How are traditional financial institutions reacting to technological change?
In North America, Europe and Asia-Pacific alone, banks are expected to spend a staggering $200 billion on IT infrastructure in 2016. However, research from Celent estimates that 75.4%, or $148.3 billion, will go to maintenance of existing legacy systems. More interestingly, the research finds that the percentage of IT budget that is spent on maintenance is set to decrease to 73.4% in 2017, as banks attempt to increase their "focus on innovation". A reduction of 2% (1% per year) at first glance hardly seems sufficient to tackle the well-funded, rapidly growing FinTech start-ups. But if we consider the overall dollar terms, we are still looking at billions worth of savings.
According to research by "NTT Communications", 71% of financial services CIOs said they would adopt cloud if their legacy IT was less complex. To further emphasise this, it was recently reported by BCN that the director of the Bank of England stated "big banks spend 70-80% of their IT budgets on maintaining legacy, rather than investing on new technology."
It isn't that banks don't want to move to the cloud or that they don't see the inherent benefits in doing so. As reported, "around 45% of financial services CIOs aim to make the transition to the cloud by 2015". The issue is that there are difficult trade-offs involved, that the small FinTech start up just doesn't have to worry about as much. BCN reports how large financial institutions CIOs are often looking for a way of obtaining the flexibility and cost saving benefits that the cloud offers in a way that "appreciate(es) the compliance, complexity and cost involved with large legacy IT estate". A marrying of the old and new, so to speak.
Furthermore, BCN states that "the cloud migration project will be a long one, possibly many years", and therein lies one of the key problems in our opinion. By the time the banks get around to implementing cloud computing more holistically, how far ahead will these nimble FinTech start-ups be? What other, even more disruptive technology and business models will have been developed? Some that may even upend the very cloud systems the banks have spent so much time and money to put in place.
However, as we will see, not all banks are moving at the same slow pace with regards to implementation of cloud computing, and different banks are going about things in very different ways. Traditional financial institutions are employing a mixed strategy, an "invest, acquire and/or build" approach, if you will. We will explain each approach in turn below.
Many banks have taken to investing in FinTech start-ups themselves, often creating their own venture arms and/or programmes in order to do so. One such prominent example is the Barclays Accelerator Programme. The emergence of their programme seems largely due to Barclays realisation that one of the most effective ways of them improving their own offerings is by engaging with the "emerging technologies" coming from the FinTech scene. The realisation that much of the expertise and opportunities lie in this rapidly expanding "start-up ecosystem", as explained on the official site for the programme. The result of the programme they ran last year were innovative ideas including "a new credit scoring system, a new money management tool... and an analytics platform designed to help companies manage risk and reputation".
Barclays are to run a similar programme in New York this year in conjunction with Techstars. The participating start-ups will receive a $200,000 investment and mentorship in exchange for giving up a reported 6-10% in equity. However, as Finovate.com points out, the programmes are less about equity and more about "knowledge transfer," which they believe is the main benefit companies would receive from working with start-ups.
Essentially, "the start-up can run 100s of experiments at a fraction the cost a large corporate would incur" and once they have learnt enough they can implement. This is further supported by a quote from David Reilly, a technology infrastructure executive at Bank of America. He states that "by investing early, banks gain early access to innovative solutions that can help reduce information technology costs and make their businesses more flexible to consumer needs". The looming question about how successful they will be at eventually implementing these innovations into their current legacy systems in any truly meaningful way is still up for debate.
Not all traditional financial institutions are being cautious and slow moving when it comes to the cloud. There are some that have already migrated a large number of their services to either public or private clouds (or a mixture of both). We put these banks in the "build" category as they have built cloud straight into their companies as opposed to just investing in FinTech start-ups or acquiring cloud based financial companies. Below for two great examples of banks that have taken the plunge:
Commonwealth Bank Of Australia
Moving to the cloud has meant that CBA (Commonwealth Bank Of Australia) doesn't have to purchase servers or incur high energy bills. Amazon is responsible for the hardware and power. "(We have saved) tens of millions of dollars... over one year," Mr Harte (Commonwealth Bank chief information officer) said, as reported by TheAustralian.com.uk. He then went on to say that the "shift out of infrastructure" and freeing up of capital meant more funds could be channelled to other areas such as business logic and new customer-facing technologies. And the bank recently announced it would utilise Amazon's first Sydney data centre, managed by Equinix, for more cloud services.
As big of a cloud fan as Harte is, he does draw a line, and that is at customer data. He recently told ZDNet that "CBA's private customer data would never be used in any third-party services", and that "privacy and security are paramount." So it is clear that under Harte not everything will find its way into the cloud, especially not customer data. He strengthens his stance on this when speaking to AFR.com. He explains how only the banks website is hosted on AWS, as doing so costs just $30,000 yearly as opposed to the $600,000 it costs hosting their site using their own data centre. He further emphasises the importance of security by saying "third parties don't get to see customer data, it's that simple. People get fired for that."
Bankinter is a Spanish industrial Bank founded in 1965 through a joint venture by Banco de Santander and Bank of America. It is currently one of the top ten banks in Spain. According to Amazon, Bankinter uses AWS as an "integral part of their credit-risk simulation application" which requires huge computational power, as they need to "perform at least 5,000,000 simulations to get realistic results." So you can imagine how expensive and complex this would be using a traditional in house hardware solution.
By using "the flexibility and power of Amazon Elastic Compute Cloud (Amazon EC2)" to perform these simulations, they can get a job that would have usually taken 24 hours done in 20 minutes. Roldan explains how AWS has opened up a whole new area for them. It has provided them the power to run simulations they were not previously able to, due to the "large amount of infrastructure required."
According to our research banks have recently been opting to invest and/or provide support to FinTech start-ups as opposed to outright acquiring them. This can be for many reasons, but we speculate it is because the banks haven't yet gotten to the stage where they would make good on an acquisition. To successfully integrate a start-ups technology in to their companies, thus make good on an acquisition, a larger culture shift within banks would probably need to take place.
This view is echoed by CityAM.com who explain that start-ups disrupting the payment industry are "less likely to be acquired by established banks". They feel the more likely acquirers would be major technology companies like Apple or Google. This idea is further supported on a broader level by Accenture’s research as part of their innovation lab. In their work on "The Hypothetical Banking Future", they see "challengers acquired by incumbents" in only 4% of future scenarios. It must be stressed though that these are just predictions, and as always, things can change.
However, there have been a few notable acquisitions of FinTech start-ups by established banks, one of which is discussed below:
Simple Bank Acquired By Banco Bilbao Vizcaya Argentaria (BBVA)
In our article on FinTech startups and cloud technology, we profiled Simple Bank as one of the FinTech disruptors using AWS at its very core. It was acquired by BBVA, a banking group with over $820 million in assets, on February 20th 2014 for $117 million. Simple did however emphasise that "its business would largely remain unchanged, operating as a separate subsidiary with the same management team". The difference being that they now have significantly more resources in order to grow faster.
If you would like to build your FinTech platform on AWS or are wondering how your start-up can best take advantage of cloud technology, do not hesitate to contact us!