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Beyond the legacy

Beyond the legacy

Billions of dollars are being spent on the upgrade of banking software systems just so they can compete. But it may lay the groundwork for new, different services - and profits.

Billions of dollars are being spent on the upgrade of banking software systems just so they can compete. But it may lay the groundwork for new, different services - and profits. In London, customers walk into a bank for a home loan and emerge 20 minutes later knowing whether they can borrow money and exactly how much. In Hong Kong, the locals switch their mortgage between currencies to potentially reduce their debt by playing the currency market. In Australia, a nation that 20 years ago was at the cutting edge of technology in financial services, progress appears to have stalled.

In 1988, when Bob Hayward moved to Australia from Los Angeles, he was amazed to see people paying for petrol using Eftpos terminals and withdrawing cash at the same time. "Australia was one of the first countries in the world to have a national debit and credit card system," says Hayward, now director of KPMG's risk and IT advisory services.

Since then, other countries have streaked ahead in the technology stakes. "In general, technology has not been used as a means of driving innovation by Australian banks," Citibank investment research analyst Craig Williams says.

But change is in the wind. In May, Commonwealth Bank of Australia sent rivals National Australia Bank, Westpac Banking Corporation and, to a lesser extent, Australia and New Zealand Banking Group into a flap by announcing a $580 million upgrade of the software systems that handle its main business, including term and demand deposits, passbook accounts and home loans.

Financial analysts are more sanguine. "The fact is that all banking core systems are becoming rapidly obsolete," JPMorgan analyst Brian Johnson says. "Addressing legacy system issues is not isolated to CBA and we expect the other Australian major banks to invest similar amounts in the coming years as the level of available support for ageing systems diminishes."

Less than a fortnight later, NAB said it had earmarked up to $900 million to overhaul its banking systems.

CBA is claiming a competitive edge by getting out of the gates early. In an overt display of gamesmanship, the bank nominated German software giant SAP as its main supplier and contracted one of SAP's biggest

integration partners in Australia, Accenture, to assist in the transformation.

There are only four serious players in core banking software: SAP NetWeaver, Oracle i-flex, Infosys Finacle and Tata Consultancy Services Quartz. By getting in early, CBA has stitched up one of the more experienced - SAP has two core banking system upgrade projects under its belt with Postbank in Germany and Nationwide Building Society in the United Kingdom - and simultaneously narrowed its rivals' options (see "Allied forces prepare for upgrades", below right).

"We've locked up the winners for the time being to leverage that first-mover advantage," chief information officer Michael Harte says. He claims two years but others suggest first-mover advantage will wear off within six to 12 months.

Is any real market share at stake underneath all this posturing? "Absolutely," says Fujitsu Australia's managing consulting director, Martin North. Outdated systems are a central obstacle to offering advanced services and, in particular, real-time processing.

The ability to confirm an offer for a mortgage at the point of sale has substantially changed UK banking in the past five years. GMAC-RFC (a subsidiary of General Motors) is now the UK's 10th-largest mortgage lender from a position of nowhere 10 years ago, North says.

In Australia, he points to ING Direct with its high-yield, no-fees savings account as the best example of how newcomers can attack lucrative areas of the financial services market using a single highly attractive product to gain a foothold before expanding into superannuation, wealth management and mortgages. The big banks rushed to close the gap on ING Direct, but at what cost?

Cost and speed to market with new product offerings constitutes a fundamental part of CBA's business case. "The back-end systems we have date back to the 1960s," Harte says. "They are the single greatest impediment to making a step-change to delightful and convenient customer service."

Most retail banking customers remain unaware of the degree of manual intervention required to execute a simple straightforward transaction such as opening or closing a savings account. People may think they are applying for a home loan over the internet but in the background that loan application is printed off and re-entered by a bank employee into the bank's core software.

Launching a credit card with a new interest rate structure - like ANZ's Balance Visa, which rewards customers for every dollar they repay as opposed to what they spend - takes Australian banks between six and 12 months on average, North says. "Half of the inefficiency in the banking system today is a direct result of the clunky core computing systems and the manual work-arounds surrounding them that have built up over the years."

North believes modern systems could strip 40 per cent of the cost out of the mortgage business in Australia, which carries higher comparative exit fees than in both the United States and the UK (see graph, above).

CBA is acutely aware of these potential savings and claims it will pass them onto customers. Executing real-time transactions at the branch teller and back-end systems simultaneously without manual intervention will reduce middle-office costs. The bank says it will not slash staff as a result. Instead, it will redistribute staff to customer service roles.

Maintaining new technology systems should be materially cheaper than nursing old software. CBA has already ripped $20 million in costs out of its IT department over the past two years and is gunning for more.

Combined, CBA says, this will improve its cost-to-income ratio - the performance metric used most commonly among financial institutions - from 44 per cent to the "mid-30s" by 2011. It is all contingent on CBA's ability to execute. "On balance, there's some scepticism by financial markets as to the benefits accruing from these sorts of [large-scale technology] projects," Williams says.

Celebrated failures in the field include NAB's integrated system implementation, written off to the tune of $200 million in 2004, and Westpac's $125 million CS90 project, scrapped in the early 1990s.

Williams is not convinced that investors perceive IT capability as a key point of differentiation between banks, partly because it is so hard to measure. "Even once these systems are put in place it's difficult for us as general observers to measure if they're being utilised well."

He says the market will scrutinise how skilfully CBA handles the disruption to customers as an indicator of the project's success or failure - as well as any movement in customer satisfaction ratios (an area where CBA lags).

North says shareholders should look to see how quickly CBA can recover from the 10 to 15 per cent productivity slump that typically coincides with a project of this scale. As for revolutionary new services, most experts agree that just because banks are capable of delivering them does not mean they will.

Retail banking customers are largely ignorant of the services they are missing out on. As a result, demand for better services exhibits itself as frustration with the current restrictions.

Alliances join forces for upgrades

With only four main companies in core banking software and a worldwide shortage of people who have executed core banking system upgrades, alliances are forming rapidly.

Commonwealth Bank has contracted German software giant SAP and information technology consultancy Accenture for its $580 million, four-year core banking system overhaul. National Australia Bank is said to be putting the ruler over Oracle's i-flex software. Westpac Banking Corp has appointed technology consultancies Booz Allen Hamilton and McKinsey & Co to review its operational systems and core IT systems. Planning its core banking modernisation will become more complicated if it merges with St George. Australia and New Zealand Banking Group is implementing Infosys' Finacle core banking software across its Asia operations over the next three years, and it appears that it will do the same in its domestic operations.

Fairfax Business Media

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