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Challenged by Regulation: The Changing IT-Sourcing Landscape of Nordic BankingAt a time when banking IT systems are plagued by stricter regulations and cost pressures, the entry of global software vendors in the Nordic market is set to reform current practices and ameliorate crucial challenges in the region.
Executive SummaryThe Nordic banking market has remained largely unchanged since the last Nordic financial crisis in the late 1980s. In the coming decade, we are likely to see major changes to the IT-sourcing landscape of this market. In particular, three factors will affect the way the banks manage their IT:
• Their local Nordic IT service providers will pro-gressively struggle to deliver cost-efficient solutions.
• Stricter regulations will force banks to cut IT-related costs to meet tight capital require-ments, even as the challenges of implementing other regulations will continue to escalate IT projects and costs.
• Emerging technologies, paired with increas-ingly tech-savvy clients, will place stress on innovation, marketing new solutions and supporting new devices and channels.
These drivers will spur the entry of global software and IT service providers and the emergence of new service models, including platform as a service (PaaS) and also potentially banking as a service (BaaS) models. Nordic banks have tradi-tionally been conservative in their choice of IT
service providers, but they now see strong incen-tives to reassess their risk-benefit analysis and consider new solutions when they build strategic sourcing partnerships for the future.
Embracing Emerging IT Solutions There appears to be a globally rising trend among banks’ IT departments to move from old homegrown legacy systems to package software systems in core banking and other IT systems. Drivers for these changes are the increasing number of new regulations, cost pressures and the need to remain competitive in a market where margins are shrinking. The rate of migration and renewal projects (starting and ongoing) vary across regions and banks of different size categories.
Despite the fact that European banks are dealing with the repercussions of the 2008-2009 financial crisis, or maybe simply because of it, there has been a perceptible shift from tradition-al legacy IT solutions to newer platforms. Some examples are Frankfurter Bankgesellschaft, Nord- deutsche Landesbank Luxembourg S.A, Roth-schild Bank AG, Amsterdam Trade, Société Générale, Barclays, Danske Bank, European Credit Management Limited (ECM) and BNP Paribas Securities Services.
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Local Nordic IT Service Providers Under FireThe weaknesses of Nordic banks’ IT solutions have lately been exposed on several occasions. In particular in the Norwegian market, where IT service providers have been criticized for serious Internet banking issues. Furthermore, local IT service providers dominating the market keep losing their general competitiveness as large global IT service providers continue to enter the market, using well-established offshore models that offer higher quality at a lower cost.
As a result, higher capitalization requirements and increased competition are escalating the cost and pressure on banks to improve their sales effectiveness. In essence, banks are being asked to provide more services with existing or fewer resources. This requires more process support from the banking IT systems — particularly the front office — to enable more automation, self-service, omni-channel support and increased one-to-one targeted campaigns and offers. All this needs to be in place while IT spending diminishes.
The cost/quality pressure opens the market to new providers of software as well as IT and BPO services. Providers such as FIS, Misys and Temenos can leverage global business models by offering economies of scale, international part-nerships that provide skills and access to offshore centers that enable very competitive pricing. Software vendors (or the banks themselves) will be able to opt for innovative delivery models like banking as a service (BaaS) through partnering with IT-outsourcing service providers. These new models, if accepted by the market, may prove to be very competitive.
Smaller Banks Seek Alternative Delivery ModelsThe change is harshest for smaller banks. These banks are likely to look for new solutions and new IT service providers. The smaller Nordic banks often utilize a PaaS model with local vendors that provide application maintenance and develop-
ment on their old legacy systems. These systems are largely outdated, expensive and inflexible, with significant limitations on scalability; further, they are architecturally challenged to adapt to modern omni-channel banking. The result is a rigid, slow IT development process for the banks. Smaller banks will also find it increasingly difficult to absorb the high capital expenditures related to their current IT service contracts and license agreements.
Larger banks, on the other hand, have more ample capital cushions to absorb such costs. They also keep more IT in house, as their very size justifies their own application maintenance and development centers. Larger banks have also, to a larger extent, outsourced and/or offshored their IT application/infrastructure to well-established service providers. But this does not mean that they could not further improve their cost/quality ratio by giving IT sourcing an extra impetus. For them, the changes are likely to be less dramatic even if they continue with their existing models and opt only to leverage some of the benefits of the evolving IT service ecosystem.
Tighter Regulations Drive Cost FocusOn the regulatory front, too, the banks feel the pinch. A number of new regulations aiming to enforce higher capital requirements are being implemented. The most important international ones are BASEL III (global) and Capital Require-ments Directive IV (CRD IV) within the EU/EEC. A key principle of these regulations is cross-border harmonization. Still, the relative success of the Nordic countries in withstanding the current financial crisis may lead to even stricter requirements under the assumption that banks which operate in growing or stable markets can better adhere to such regulations. On top of the increased capital requirements, a number of other regulations are currently being implement-ed. These will also be costly for the banks as they require changes in systems and processes.
Tighter regulatory requirements drive cost focus in three dimensions:
• Regulation goes across the IT and process stack. Regulatory changes need to be reflected in IT security, data availability and consolidation, reporting, business processes, product offering and product specifications. These changes are often costly to implement. The costs are especially high for Nordic banks with a high degree of rigid legacy IT systems,
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Regulatory changes need to be reflected in IT security, data
availability and consolidation, reporting, business processes,
product offering and product specifications.
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but the numerous restrictions in organization and process (strict labor laws, limited access to skills, etc.) are impacting all banks.
• Noncompliance impacts the bottom line. The costs of noncompliance with new regula-tions can be extremely high. So far, Nordic banks have generally managed to steer clear of the fines that other global banks — such as Standard Chartered, RBS, UBS and several other major banks — have received for their inability to comply with the regulations.
• Compliance demands reduced expenditure. Increasing capital requirements is a regulation by itself — and higher degrees of capital in a competitive market will be hard to achieve without reduced capital expenditure.
There is a long list of upcoming regulatory and compliance-related changes that will impact the banking IT system, and we anticipate it to grow further. Some of the biggest ongoing projects are Single Euro Payment Area (SEPA), FINREP reporting standard changes, Basel III, PCI DSS (data security standard for improved card holder protection), Foreign Account Tax Compliance Act (FATCA), European Market Infrastructure Regu-lation (EMIR), Markets in Financial Instruments Regulation (MiFIR) and Markets in Financial Instruments Directive (MiFID II).
To efficiently keep costs down while ensuring compliance, Nordic banks need to partner with organizations that have the necessary knowledge of the applicable regulations, the tools to enable compliance and, highly important, the ability to implement the changes to the processes in a cost-efficient manner. This will be very difficult to do without the economies of scale and skills base that only large global players have access to.
An increased focus on costs is also likely to intensify banks’ efforts to attract and retain the “right” customers in order to squeeze better margins out of their customer base. Hence, demands for data availability, data consolida-tion and reporting are not only a compliance and KYC concern, but also a major driver for strategy, client segmentation, 360° view of the customer, targeted marketing and other CRM improve-ments. In turn, this drives the need for seamless integration and standardization of information technology across functions and increases the pressure to phase out fragmented legacy envi-ronments.
Another aspect of the regulations currently being implemented that favors the global software and service providers is the fact that the regulations, in addition to being complex, are increasingly harmonized on a global and/or pan-European scale. Only a large global organization is able to benefit from distributing the workload across regions and offering solutions to a large number of customers, each absorbing a share of the costs of compliance with the necessary changes. The smaller local players will be at a disadvantage as the costs of maintaining skills and understand-ing of each regulation — as well as the effort in updating software and IT — can be absorbed by only a handful of customers. Previously, these small local players benefitted from their expertise in specific local regulations that often escaped the larger players’ focus, but this strength is now quickly eroding.
As with other cost/quality challenges, the regula-tions are likely to hit smaller banks the hardest, as they do not have the size and capital to absorb the necessary IT system changes using their current models. To stay in the race, they need to choose new IT service delivery models that enable a shift from capital expenditure to operational expenditure.
Customers Drive the Innovation AgendaNordic banks embracing new technologies and a new generation of tech-savvy customers are being hit with alternate tides of benefits and threats. The ones that manage to utilize these technologies and meet the ever-changing needs and expectations of customers will be able to offer new and better-tailored products and, consequently, expand their customer base. To succeed, however, banks will need to pursue the right strategies, identify the right trends, build the right image and make a leap in the market while continuously innovating solutions for the next generation of changes. Those that fail in
As with other cost/quality challenges, the regulations are likely to hit smaller banks the hardest, as they do not have the size and capital to absorb the necessary IT system changes using their current models.
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this will find their market share dwindling and will be scooped up by winning rivals as well as emerging nontraditional banking players armed with superior products and nimble operations. To stay afloat, banks will need to rely on IT service providers and technology solutions that provide the agility and time-to-market (TTM) that enables them to swiftly reply to changing customer demands. Companies basking in complacency might find their profits weighed down by costly and outdated IT service providers.
Customer needs will impact banks in several ways:
• Seamless omni-channel banking: Customers expect that they will receive the same level of service independent of which channel they use. Furthermore, they expect that they can start a process with a bank through one channel and complete it through a different channel. In order to satisfy this need, banks need to have fully integrated and efficient IT enabling information that is seamlessly shared across channels, processes and solutions.
• Complete relationship overview: Customers expect their banks to have a complete overview of the relationship they have with the bank, including current services and their history of both product use and communica-tion concerning solutions and offerings. This requires a complete log of customer interac-tion independent of which channel is and has been used.
• Increased service-level expectations: Cus-tomer experiences spur big changes. Banks’ performance and service levels now depend on the experience customers have with other nonbank services. When using a tablet appli-cation from a bank, the user will compare the
user-friendliness and functionality of the appli-cation not just with the applications of other banks, but with services across industries: online retailers, utility providers, local cinemas, etc. Creativity and enhanced service provided by any industry will raise the bar of expecta-tions for banking customers.
• Ability to provide customized offers and products: To retain customer loyalty and offer fast-paced customized services, banks need to pass disparate customer data through a sieve of strong analytics. The resulting customer information needs to be available across all channels so decisions can be made and actions taken based on it. Also, the decisions need to be made according to the same principles and information independent of who makes it and through which channel. This requires highly sophisticated capabilities for analyzing customer data and transactions, which thereby enables feeding actionable insight into the operative processes across channels.
The Solution: Global Software and IT Service ProvidersIn order to face the challenges we have described, Nordic banks will be forced to reinvent their business models and, as a key component, their IT-sourcing models. The formula for survival will be to form partnerships with software and IT service providers that can offer the right quality of service and skills at a competitive price level.
Forming such partnerships will foment a robust business model and a stronger focus on core activities. Typically, the partnerships are flexible enough to consider individual bank’s preferenc-es with regard to risk appetite, control and fee model.
The key advantages of forming closer partner-ships with the software and IT service providers, potentially establishing such PaaS models, are:
• Operational and IT cost reduction as well as reduced compliance costs.
• Increased agility and improved cost/price ratio through transaction-based pricing models.
• Quicker TTM through access to large vendors’ innovation capabilities, availability of required skills and scalability of resources.
Large global IT service providers already score significantly higher than smaller local players on client satisfaction , and they have the ability to provide a cost/quality ratio that is difficult for
When using a tablet application from a bank, the user will
compare the user-friendliness and functionality of the application
not just with the applications of other banks, but with services
across industries: online retailers, utility providers, local cinemas,
etc. Creativity and enhanced service provided by any industry will raise the bar of expectations
for banking customers.
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To support the bank’s strategic intent and aspirations, its IT department needs to carefully evaluate the available software options against the bank’s business needs and TCO of each option.
smaller players to match.1 Global players also benefit from the international harmonization that is increasingly reflected in banking regulations. With determination and the right partnering, they can build stronger delivery models that provide superior benefits to their clients and enable them to capture significant market share. PaaS model variants already exist in places like Finland where Samlink provides this service — though based on an aging legacy system. Both software and service providers seem ready for this change and they are increasingly partnering to deliver PaaS implementations and services of core banking solutions. The question is whether the previously risk-averse Nordic banks are willing to replace their long-standing local IT service providers with new global players. With the potential benefits outweighing costs and risks, Nordic banks should see this as a palatable option. Those that hesitate for too long, however, risk being left behind in a market with a rapidly changing landscape.
Investigate the Banking as a Service ModelWhile larger banks might make the shift from tra-ditional local IT service providers to larger global ones, smaller banks are likely to go even further and consider completely new service models such as the banking as a service (BaaS) format.
A BaaS model that enables a bank to shift away from current capital-expenditure-intensive solu-tions will incur numerous benefits:
• Old legacy platforms can give way to sophisti-cated software that is developed and serviced by a large software provider.
• TTM will radically shrink in making changes in business models or responding to new customer needs, because new services and product offerings will be quicker to launch with modern solutions.
• Furthermore, fees can be paid — for example — in a form of transactional costs or in some form of pay-as-you-go licensing, limiting the capital expenditure and providing agility by tying costs to revenue, operations and transac-tion volumes.
• Finally, tighter relationships with global software and service providers offer even small banks a network of knowledge and competency that they otherwise would struggle to obtain.
Current local IT service providers offering the more traditional PaaS solutions are facing sig-
nificant challenges in reinventing themselves to meet the BaaS model requirements and compe-tition created by the newcomers to the Nordic IT market. Traditional local IT vendors need to champion investments in innovation. Realistically, this can be done only by replacing the current legacy system with a global packaged banking product. But this generates several complications for the vendors. To mention just a few:
• The sheer renewal project size is easily beyond vendors’ capabilities, skills and financial resources.
• Their financial model will change, because in the new model a large portion of the customer revenue will flow through as product licenses to a third-party software vendor.
• Working as a systems integrator of a global packaged software product (as opposed to being a software developer of a custom solution) is a specific competence, and the systems integrator needs to constantly add value both for its customer and its software vendor partner, or risk becoming obsolete.
The Challenges AheadBanks need to consider whether the chosen software product solution(s) can evolve in accor-dance with requirements such as functionalities, competencies and continued compliance with changing regulations.
In order to support the bank’s strategic intent and aspirations, its IT department needs to carefully evaluate the available software options against the bank’s business needs and TCO of each option. Most of the leading banking software providers offer products that are at least “good enough” to meet typical banking requirements. But that may not be enough to get a competitive or cost advantage over local competitors. In addition, the fit with the existing application architecture and the rest of the infrastructure needs to be validated.
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The Nordic banking market is a small market. Any local customizations, however minor, are done on an as-needed basis, usually initiated by a systems integrator working for a particular customer and further built upon by the software product company. It is thus important for the bank to verify that its global vendors partner with local vendors or establish enough local presence to create the localized version complying with the local regulations.
In general, banks should review the strategic and cultural fit with the software and IT service partner candidates. Projects related to renewing or migrating banking systems are typically long and somewhat risky. There is no need to further complicate project management due to a mismatch in values or in ways of working. Banks’ IT departments have a good opportunity to evaluate the cooperation and fit with the software and partner candidates during the RFI and RFP processes.
Another risk to consider is the need for data con-version from the legacy systems. For example, conversion testing and integration can make migration to a new platform exceedingly compli-cated, due to the nature of disintegrated legacy systems, their inherent data structure and the quality of the data accumulated over the years. All these make extracting nuggets of coherent data complex. New (packaged software) platforms generally have stricter business rules than the legacy systems did. For example, packaged systems may require fixed collateral for a loan, whereas older systems might have loan and col-lateral data distributed across separate systems with weak or no data links between them. These kinds of conflicts in the business rules are likely to significantly complicate the automated export of data during migration to a new platform. Fixing misalignment between business rules in old and new systems will require a significant amount of
manual effort in restructuring and cleaning the data sets. But the migration needs to be done in a fairly short time window — typically overnight. This makes time-consuming manual labor an unfeasible option.
Banks, therefore, need to lean on the best practices and data conversion tools that their vendors can provide. They can adopt tools like automated data extraction and data cleansing or running the old system and the new system in parallel for a period of time. The preparations for the data conversion need to be started as early as possible, since it is likely to form the critical path in the migration project given the careful planning, control and testing it requires.
The Bottom LineNordic banks, especially smaller banks, are facing increasing cost pressure due to:
• Increased regulations of the financial industry.
• Changing customer expectations.
These pressures require the banks to rethink their IT cost structure and sourcing strategies. Banks’ current IT departments and/or local IT service providers with their legacy platforms are strug-gling to even meet regulatory requirements and hardly have sufficient means to tackle the chal-lenges created by customer expectations.
At the same time, global banking software vendors and IT service providers are entering the Nordic banking IT market with increasing determi-nation. Their entry has been made easier by the consolidation driven by pan-European and global financial regulations. The previously high market entry criteria created by the purely local practices and regulations are quickly becoming obsolete. Competitive advantages created by large scale and access to global sourcing models that we see in other industries’ IT markets are also becoming activated in the banking IT market.
In order to remain compliant, competitive and relevant for customers and owners, banks need to investigate new software and IT service partner options as well as new service models for sourcing their banking IT platforms. Depending on the banks’ market strategies, availability of capital, appetite for risk and lifecycle phase of the current IT platforms, bank CIOs need to examine a wider range of options for sourcing their future IT solutions.
Conversion testing and integration can make migration to a new
platform exceedingly complicated, due to the nature of disintegrated
legacy systems, their inherent data structure and the quality of the
data accumulated over the years.
About CognizantCognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process out-sourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquartered in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industry and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 50 delivery centers worldwide and approximately 171,400 employees as of December 31, 2013, Cognizant is a member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top performing and fastest growing companies in the world. Visit us online at www.cognizant.com or follow us on Twitter: Cognizant.
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About the AuthorsIlkka Schulman is a Director within Cognizant Business Consulting and leads the Strategic Services in the Nordics. He can be reached at [email protected].
Sari Inkilä is a Senior Manager – Strategic Services within Cognizant Business Consulting. She can be reached at [email protected].
Erik Tjønneland is a Senior Consultant – Strategic Services within Cognizant Business Consulting. He can be reached at [email protected].
Footnote1 KPMG’s annual “Nordic Service Providers Performance Report” places the traditional providers of IT
services to the Nordic banks at the bottom of the customer satisfaction rankings. Meanwhile, the top rankings are dominated by large global service providers.
