Bigger is not always better

A tougher regulatory environment means banks are playing it safe with their IT. Ralph Silva explains how this could be stifling the innovation they need to stay competitive.

European financial services providers have always proved difficult customers for the world's IT providers. Banks' long sales cycles, complex legacy systems, demanding lines of business and large and capable IT departments all add to vendors' ongoing frustration.

So why do vendors keep targeting banks? Simple: they are the biggest commercial spenders on IT.

Banks are in control. With IT staffs that dwarf all but those of the very largest IT suppliers and with seemingly limitless resources, banks always retain the option of in-house development. As a result, they are unwilling to compromise on a solution and certainly would not compromise on the vendor.

Cheat Sheets

♦ Basel II
♦ MiFID
♦ Sarbanes-Oxley

Banks have always preferred large vendors, those with significant balance sheets and long track records serving the financial services industry. Nevertheless, in the past some banks considered using smaller operators that could demonstrate innovation.

Such banks were prepared to provide these smaller vendors with an environment that would allow them to prove they could do the job. Unfortunately, recent trends show that banks are now buying exclusively from bigger vendors, without even considering the merits of systems offered by small suppliers.

We can attribute this trend largely to the oppressive regulatory environment that burdens the financial services industry. Regulations such as Single Euro Payments Area (Sepa), Markets in Financial Instruments Directive (MiFID), Basel II and International Accounting Standards (IAS) are all enforcing the lawmakers' desire to increase banking accountability.

Small vendors are not in a position to take risks with accountability. So, should problems arise, the burden of responsibility is on the banks, which would be unable to recoup losses. However, should problems arise with large vendors, which do have the kind of balance sheets that can handle major payouts, banks' exposure is more limited.

Today, TowerGroup estimates that European tier 1 banks impose a vendor threshold of about £1.5bn in revenue, almost double what it was two years ago. Banks are also looking for vendors that have financial services experience and a firm understanding of regulations.

On the positive side, banks have dropped their demand for domestic suppliers and will consider a vendor regardless of where it is domiciled.

In 1928, Ford Motor Company built a massive manufacturing facility on the shores of the River Rouge in Dearborn, Michigan. The plant was created to build the Model A, a widely successful product for its day. This plant had more than 100,000 employees working in 16 million square feet throughout its 93 buildings.

The facility had its own electrical plant, ore processing facility, lumber mill, and everything else that was required to build and assemble the Model A. It is interesting that, some 80 years later, the European tier 1 banks mirror Ford's approach. Banks still believe they must control all aspects of product development, creation, distribution and support.

HSBC employs about 23,000 IT professionals, 13,000 of whom can develop solutions; this is more than seven per cent of HSBC's staff. So, what do banks do? With this commitment level, you would be forgiven for believing they are IT companies, but of course they are not.

HSBC, along with all other European banks, is supposed to focus on serving customers, not on writing code. Banks need to increase their reliance on vendors' solutions, business process outsourcing (BPO) and outsourcing solutions that enable them to spend more time on their core business and interactions with customers.

By excluding small suppliers, banks are inadvertently letting technology stagnate. That is not to say that large vendors do not innovate; they do. However, large vendors typically promote efficiency of product, not evolutionary change. With some exceptions, the big operators don't deliver innovation, this usually comes from small vendors fighting for market share.

Small suppliers need to battle for acceptance. Collaborating with larger organisations will help them reduce risk in the eyes of the banks, develop domestic experiences and build a solid understanding of the regulatory environment. They also should keep prices at a reasonable level to make it easy for banks to say yes. Other priorities should be promoting test implementation and building trust with banks' employees.

Banks need to combat the desire to only deal with large vendors. European banks have a long and proud history of implementing innovative solutions, which they have done through partnerships with small suppliers that offer progressive solutions.

Banks must keep moving forward or they will lose out to other industries, such as retail, that are looking at financial services as a growth opportunity. They need to keep an open mind and consider all solutions, regardless of the balance sheet.

For the smaller vendors, it is appropriate for banks to keep them in test environments until they have proved themselves, but once they do, they should be given a chance.

Ralph Silva is senior analyst at financial services consultancy TowerGroup