How should the chief executive of a community bank analyze and justify technology spending? This question has become more pressing in recent years.

Technology expenditures are increasing at three times the rate of inflation, and in many banks represent the largest noninterest expense after human resources. Boards of directors are asking more questions about technology, wanting to know what investments are being made and why.

However, even with the growth in technology spending and the visibility technology has in most banks today, defining, tracking, and understanding total technology spending is very difficult in most community banks across the country.

There are many reasons, of course, but here are some of the main ones:

*There is no uniform definition of "technology spending."

Almost any two banks could agree on what constitutes personnel expenses, but you would not find the same concurrence with technology spending. A good example of this is an end-user who is devoting half of his or her time to systems support. Some banks assign this time as a technology cost; some do not.

*Technology expenditures are not adequately itemized.

Most banks do not have a detailed general ledger tracking system for technology spending as they do for other expense categories. Often, it is recorded under general categories such as "hardware," "software," and "furniture and equipment expense."

*Expense tracking and accountability is unclear.

One of the things that helps analysis of expenses is when a single department is accountable for almost all expenditures, and uses some kind of system for tracking and reporting. Human Resources is an example of this. No such luck with technology. Many line managers approve and pay their own technology expenses, and often no one in the bank has a mandate to track overall spending.

So analyzing technology spending takes some work. At the same time, community bank executives need a way to get better at understanding what is being spent and justifying investments. We believe that the first step in accomplishing this is to define expense categories that make sense for a community bank manager. These categories should be understandable from a banking perspective and should allow a look at total spending. Here are five categories into which we suggest community banks divide technology spending:

*Core systems cost - this is the cost to run the core deposit, loan, general ledger, and customer information file systems. It is either the hardware, software, and human resource costs associated with an in-house system or the service bureau bill.

This is a necessary investment for any bank. Increasingly, core processing services are becoming commodity priced as systems become more efficient and banks seek to use savings from reduced core costs to fund other technology initiatives.

*Telecommunications - this is the cost of data lines for your branches and automated teller machines. It is usually a part of the telephone bill or a section of your service bureau bill. Integration of voice and data lines promises future efficiency and savings, and banks should factor telecommunications upgrades into their planning.

*Infrastructure - this is the depreciation cost of the hardware, software, and operating systems needed to run bank applications. It includes file servers, PCs, printers, wiring, communications hardware, and operating systems such as Windows and Novell.

In the past, these investments were often made as part of another decision. For example, branch equipment was often purchased because it ran the branch platform and teller software selected by the bank. In the future, infrastructure must be viewed as a required, ongoing strategic investment, not as a part of a particular business initiative. PCs and local area networks support a variety of functions for an employee - such as branch automation, word processing, loan application tracking, E-mail, and Internet access. The investment must be planned and made to support the total needs of an employee.

*Local strategic applications - this category includes systems and programs needed by a particular business unit, often PC-based. Examples of these systems are branch automation, mortgage loan origination, asset/liability management, optical report storage, and credit scoring software.

Unlike with core systems, the need for the program is dictated by the strategic goals of the business unit. Branch sales and tracking software is necessary only if the bank has decided that branches will be true sales centers. A laptop loan origination system is necessary only if remote loan origination is a strategic step necessitated by the market and business plans of the bank. Each bank must make such decisions independently and based on their goals.

These initiatives should be justified through a combination of reduced costs and increased revenues. Business line managers must take accountability for the justification.

*Electronic delivery systems - this category encompasses all systems that allow customers to bank electronically. It includes automated teller machines, eletronic funds transfer, debit cards, cash management systems for small businesses, voice response units, home banking, and Internet banking.

Electronic delivery is the most visible part of banking to both customers and investors today. Mature electronic delivery vehicles (ATMs, funds transfer, voice-response) are not only necessary parts of a bank's service, but can also be justified through viable business cases. Newer electronic delivery vehicles (home banking, Internet banking) need to be treated at this point as research and development investments, but most banks will have to make at least some investment in these technologies.

Each of these spending categories has a different degree of necessity, depending on the bank's business strategy. Spending in each can be controlled to different degrees in different ways. Each requires a different approach to cost justification.

Before any of this can happen, however, banks must better understand what they are spending and why. If you have not begun this process, you should.

Mr. Roche is managing director of systems & operations at M One Inc., a Phoenix-based consulting firm. This is the second in a continuing series of articles on the technology of community banking.

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