With technological innovation moving too fast for many back offices, banks large and small have turned to outside companies to handle core processing functions.
But there has been a change in the conventional wisdom that community banks are more likely than large banks to hire a third party.
The 1996 American Banker technology survey, conducted by Payment Systems Inc. in Tampa, shows that increasingly, the nation's largest banks are outsourcing, or contracting for services.
More than two-thirds of this group - banks with assets in excess of $1.6 billion - have farmed out processing for systems such as demand deposit, item processing, consumer loans, cash management, and general ledger.
And it seems the bigger the bank, the more likely it is to contract out for services.
More than 72% of the top 100 banks have outsourced some core functions, according to the survey. Banks in the second and third 100- institution tiers outsourced 65% and 67% of the time, respectively.
In stark contrast, 38% of banks outside the top 300 category are doing so, according to the survey. Bankers are more likely to farm out essential functions than ancillary activities, it showed.
Fewer than half the respondents said their banks outsourced noncore functions such as mortgage and mutual fund processing, portfolio management, stock transfer, and trust.
Industry watchers said banks are turning to outside expertise not only for access to new technology, but also to help consolidate systems and cut costs.
During the late 1980s, many banks began turning to third parties to perform increasingly expensive core processing functions.
Even today, banks announcing outsourcing contracts often stress the cost savings they will achieve by avoiding hefty investments in new technology.
But Kirk Domingos, executive vice president at Hibernia Corp. in New Orleans, said his peers are starting to realize that saving money is just one reason to outsource.
"You're bringing in a group with a better set of skills than you have in-house, and you're using those people to enhance your business," he said. "I'm not in the business of data processing. I think it's pretty dumb not to outsource."
The survey indicates that banks between $1 billion and $3 billion in assets are the most likely to outsource core functions.
All of the 67 respondents in this group used a third party for deposit account processing and customer information files. And some 87% in this group farmed out consumer and commercial loan processing.
Fewer than half of the largest 100 banks outsource the same functions, according to the survey, and the smallest banks outsourced them about 30% of the time.
Many bankers contacted for this story said outsourcing gave them access to technology they otherwise could not afford."We were running on ancient systems," said John King, vice president for technology management at Provident Bank in Baltimore.
The $2.4 billion-asset bank uses M&I Data Services, a unit of Marshall & Ilsley Corp. in Milwaukee, as its service bureau.
"In our competitive market, we simply didn't have the luxury of buying new systems. M&I runs on the industry standard," Mr. King said.
Outsourcing also has become a tool to help banks with consolidations.
Industry observers said systems integration is the driving force behind many of the largest banks' outsourcing pacts.
"It helps you get all operations onto a common platform and accommodate the jumps in volumes that happen during an acquisition," said Lawrence A. Willis, consultant at First Manhattan Consulting Group in New York. "That can significantly accelerate the pace of consolidation."
For years, Hibernia has been considered an outsourcing pioneer among banks. It signed its first significant outsourcing contract in 1989 with International Business Machines Corp.
The data processing agreement was made with an eye on cutting $25 million from the bank's operations budget over 10 years.
About the same time, executives at the bank were struggling to find ways to cut costs and upgrade computer platforms and systems, sources close to the agreement said.
In the early 1990s, Hibernia suffered severe losses on commercial loans that went sour, but the outsourcing arrangement with IBM allowed the bank to achieve some savings, Mr. Domingos said.
In 1991, hoping to nearly double expected cost savings to $40 million by 2000, Hibernia canceled its contract with IBM in favor of an agreement with Systematics Inc. of Little Rock.
Now known as Alltel Information Systems Inc., that company has helped Hibernia grow from $4 billion of assets in 1992 to its current $7.1 billion by allowing the bank to absorb increasing volumes without adding costs, Mr. Domingos said.
"They could upgrade the processing power as we grew and added capacity," he said.
Executives at $6.1 billion-asset OnBancorp in Syracuse tell a similar tale. An Alltel customer since 1993, OnBank has grown over the last two years by swallowing up $3 billion of assets from Columbia Savings Bank in Rochester and branches acquired from Midlantic Corp.
OnBank's facilities management contract - under which Alltel processes checks, deposit accounts, and loans at a bank-owned data center - has cut 20% of the $7 million the bank had been spending on operations, said Howard Sharp, executive vice president.
More important, Mr. Sharp said, is that outsourcing has let OnBank absorb higher transaction volumes and still cut costs. The outsourcing arrangement has allowed the bank to focus on growth without the distraction of maintaining a specialized technical staff, he said.
"It's easier to put together a task force to integrate systems by relying on outsourcers than it is to rely on them in-house," said Mr. Sharp. "You don't have to staff up with the talent, and you can bring them in on an as-needed basis."
Executives at $650 million-asset Matewan Bancshares in Williamson, W.Va., signed a contract with Electronic Data Systems Corp. of Plano, Texas, in 1995 in part because the bank's rural customer base made it difficult to attract technological talent.
"It was a tremendous challenge for us," said Timothy Edwards, chief operations officer at Matewan. "Our choice was diverting our attention to our growth plan by setting up an in-house technical staff and keeping them up-to-date or outsourcing and devoting greater energy to growth."
As with larger banks, Matewan has been able to increase its assets through acquisitions. The consolidation of some Ohio branches it bought from Banc One Corp. was done much more cheaply and quickly through a service bureau of Electronic Data Systems, which is based in Plano, Tex.
"We were able to turn a nine-month acquisition into a three-month acquisition," said Mr. Edwards.
Although systems consolidation is helping the outsourcing industry flourish, observers said it will become more specialized.
The survey, which showed that fewer than half of banks now outsource noncore functions, also indicates that cost-cutting will drive more of these functions from back offices to outside firms.
"Outsourcing as a matter of survival has diminished," said William Bradway, a consultant at Tower Group in Wellesley, Mass. "Banks are increasingly looking at individual functions and reviewing their options. They will pick and choose the lowest cost option, which often will mean turning to an outside expert."
Mr. Domingos at Hibernia agreed: "You have to consider where you want your business to go and look at alternatives for getting there. I think people are doing what makes sense."
