Financial Institutions Need To Work Harder – and Faster – To Take Greater Advantage of Third-Party Software Solutions

Jan 27, 2016

Financial Institutions Need To Work Harder – and Faster – To Take Greater Advantage of Third-Party Software Solutions

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For years, financial institutions have been spending billions of dollars per year on internally developed software in an effort to gain a competitive advantage – while talking about switching to third-party-based applications. According to a recent article, a well-known financial services firm has more people on its technology team (9,000+ full-time engineers) than Twitter (~3,600 in 2014) or LinkedIn (~6,900 in 2014). They have about the same number as Facebook’s total employee count (~9,200 in 2014). And that financial services firm isn’t alone. In some cases, chief technology officers at even medium-sized financial services firms are managing technology businesses as large and complex as those at many third-party software firms.

Perhaps the line between competitive differentiation and consortium utility fodder is difficult to divine from inside the banks’ IT industrial complex. According to one study, information technology is the largest support function at most of the larger institutions (and a significant cost center at smaller ones). And a large portion of that spend is going to software applications that are designed to facilitate things like settlement, clearance, corporate action and reference data processing, global master files, securities pricing, accounting, portfolio management, and a host of other infrastructure applications that are available from third-parties software vendors whose products are robust and entail a total cost of ownership that often is a small fraction of the fully-loaded cost of internally developed applications.

In an era in which financial institutions are under tremendous pressure to increase regulatory capital, reduce costs and improve Return on Equity (ROE); and in which the opportunities to increase profit through proprietary trading and agency trading are under pressure, financial institutions all ought to be doing more to speed the adoption of alternative business models and processes. It’s time for all institutions to take a big step back; look holistically at where the money is best spent; and move much more aggressively – before they drown.

Internally developed software applications are not only more expensive to operate than many third-party applications, in many cases they are less efficient. They are less likely to take advantage of the latest advances in programming, cloud storage, SaaS capabilities, and are often less flexible. Third-party software firms have the advantage of being able to learn from multiple customer organizations and apply best practices. As a result, many are offering increasingly flexible, highly sophisticated, industry-vetted solutions to an increasingly complex set of problems.

It’s not that the big banks don’t get it. A 2015 study by Gartner expects third-party spend at banking and securities firms to grow at approximately twice the rate of internal IT services spend and reach more than $300 billion by 2019. It’s just that the firms aren’t moving aggressively enough. A joint research report from Oliver Wyman & Morgan Stanley estimates “$7 to $9 billion of annual industry costs could be pushed out into an external supply chain”, with net annual savings of $3 to $5 billion. That’s real. The external spend is growing at 5% a year, when it should be growing at three times that rate.

We can’t be sure exactly where banks will be allocating IT budget dollars. Much of it is likely to continue to be focused on the aforementioned information infrastructure and back-office plumbing areas. But there are so many other ripe opportunities to replace internal systems, automate processes that historically have been people- and spreadsheet-based, make use of standardizing pricing and analytics, as well as to apply third-party software to areas such as governance, risk and compliance. For some firms there may even be an opportunity to spin off tech groups as separate businesses. (In a 2015 white paper, Morgan Stanley estimated that “Spinning some of the technology support and infrastructure costs out of the banks could release billions of dollars in new value.”)

The opportunities for the financial institutions to reduce cost, while at the same time improving performance is too tempting for them to continue to pass up. That’s why we like being in this business.

It will be interesting to watch.

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