|THE FUTURE OF BANKING—PART 1 It hinges on ‘intelligent’ use of technology|
How are industry professionals reducing the cost and time of product delivery using emerging technologies? Tech Topics moderated a panel of experts who provided sharp insights into the challenges facing banks and how they are responding. In part one of a two-part series, responses to regulatory pressures, the use of cloud computing, and mobile technology developments figure prominently in the industry’s future.
Panelists include Kevin Petrasic, partner, Global Banking Practice, Paul Hastings LLP; Graham Hill, senior vice-president, Cloud Infrastructure, Citi Group; Bradley Schaufenbuel, director of information security, Midland States Bank, Effingham, Ill.; and Lawrence Kaplan, banking regulatory and payments attorney, Paul Hastings LLP. The roundtable was organized under the auspices of ClearPath Analysis.
Tech Topics: How are banks coping with the crush of new regulation at a time when they are seeking to cut costs while maintaining profitability?
Graham Hill: Banks have always been implementing efficiency improvements within a regulated environment, so it is not something unfamiliar to us. We are certainly focused on increasing agility and lowering the cost of operations, and quickly implementing state-of-the-art technology, which is a key part of that. One of the biggest technology changes right now is the move toward cloud computing. In this case, we are tasked with engineering solutions that give us the competitive efficiencies of cloud, while maintaining regulatory compliance and customer security. We found that by consolidating into state-of-the-art data centers and creating a private cloud infrastructure, we are able to reduce the time to market for new systems from 45 days to less than one hour. [We are] operating them at a lower cost than external providers and [are] still fully maintain[ing] compliance.
Kevin Petrasic: I agree that the industry is now turning towards cloud computing as well as other improvements in IT [information technology]. This is very significant with our clients, but also raises the risk profile. For example, in accessing the cloud, there are significant data privacy and security issues that all institutions need to consider. The European Union privacy directive is much more stringent than what is applicable in the United States. There are other IT risk issues that institutions need to grapple with. Among the big issues, from a regulatory perspective, are continuing concerns regarding the use of technology and the regulatory risks and related costs that are imposed. Risk management is all encompassing, and the regulators expect institutions to model their programs accordingly. There is a tremendous focus on issues such as to what extent does the use of new IT expose institutions to additional risks?
Lawrence Kaplan: The new regulations and how banks cope with the crush of new regulations requires incredible planning. What we have been seeing and advising clients is that there is a host of new rules, requirements, and guidelines from regulators. Each of these requires incredible lead time prior to the rules’ effective date and when new products are launched. From the first day a new product is planned, banks and technology companies need to focus on putting in place compliance regimes, and they need to understand a host of requirements governing data privacy and data sharing, and how all these rules apply to a new product. The expense is incredible with these new regulations.
Moreover, in the United States, we also have a new agency dealing with banks over $10 billion: the Consumer Financial Protection Bureau. This puts significant new regulatory and financial pressure on financial institutions. Many institutions cope with these pressures through investments in automation as well as outsourcing. However, outsourcing requires intensive oversight. As we saw with the mortgage servicing crisis, outsourcing can create significant regulatory problems. As the Comptroller of the Currency recently warned, banks’ operational risk is where regulators will be focusing. In response, we have been advising our clients that for any new product or initiative launch, compliance, auditing, and managing any operational risk checks are critical.
Bradley Schaunfenbuel: Midland States Bank actually views the crush of new regulation as an opportunity for it to gain a competitive advantage over its rivals, rather than as a threat. We are making strategic investments in our regulatory compliance function, designed to both improve our ability to assess the impact of new regulations and embed compliance functions into business processes in a cost-effective and efficient manner … As the efficiency ratios of institutions—which fail to build out robust regulatory compliance functions—are falling, ours remain steady or improve over time. In fact, we were recently named the 22nd most efficient bank in the United States by Bank Director. Higher efficiency results in greater competitiveness, and so we are seeing returns from our investments in regulatory compliance, in the form of increasing market share.
TT: There is a lot of talk about using analytics to bore down to the customer in order to improve the profitability of and the services provided to customers. What is your feeling on the use of analytics to cope with all of these pressures?
Hill: The financial industry has always regarded analytics as vitally important. As computing power increases and algorithms improve, the capabilities we have for data analysis increase even further. However, our businesses tell us that profit opportunity timeframes are shrinking—and that makes time to implement new models or analytic technique, the most critical issue.
Schaufenbuel: Banks are notorious for sitting on gold mines of data that could provide them with valuable insights into their customers’ needs. This data could enable them to provide better customer service and improve the profitability of their relationships with customers, but they are doing absolutely nothing with it. At Midland States Bank, we are making strategic investments in data analytics and business intelligence software in an effort to turn all our customer data into actionable information. Although the investment required to extract data from several disparate banking systems and transform it into actionable intelligence is substantial, the resulting improvements in cross-sales and customer satisfaction can generate significant return on these investments.
TT: What are the current tactics and stringent measures that banks are using to raise their profits in uncertain times?
Petrasic: The bottom line is improving efficiency, and this is the subtext of emerging technologies. This is where institutions are able to differentiate their niche from their competitors’ business operations. The strongest are able to position themselves competitively in both the immediate future and for future growth. In a difficult interest-rate environment, institutions that approach this from a long-view perspective will end up being the strongest competitors. While economizing is certainly very important right now, the banks that see and seize opportunities to implement emerging technologies in a cost-effective manner will be the strongest competitors over the long run. Specifically, banks should be dedicating resources to studying consumer likes and dislikes; what is working for a competitor and why; what are the risks of new approaches; and what the existing regulatory constraints are. They should also explore how to partner and work with regulators to fashion and implement effective regulatory changes, including eliminating antiquated laws that have not kept up with the pace of technological innovations.
Kaplan: Banks need to invest in technology and in programs, especially in compliance systems in order to avoid risks. Unfortunately, you are only going to be as good as your worst competitor. For example, if one bank has a data breach, customers will question the security of all banks. Investment in quality technological solutions ensures that a bank’s customers are protected and the bank is in an advantageous position, if or when a competitor stubs its toe.
Schaufenbuel: Midland States Bank’s strategy for improving profitability rests on two key objectives: 1) increasing noninterest income sources, and 2) diversifying risk. To increase noninterest income, we are investing more resources into business lines such as wealth management (securities brokerage, retirement planning services, and trust administration) as well as adding new lines of business such as merchant services and credit card processing services. To diversify our risk, we are adding new types of loans to our portfolio, including private student loans and consumer loans.
TT: Are there current technology trends that will change the industry, such as mobile banking and data analytics?
Petrasic: At Paul Hastings, we have a robust payment systems practice and work with many different product offerings and IT solutions, which are being applied and adapted to traditional banking products. We expect this work to continue for many years to come. Until very recently, in the mobile banking context, the United States was far behind most countries, including many African nations. Over the past several years, we have seen a dramatic improvement in the United States in the focus and expansion of mobile payment solutions. This is just one of a number of areas in which technology trends are changing the way consumers access banking products and services, and how institutions are responding to consumer demands for change.
Hill: Cloud techniques are rapidly changing the software delivery model. A new software company today will almost certainly prefer to offer its product as a hosted service rather than installed in customers’ premises. This means that the IT decision-making process will shift from evaluation of how a product runs in your environment to how the product runs in their environment. It will have profound regulatory consequences.
Petrasic: There are a couple different models that are being implemented right now, and certainly large institutions like Citi are extremely aggressive in terms of utilizing IT and adapting quickly to provide clients with optimal solutions that address their banking needs. In the U.S market, the largest banks can make a significant impact, and we are certainly seeing this happen. At the same time, there are interesting developments in other sectors, both at smaller institutions and with new entrants to the banking space. This is a fascinating confluence of events shaping the banking world, and, in many respects, banking has become the new frontier for IT at the very same time as IT is rapidly becoming industry’s medium of “natural selection.” For example, in the United States, the largest banks have a very significant portion of the U.S banking population in terms of assets, and at the same time many smaller institutions are struggling to survive. Interestingly, one of the biggest challenges for all these institutions is how to spend their IT dollars. To a significant extent, the predominant and most cost-effective solutions for institutions of all sizes are third-party products that institutions take and tailor to their existing system and operations. The issue is particularly acute for smaller institutions that do not have the money to implement comprehensive solutions on their own to address emerging challenges involving issues such as the Bank Secrecy Act, anti-money laundering, and Office of Foreign Assets Control compliance. It is not just smaller banks that have the resource problem, today banks of all sizes rely significantly on developed frameworks from third-party vendors, which they then have to tailor to their specific programs.
Schaufenbuel: I believe that mobile technology will change the industry, at least in the retail banking arena. Products that are novel today (in the United States), such as mobile deposit capture, mobile banking apps, and mobile payments, will be pervasive in the near future. These technologies have the potential to change the entire consumer-banking business model by eliminating the need for brick and mortar branches and possibly even automated teller machines. The customer base of institutions that are slow to adopt these technologies will shrink as the next generation of consumers migrate to mobile-savvy competitors and assets shift away from their aging customer base.
Part 2, next week: More on mobile banking, and a frank evaluation of potential winners and losers in the years ahead.
To download the entire (free) ClearPath report, click here.
[This article was posted on July 10, 2012, on the website of ABA Banking Journal, www.ababj.com.]
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