Europe Yanks IT Purse Strings

Even leading banks are reducing their IT spending. The ranking of banks by IT spending has not dramatically changed this year, reflecting the overall reduction in spending. We expect HSBC to be number one in terms of investment in technology; their investment should total €3.05 billion ($3.63 billion) this year.

European banks are not only reducing their IT budgets to reduce their operating costs. Cost reduction is also the main benefit they expect from IT projects. When asked about the main benefits expected from IT projects, 88 percent of banks interviewed answered, "cost reduction." Because this issue needs to be addressed specifically by each bank, it’s not surprising that 56 percent of European banks have set specific priorities for IT projects this year. Among the strategies to achieve cost reduction, outsourcing and centralization of IT operations seem to be the most popular.

Outsourcing should certainly reduce costs, but it will eventually lead to tensions between banks and their employees and unions. Nevertheless, the idea of outsourcing is being taken more and more seriously. We estimate that this year, 9 percent of human resources in banks’ IT departments, and more than 5 percent of hardware, will be outsourced.

Despite global IT spending reduction, new projects will get a reasonable piece of the pie. The investment in new projects will be fairly high this year, at 9.5 percent of the total IT budget. Cost reduction will again be a factor, particularly maintenance costs. New technologies are more cost-effective to maintain than legacy systems, such as mainframes.

Despite an expected improvement in the economic environment in 2004, banks in Europe are planning to decrease their IT investments this year. Technology projects are still very important to banks, but other, future developments are capturing some share of banks’ budgets. IT, which had been on the top of the agenda for the past decade, is losing some ground. IT spending has experienced growth over the past two years—in 2002, spending was up 2 percent over 2001 and 2003 spending was up 3 percent over 2002 spending. This year, however, will be marked by a decrease in IT spending, with IT spending 5 percent lower than 2003 spending, and 2 percent lower than 2001 spending.

Despite the reduction of European banks’ IT budgets, they still represent a large share of the overall operating budget. In Germany, an average of 19.8 percent of overall expenses is allocated by banks to IT, while the figure is 19 percent in Italy, 18.2 percent in the UK, 17.8 percent in the Netherlands, 16.3 percent in Switzerland, 15.5 percent in Italy and 14.5 percent in France. European banks, especially German firms, are focusing heavily on cost reduction, and as the share of IT budget consumed by overall operating expenses remains quite high, the real level of IT budgets is decreasing and will continue to do so.

In terms of IT spending this year, HSBC has taken the lead from Deutsche Bank, a position it shares with UBS. ABN Amro is fourth, and will spend an estimated €2.2 billion ($2.6 billion). These four banks form a small club of European banks spending more than €2 billion ($2.4 billion) on IT in 2004.

Among the 12 leading European banks, eight have a smaller 2004 IT budget compared to 2003. In particular, only HSBC Holdings (+9 percent), Royal Bank of Scotland (+5 percent), BNP Paribas (+5 percent) and Barclays Bank (+3 percent) will increase their spending in IT in 2004. The eight other banks are decreasing their IT budgets in 2004. Three German banks and a Swiss bank are experiencing the most substantial decreases: Deutsche Bank (-15 percent), Commerzbank, Dresdner Bank and Credit Suisse (-10 percent each).

Since investment in IT has been a priority for European banks for the past five years, it is not surprising that spending should level off in 2004. This decrease reflects the strong focus on cost reduction in the financial industry as a whole and also the maturity of the market, which is trying to eke out all remaining benefits from earlier investments before making new ones. Actually, the goals assigned to IT by banks have clearly changed in the past two years, and IT priorities are in line with the business strategies of European banks.

Participating European banks state that their IT spending in 2004 will be lower than it was in 2003. However, this new situation does not mean that banks are holding off on new projects. Their expectations for IT project implementation reflect their current business strategies.

Our survey revealed that the main goal of IT projects for European banks in 2004 is cost reduction; 88 percent of banks mentioned this goal in their top three benefits expected from IT projects. Three benefits stand out among those expected from IT projects: cost reduction (88 percent), replacing legacy systems (77 percent) and improving customer service (65 percent). Enabling cross-selling is only mentioned by 48 percent of banks interviewed, while integration of a system by a different organization was mentioned by 45 percent. Increasing flexibility was mentioned by 40 percent of the banks we surveyed, while calculating customer profitability and increasing delivery speed was mentioned by 35 percent.

It is interesting to note that replacement of a legacy system will clearly have an impact on cost reduction, as new technologies are cheaper to maintain and allow greater straight-through processing (STP). But replacement of legacy systems is also related to improving customer services, because replacing a legacy system should allow a higher quality of services.

When banks were asked about their IT priorities for each year, from 1998 to 2000, an overwhelming majority of European banks would have answered online banking and CRM. This no longer the case, as most European banks need to face their own internal issues. IT priorities are slightly different from one another, and it is impossible to detect large trends toward particular areas, as was the case in the past. Our survey found that despite naming a particular home-issued project, there are six types of IT projects that are in a 10 percent bracket of answers: recent branch system (36 percent); centralized back office (35 percent), satisfactory CRM system (31 percent), cash management solution (29 percent); recent core banking system (29 percent), and online trade finance solution (25 percent).

This lack of consistency among European banks reflects the maturity of the market. Most banks have already made the implementations they’ll need to compete in the 21st Century. A good example is that only 15 percent of banks mentioned direct Internet sales as a priority, because most banks have already invested in this technology. The fact that banks are using technology to fulfill their own needs, coupled with the fact that the usual buzzwords are not popular anymore, is a strong sign of market maturity and better use of technology.

The financial industry relies heavily on technology, and has done so for a long time. Therefore, the cost of maintaining existing systems is extremely high. More precisely, 90.5 percent of 2004 IT budgets in European banks will be allocated to maintenance, and only 9.5 percent to new projects. Although this percentage must be put in the context of 88 percent of banks naming cost reduction as a main benefit of IT, it is clear that new technologies should reduce the maintenance costs incurred by use of a legacy system.

In 2004 budgets, however, new projects have the strongest share. Despite the focus on cost reduction, we expect to see European banks allocating more of their budgets to new projects in 2004 than they did during the past four years. As we’ve seen, 9.5 percent of 2004 IT budgets will be allocated to new projects, compared to less then 9 percent in 2003, 7 percent in 2002, and 7.5 percent in 2001. One could assume that, due to the depressed economic environment, most new projects would be on hold until a recovery begins. This assumption is unwarranted for two main reasons. First, the type of projects undertaken has changed: large-scale projects are out of favor. Today, most new IT projects have a short time horizon and must provide a positive ROI in a short timeframe (a maximum of two years). Numerous IT projects are related to operating cost reduction, such as consolidating various IT platforms, or automating administrative tasks, among others. Second, European banks see the need to reduce their maintenance spending as a crucial issue because the related fixed costs negatively affect their valuations by financial analysts. As a result, IT budget decreases at European banks have been affected in terms of maintenance and new project budgets. This keeps the overall spending share on new projects high.

At universal banks, almost 40 percent of their IT budgets is dedicated to investment banking, despite the low results of this division at many European banks during the past three years. After that comes the retail banking division, with almost 34 percent of budget allocation, and last, the wholesale banking division came in with less than 28 percent. These findings make sense as investment banking divisions have always been significant consumers of IT. A quick look at any trading floor makes this observation self-explanatory.

When looking at a bank’s IT spending vertically, the largest line item on European banks’ IT budgets still remains human resources. In fact, 57 percent (41 percent internal staff and 16 percent consultants) of the IT budget is dedicated to human resources, followed by hardware (17 percent) and software licensing and support (16 percent). Due to the industry’s high level of network operations, connectivity and bandwidth now represent a sizable 5 percent in an average bank’s budget.

Spending on new projects is different from the overall IT budget. The importance of human resources is still critical in new projects investment but the role of consultants is much more important than the IT budget as a whole. One quarter of the budget is spent on consultants for new projects compared to 16 percent of the overall IT spending. Logically, investments dedicated to internal staff are lower for new projects. Also, we see that over 20 percent of new IT project spending is allocated to software (compared to 12 percent in the overall budget). This is a reflection of the fact that new IT projects in European banks tend to use fewer internal staff members and less in-house-developed software and instead rely more heavily on consultants and external software. This can be explained by the need for shorter "time to market" development, ROI and the rapid change of technology standards.

Although European banks have focused, and continue to focus, on cost reduction for obvious reasons, the ways they address this issue with IT are harder to ascertain. However, our research has shown that European banks pursue strategies of centralizing IT operations, outsourcing, and using more packaged applications to achieve this goal.

In the European banking industry, there has been a trend toward greater consolidation in the past 10 years. This trend has resulted in large conglomerates with different IT standards and operating platforms. Because integration after a merger could take many years, and also because cost reduction was not so crucial before the economic downturn, banks were not very worried about IT synergies among different firms. Not so today. Most European banks have created centralized IT departments that are responsible for implementing one standard for each operation worldwide and also for maintaining one centralized IT operations center for each market. Geographic centralization should have a direct impact on maintenance costs, and also on overall IT spending because it mutualizes costs across different companies and business units, and eventually on IT human resources, which will be reduced as a result.

Banks also have begun to centralize their core competencies. For example, there is a major trend towards centralizing back-office operations for retail banking. For example, while more than 30 percent of European bank branches had their own back office in 1996, today less than 5 percent do. Such programs are aimed at reducing fixed costs, increasing income, preventing future inefficiencies, improving quality of services, and reducing operational risk.

The cost-cutting nature of outsourcing hasn’t escaped most European firms, which have explored the benefits of outsourcing hardware support as well as project development and operations. Today, as many hardware providers offer hardware outsourcing, banks are more seriously considering those services. We estimate that 6 percent of hardware in the European banking industry will be outsourced in 2004 along with 9 percent of human resources.

For IT staff at banks, it is very difficult to keep up with all the new technology standards and languages as they are created. Therefore, European banks are more likely to use pre-packaged solutions for their non-strategic deployments in order to reduce their times to market. In fact, 24 percent of new deployments at European banks in 2004 will use pre-packaged software, compared to 9 percent in 2000.

Our research indicates that the European banking industry will reduce its technology spending this year and that the trend might continue in subsequent years, as banks reduce their maintenance costs by implementing newer technologies, and by rationalizing their IT infrastructures. IT departments will focus on technology spending to reduce costs, replace legacy systems and improve customer service. To achieve these goals, banks will largely launch internal projects to address their specific issues.

The overall use of technology has clearly cooled down in European banks, as they are now in the process of generating efficiency gains from past investments. Most of the attention will continue to be focused on branch systems, centralized back offices, and improving CRM system efficiency, as well as multi-channel integration.

We expect banks to combine in-house development with third-party technologies and integrators. As a means of reducing costs and staying abreast of the latest technology, we expect the banking industry to rely more on external resources for new projects than it has in the past. Centralizing operations and outsourcing will allow for greater efficiency and reductions in maintenance costs.

Axel Pierron is an analyst with Boston-headquartered consultancy Celent Communications.