Editor's note: This post originally appeared in the August issue of American Banker Magazine.
There is no doubt that banks are seeking to invest in new technology and improve their quality of service to better retain existing customers. At the same time, budgets continue to be constrained, with the majority of information technology spending locked in just to keep the bank running on a day-to-day basis. While this situation itself is not new, the resolve of banks to address this issue perhaps is.
Many banks see further price compression as being inevitable and are more certain than ever before in their belief that things simply cannot continue the way they are over the long term. So the entire operating model is beginning to be revisited now, with a sense that only by undertaking radical change will a bank manage to achieve results that are anything other than incremental.
One area ripe for something radical to happen is payments infrastructure, which accounts for a large proportion of bank expenses (up to a third, some estimates say) while offering little opportunity for differentiation. Making a significant difference to the cost base of payments could make a significant difference to the bank overall.
Of course, defining "significant" is no easy task. For years now, banks have been shaving costs in this area, making their payments infrastructure as efficient as possible. How then to make that step change, from streamlining to radically streamlining? And furthermore, how can payments become a competitive differentiator?
At Celent, we're seeing two big trends in this regard. First is a move toward payment services hubs (PSHs). Payments infrastructure tends to be built around distinct operational functions, often duplicated as a result of mergers. PSHs replace the jumble with a single, logically constructed system. While the adoption of PSHs in many cases has been in response to a regulatory driver such as new or faster payment types, PSHs have other advantages. Most notable is the move to modern technology and architecture, which lowers costs by removing the duplication and replication of technology and delivering services in a more standardized way.
The other surge in demand we see is for outsourcing. In many international markets, core payments systems historically have never been outsourced, unlike in the United States, where it is more common than in any other market.
The focus now is on linking these two trends together. A good case study is the shipping industry, which thrived in the latter half of the last century after it abandoned the painstaking process of loading differently sized cargo by hand and invested instead in reusable containers in standard sizes. Standardization often gets equated to commoditization, but in this case it enhanced the competitive positioning of the major players. The new containers could be loaded by machinery at fraction of the cost of the old method. Ancillary services sprung up, with some firms building or maintaining cranes at the docks, and others selling advertising on the sides of the containers. No one business does everything; it is an ecosystem of specialists.
In payments, hubs can allow for just that type of ecosystem. PSHs break up the steps in the payments value chain into discrete blocks, rather than by product silo. The new idea to consider now is to break each step into discrete service layers, to further isolate the individual elementsany one of which could then potentially be outsourced to a specialist.
A reason many banks shy away from outsourcing is the perceived loss of control. But by separating out the service layers, a new possibility arisesusing a PSH, but off premise. You can run the systems in parallel, you don't have the up-front costs and you retain control. One provider who offers this service estimates that the cost is less than 20% of what it costs a bank to run its existing systems.
We deliberately avoid using the term "cloud" too much, as it tends to confuse. But banks already use hosted versions of many things, including core platforms. Cloud-based payments infrastructure would not be too large a leap from here.
For a handful of enlightened institutions, the vision isn't all that radical. But what's needed now at most banks is a step change in thinking.
There is a saying, attributed in some places to Albert Einstein and in others to Mark Twain (and wise in any case), "If you always do what you always did, you'll always get what you always got."
Can banks afford to just repeat what they've always done?
Gareth Lodge is a senior analyst in the banking group at Celent. He is based in London.