There are still a few bankers who can recall a time before immediate access to data, real time transactions and 24/7 service. This was a time when banks would often ignore the impact of shared services and IT on their profitability and performance measurement.
In the early days of my banking career, I managed a large consumer lending office in the branch network of mid-size regional bank. In those days you predominately operated on an island, with the autonomy to make decisions, but with limited information that was dated by at least 24 hours, if not a week or a month. Waiting for the courier to arrive with those green bar reports to learn what happened yesterday or last week, left you disconnected from the IT and operations organization.
However, being disconnected also meant that you could not be held accountable for the spend of those organizations. Service allocations were typically a single line item in your “below the line” indirect expenses that were not included in the performance review of your organization. Today that paradigm has shifted, and shared services and IT are very much a part of how banks deliver products and services to their customers.
Over the past twenty years or so banks have invested considerable time and effort to centralize and automate as many functions as possible, however, many organizations continue to live in the past and separate front and back office expenses. This distinction is increasingly less meaningful if bankers want to understand the true profitability of various organizations, customers and products. Bank management must understand the impact that technology expense is having on their profitability.
Since 2008 the banking industry has focused on cost management and slashed their operating budgets. Many banks have searched for efficiencies through automation, consolidating operations and branch rationalization initiatives. Particularly the retail bank, what was once a decentralized organization is evolving into a more homogeneous and consolidated environment. To support this evolution, improved cost information is driving better management reporting to understand the organization’s dimensional profitability.
For the last few years automation and development of alternative delivery channels have become a primary focus of most banks placing the spotlight squarely on IT. Worldwide in 2014, banks are expected to spend over $215 billion on their IT organizations, which is approximately half of all IT spending in the financial services sector. In the US, while most areas in the bank are still looking for areas to reduce spend, the IT budget is expected to grow by and annual rate of 4.2% to 5.0% over the next three years. Most banks are expecting to see a continued increase in their operating budgets to keep pace with the increased demands for alternative delivery channels. The American Banker projects the top areas of IT spending in the near future, will focus on; online Banking and Mobile Payments, Marketing Analytics and Data Management and the continued integration of delivery channels across the banking platform. This data leads to two indisputable conclusions regarding bank profitability:
Alternative delivery channels are increasingly critical to account acquisition and servicing, and the role of the branch will continue to evolve based on this shift. Financial data from the technology organization will have to be translated into meaningful financial information for both the technology group and the business owners. The CIO and the CFO must cooperate in driving change that will provide both sides with the financial information they need, the right methodology to deliver that information and the toolset to support this transformation. The production cost of IT should be driven to application cost pools based on the consumption of IT resources by the applications supported. Customer facing application costs can be driven directly to product profitability through a transactional unit cost based on customer usage. Service and core application costs can be driven to the owning business units and embedded in their profitability reporting.
The profitability system should also provide the ability to track costs back from the end point to the originating organization, providing the financial transparency that most organizations are striving to obtain. Understanding IT costs and aligning them appropriately is increasingly important as banks continue to struggle with tactical and strategic decisions about how to efficiently use their delivery channels.
IT spend required to support the increased automation of processes and delivery channels are by nature larger in scale, longer term, and often less flexible than traditional resources. Banks can’t install and uninstall systems nearly as quickly as they can increase or reduce tellers, sales force, or back office personnel. Understanding excess capacity, step functions of investments, and fixed vs. variable expenses are more important than ever as the supporting infrastructure of banking shifts towards IT.
While banks have made a considerable investment in understanding the various dimensions of profitability, many have been unable or unwilling to invest the time and effort to understand IT cost. With the growth and importance of IT to the organization this will not be a sustainable approach for banks. Technology is clearly a part of the cost equation that must be measured and analyzed to understand bank profitability, and it can no longer be ignored.
Tags: Activity Based Costing, Cost Management, Financial Transparency, IT Cost Management