Technology investments drive up banks’ costs

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For all their boastful talk of becoming technology companies, most banks still run on core systems installed in the 1970s and 1980s.

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It is surprisingly difficult to find out how much banks spend each year on IT. 

Banks periodically try and tell the world – especially when tech stocks boom and trade at high valuation multiples – that they too are essentially technology companies that just happen to have regulated financial businesses attached. 

Goldman Sachs, for example, has 34,400 employees, of whom 9,000 are software engineers. That’s about the same as Facebook and more than the entire payroll combined of Twitter and LinkedIn. 

And yet how much banks actually spend on IT – including investment in new systems to bring product and customer channels into the digital age, typically accounted as capital expenditure amortized over time; the annual expense of running legacy systems; and then pay for IT staff – is not easy for investors to extract from financial statements.

Analysts at Citi took a stab at it recently. They estimate that maintaining legacy systems, investing in new ones and paying IT staff together amounts to anywhere from 15% to 25% of a typical bank’s annual budget. That’s a lot. Banks spend around $200 billion every year on IT. Most of that – Citi estimates close to 80% – is spent internally on legacy and new proprietary systems rather than on systems installed and maintained by third-party vendors.

Lipstick on a pig

For several years now banks have been telling Euromoney about their digital transformations and investments in gee-whiz systems to delight customers, often in collaboration with the very fintech upstarts that originally aimed to disrupt them. They are embracing the cloud, AI, robotic software, seizing new opportunities in big data, yadda, yadda, yadda.

Have they just been putting lipstick on a pig?

Citi points out that many banks still depend on legacy IT platforms that are now as much as 40 years old, running on languages few recently graduated IT professionals are familiar with. Banks may be trumpeting their embrace of digital technology, but the expensive and time-consuming reinvention of core systems was reined in at many after the global financial crisis. 

Celent suggests that 77% of annual IT budgets at European banks and perhaps 67% at Asian banks still goes on running and maintaining legacy systems.

Re-engineering mainframe-based systems put in place in the 1970s and 1980s and now coming close to redundancy has typically cost more and taken longer than banks first budgeted. Banking software firm Temenos suggests a typical upgrade of core banking software can take between two and five years.

Australian banks, the Citi analysts suggest, have led the way in overhauling legacy systems. Their experience may be telling. Citi reminds us that when Commonwealth Bank of Australia announced a replacement of its core IT system in 2008, it initially estimated that the cost would be A$580 million ($459 million) over four years. The final price tag was A$1.3 billion over five years. National Australia Bank may take 15 years to transition all existing customers and products onto new systems, a task it originally hoped would take just five.

In the medium term, Citi suggests that the proportion of global banks’ annual budgets spent on IT could rise by 10 percentage points before any big savings may eventually accrue to annual running costs. And while bank executives and investors in bank stocks ponder this, they must ask themselves whether the GAFAs (Google, Apple, Facebook, Amazon) might yet replicate the success of the BATs (Baidu, Alibaba and Tencent), who have already diversified from payments into broader financial services. 

Don’t think of banks as technology companies. Think of them as technology companies’ most lucrative customers.