A fundamental challenge facing small banks today is navigating through the increasingly complex world of data processing.

While some major vendors of outsourcing services promote a broad array of options, the market is rapidly being dominated by a few major players with rising shares of the pie. And many community banks feel they are being overlooked as larger outsourcers increasingly look to national and even international banks.

While regional banks frequently turn to outsourcing to achieve cost savings in specific areas, community banks traditionally have used it as a matter of necessity. Dramatic economies of processing scale, after all, favor their large competitors.

But now some community institutions are questioning whether taking core data processing out of the bank has turned into a Faustian bargain: pleasant in the short run but damning in the long run.

"You lose a lot of control once you outsource and become just part of a group," said Robert W. Moyer, chief executive officer of Wilber National Bank, a $500 million-asset institution in Oneonta, N.Y.

"You have to have a lot of confidence in where they are going," said Mr. Moyer, whose upstate New York bank writes its own software to run on the computers that govern the bank's core functions.

But while Wilber National has an unusual level of technical sophistication for a community bank (it began offering Web-based transactions long before many major banks), its attempt to ensure that it keeps a handle on its information is not rare.

An increasing number of community banks are exploring computer systems that let bank employees - rather than vendors - handle operations in-house. Though the software and its upgrades come from an outside company, bank employees operate it themselves.

"With a lot of the servicers these days, the bank captures," transmits, and prints the data "all within the bank," said Bahram Yusefzedah, chief executive officer of Phoenix International Limited, Maitland, Fla., which makes bank software based on the client-server model.

"The outsourcer is doing the data crunching, but the bank is doing all of the labor-intensive grunt work. You might as well take it all in- house," said Mr. Yusefzedah, whose software operates on personal computers rather than the more expensive mainframes.

Phoenix International's system has the added advantage of enabling simpler and easier upgrading, said Mr. Yusefzedah. And it puts control back at the bank's fingertips.

But while fewer than 100 U.S. banks use client-server software such as that designed by Phoenix International and others for core functions, the urge to obtain greater adaptability rests upon a desire among banks large and small to tap into the increasingly rapid pace of change in the industry.

The difficulty of maintaining technological knowledge that is current is important in a bank's selection of an outsourcer. If you can't afford to focus on changes in technology, industry officials agree, you shouldn't be in the business of transaction processing.

"Because of the demand for change, and because change comes with increasingly frequency, that cost becomes far more significant" than monthly per-piece processing fees, said George Dalton, president of Fiserv Inc., Brookfield, Wis., one of the largest vendors of outsourcing services.

"Organizations say, 'Perhaps we shouldn't be in the business' " of managing transactions, said Mr. Dalton, who exudes enthusiasm for taking that burden off the backs of community banks. "I live in the business and I love it. It's what I want to do when I grow up."

In spite of increasing vendor consolidation in recent years, many experts say the options available to small banks are better than ever.

"Today, it's a buyers' market for all that any bank has ever wanted in the technology arena," said M. Arthur Gillis, head of Computer Based Solutions in Dallas.

"Because the technology today is scalable," he said, "there is no excuse for a bank to whimper or complain in this arena. They just have to be alert and awake to achieve their objectives."

Less sanguine are the small banks that feel themselves to be lightly regarded faces in a crowd of customers at one of the dwindling band of giant outsourcing companies or which are being forced to abandon an elderly but comfortable processing solution.

In 1995, 14 vendors provided 93% of the core processing services for banks that outsourced, according to Computer Based Solutions. In 1987, 24 vendors had controlled 73% of the market.

To make matters worse for some banks, the old system of correspondent banking is fading fast. The ranks of banks that process for other banks has been steadily thinned. Norwest Corp., Citicorp, Mellon Bank Corp., and the former BayBanks Inc. are among the defectors.

"Twenty years ago, there was an outsourcer practically everywhere, all over the country - they were called big banks," said Mr. Gillis.

When it employed outsourcers for core functions throughout the 1970s and early 1980s, Wilber National, the upstate New York bank, discovered that it was just one of many institutions waiting in line.

"When you wanted a change, you put it in the queue," said Mr. Moyer, Wilber's CEO. "We got into this situation where, if you wanted anything different, you'd have to request a change. And if you were the only one that wanted it, you didn't get it unless you paid for it."

And with more banks lining up at fewer companies, the queues are longer and individualized attention is chancier, bankers say.

Bankers often complain that they don't get the attention they used to receive, said Carl A. Faulkner, managing director of M One Inc., a Phoenix consultancy.

Frequently, they are stuck with whatever they agreed to years earlier.

"We counsel our clients that are unhappy with vendors that they have to understand that it takes a pretty good improvement in cost to make a change worthwhile, because it is a pain," Mr. Faulkner said.

Even Mr. Gillis conceded that banks have had greater difficulty locating a local company to meet their needs. "As big banks sent 'Dear John' letters to the little guys, . . . these little banks felt left out because they can't cozy up to their outsourcer," he said.

Some community bankers are turning to regional cooperatives - frequently organized by bankers' banks - hoping to find strength in numbers.

"Most small-bank CEOs don't have the time or the resources to go out and hire a consultant," said Al Roensch, president of San Francisco's Pacific Coast Bankers Bank, which recently gathered California banks that needed either to convert systems or switch processors.

"People are looking for assistance in trying to help determine what software or what data processing is out there," said Mr. Roensch. "We got nine or 10 vendors to show up, and quite a few banks were able to hear all these people's presentation in one day."

The turnout was important because "there are a number of larger vendors giving the attitude that the small banks are not important," Mr. Roensch said. Executives from 30 financial institutions remained gathered well past 5 o'clock on the Friday afternoon of their late February meeting in Los Angeles, he said.

"Changing data processors is an important issue for a small bank," said Mr. Roensch. "It is traumatic to go through it because it disrupts the entire bank. There are new codes, new numbers, and I think one of the problems in Southern California is that so many banks grew up with the system that was being asked to change."

Regardless of their outsourcer, many banks in the Pacific Coast meeting felt concern that such a large part of their bank might be tied to a single vendor.

Other organizations catering to community banks have seen advantages in banding together for information about and negotiations with large outsourcers. And one newly formed company offers community banks and bankers' banks access to an on-line technology that few large banks currently offer.

The company, Reston, Va.-based Talegis LLC, offers Affinity Technology Group's automated loan machines to community bank customers. The machines, called ALMs, issue loans to bank customers, disbursed as checks embossed with photographic identification.

Community bankers sensitive to emerging technology such as Internet and PC banking reckon that technological change can actually help them compete more vigorously against larger banks.

Banks in the $1 billion-asset range can gain significant advantages over their bigger competitors by adopting reengineering and in-house solutions based on the client-server model, according to Mr. Yusefzedah of Phoenix International.

"That way, they can out-national their local competitors and out- local the national banks," he said.

Olin Broadway, founder of Charlotte, N.C.-based Broadway & Seymour and now chairman of systems integrator Sonata Systems across town, said he agrees that community banks can find advantages in the world of changing technologies.

"It is our bet that the smaller banks will not lose much in the changeover to home banking," said Mr. Broadway.

"As the larger banks are setting objectives to reduce the number of branches, this represents an opportunity for community banks, who generally know their customers better," said Mr. Broadway.

But obstacles remain to getting there.

"Eventually, a lot of these 20-year-old systems are going to go away," said Mr. Gillis. "Even though we know the merits of these (new) technologies, and every smart company and builder of systems understands what the direction is, they can't make the cut overnight or quickly."

Why? Because "security, reliability, and assurances are more meaningful to bankers than the latest technology," said Mr. Gillis.

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