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March 2002

The big spenders learn to budget


The days of promiscuous big spending on IT may be over for investment banks. However, because the splurge was often ill-directed and uncoordinated there’s still a lot to be done – and spent – to patch up old mistakes, deal with major developments such as T+1 clearance and upgrade neglected back-office systems. Worryingly, most banks still seem unwilling to cooperate with rivals on pooled systems and the development of common standards.




Over the past few years, the bulge-bracket investment banks have indulged in something of a tech-spending frenzy. There have been huge events to prepare for such as the euro, Y2K and Basle II compliance. In addition, post-merger integration has been a major headache and there have been compelling competitive pressures. The development of the internet as a new distribution channel, for example, was something that few banks believed they could ignore in the boom times without grave damage to their businesses.
Unfortunately the rise of online finance coincided with a bull market full of institutions flush with cash, big egos, big money and a tireless quest for the latest IT gadgetry. "There was a triple whammy - a huge internet boom, a massive expectation of what it could do at a time of booming markets and everyone making too much money," says Justin Bull, managing director and head of e-commerce at Barclays Capital. "It made people think they were masters of the universe. It was a wonderful arrogance, but that attitude can also become your comeuppance." Comeuppance has materialized as an enormous amount of waste - without too much to show for it.
Many expensive projects have never been implemented and once-impressive proprietary systems have passed their sell-by dates. Technology has even been introduced without a specific idea of what to do with it. Now, in a downturn when many chief investment officers are cutting costs, investment banks face a critical new round of investment in ailing back offices, neglected in the stampede for dazzling front-office functionality.
Banks do not disclose IT spending as a separate line in their accounts and are generally secretive about what has been spent. However, SEC regulated company information taken from audited financial statements and 10-K filings shows that Deutsche Bank's IT outlay in 2000 was $3.2 billion (see table). Other top spenders were Citigroup, UBS Warburg, JPMorgan, Credit Suisse First Boston and Merrill Lynch, all of whose spending was apparently in the $2 billion to $3 billion a year bracket. Deutsche and CSFB spent more than a quarter of total operating expenses on IT. Consultants at Andersen, which collated the SEC figures, say the spending doesn't necessarily include IT salary costs. This means total IT spend as a proportion of total operating costs could have been much higher.
Many analysts reckon that IT spend rates of 15% to 25% of total operating expenses have not been at all unusual over the past few years and that IT spending way surpassed the next biggest spending sector of telecoms. Many banks did not budget for that much. A research report from TowerGroup and the Securities Industry Association (SIA) in June 2001 says that the compound annual growth rate for IT spending for the north American securities industry between 1998 and 2000 was 17%, when firms were predicting about 7%. IT spending, it seems, was out of control.
To a large extent, they have got away with it. Of all the banking equity analysts Euromoney called, few had paid much attention to technology spend if they had looked at it at all. As Diane Glossman, managing director at UBS PaineWebber, says: "These are not figures that are disclosed separately by the companies so most people don't attempt to educate themselves about that. In my view, most analysts do not focus on the effectiveness of bank technology usage."
Not all banks accept the Andersen figures. Mitchel Lenson, chief investment officer for corporate investment banking at Deutsche Bank, says the bank did not spend $3.2 billion in 2000, but concedes that spending must be cut. "Our IT costs are not on the good side of the industry average, and they need to come down. We worry less about the absolute numbers and more about looking at IT spend as a percentage of revenue or operating costs and comparing those numbers to our peers."
Yet some banks could have spent significantly more. Dennis O'Leary, ex co-head of LabMorgan, the e-commerce division of JPMorgan, has said that just after the merger with Chase the bank spent $4 billion on technology annually. One CIO says his bank doesn't measure IT spending as a proportion of operating costs but that Morgan Stanley, Goldman Sachs and CSFB consistently spend 14% to 15% of annual revenue on IT. This would dwarf Andersen's figures. The five largest US investment banks in the US certainly accounted for almost 40% of total IT spending when TowerGroup/SIA last looked at this in 2000.
Banks may have run up multi-billion dollar IT bills but it wasn't necessarily CIOs that were driving them. Spending was often ad hoc and driven from the bottom to the top of the bank. "CIOs are poor at controlling costs in boom times," says Juan Amador, partner at Accenture. Those CIOs may have had an overall plan but the plan was being driven with money from front office and that was going into expensive legacy systems.
Some say that banks had to go this way because of the historical lack of viable offerings from the vendor marketplace but banks also suffer from an ingrained mentality that if they are to be seen by the market as reputable they should have proprietary systems. Whatever the motivation, building IT in-house is a luxury that few other industries other than the military indulge in today.
UBS Warburg used to run its derivatives business on a system based on Apple Macs. A few years back when it designed this bespoke system it was doubtless hailed as giving the banks an edge over its rivals. But today it looks quirky. "I'm sure they were fine, but Macs scarcely have the robustness one would expect today," says a source.
Traders and their toys
All too often it was the traders bringing in millions in revenue that had the leverage to demand the most expensive, customized systems to support their own divisions. "Traders have been brought up to buy the biggest and fastest. Practicality, compatibility and return on investment has come a poor second," says Keith Saxton, a former head of trading at several banks including Deutsche, who is now director of the financial markets business at IBM. Barclays Capital's Bull says this often happened at other banks, irrespective of the economic viability, based on what he calls a "build it and let's hope it makes money mentality". One source goes further. "It can cost millions to set up the systems to cope with a sophisticated instrument with no more than a handful of clients and that can make a trader's optimistic project look a joke."
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