have hardly any means left to rise up to the challenges created by the customer expectations. platforms, the bank’s CIOs need to start looking at a wider range of options for sourcing their future IT solutions. References i KPMG’s annual “Nordic Service providers Performance Report” place the traditional providers of IT Services to the Nordic banks right at the bottom of the customer satisfaction ranking. Meanwhile, the top of the same ranking is dominated by large global service providers. About the Authors Ilkka Schulman is a Director at Cognizant Business Consulting and leads the Strategic Services in the Nordics. He can be reached at Ilkka.Schulman@cognizant.com. Sari Inkilä is a Senior Manager Strategic Services at Cognizant Business Consulting. She can be reached at sari.inkila@cognizant.com. Erik Tjønneland is a Senior Consultant Strategic Services at Cognizant Business Consulting. He can be reached at Erik.Tjonneland@cognizant.com. At the same time global banking software vendors and IT service providers are entering the Nordic banking IT market with increasing determination. Their entry made easier by the consolidation driven by the pan-European and global financial regulations. The previously high market entry criteria created by the purely local practices and regulations are quickly becoming almost obsolete. Competitive advantages created by large scale and access to global sourcing models that we see in the IT market of other industries, are becoming valid also in the banking IT market. In order to remain compliant, competitive, and relevant for the customers and owners, banks need to investigate new software and IT service partner options as well as new service models for sourcing their banking IT platforms. Depending on the banks’ market strategies, availability of capital, appetite for risk and life-cycle phase of the current IT 7 A Point of View to the Nordic Banking IT Sourcing Landscape | October 2013