Dtt Fsi Temenos ProfitabilityGap 2012 04

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TemenosWhite Paper

April 2012

Bridging the Proitability Gap

In association with


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Temenos White Paper02

Executive Summary

02 Executive Summary03 The Proftability Gap05 How Modern Core Banking Sotware Can Address

The Proftability Gap07 Banks Using Modern Core Banking Systems Demonstrate

Signifcantly Higher Returns08 To What Extent Could Core System Replacement Help Bridge The

Proftability Gap?09 Why Banks Need To Act Now11 Running A Successul Core Banking Implementation14 Best Practices For Core Replacement18 Summary

Contents

For a period spanning almost 3 decades, the banking sector hasenjoyed extremely high proitability. In the period 1980-2007,banks earned an average annual Return on Equity (RoE) o 16%

- high both in comparison to historical levels and relative to otherindustries. This elevated level o RoE was acilitated and sustainedby three main actors: deregulation, strong global macro-economicconditions and high leverage.

However, owing to a number o structural changes in the industry,global banking RoE has now been reset to materially lower levels;essentially, a proitability gap has opened up. There are our mainstructural changes that have driven down RoE: tougher regulation,especially in the orm o higher capital requirements; changing

customer behaviour, putting pressure on pricing at the same time asraising cost to serve; increased unding costs, stemming in particularrom a relative shrinkage in the wholesale lending market; and, moreintense competition arising chiely rom new market entrants.

In this paper, we set out how core banking renewal could provide thelevers or banks to grow RoE. Since modern core banking systems areintegrated, lexible and scalable, they can help banks to improve RoE inour key ways. Firstly, by providing complete and real-time inormation,they can help banks to improve the level o cross-selling and lowerthe level o non-perorming loans. Secondly, by improving the levelo automation and straight-through-processing, they can help banksto reduce operational and IT costs. Thirdly, the inherent scalability othe systems allows banks to extract economies o scale rom organicgrowth and acquisitions, particularly in operations, processing and IT.

Lastly, the lexibility o the systems allows banks to adapt very quicklyto changing market conditions such as launching new products.

We also attempt to quantiy the possible impact on industryproitability rom core banking renewal. We have conducted analysison the relative proitability o banks running core banking systemscompared to banks running legacy applications. This analysis, based ona large data sample across multiple years, illustrates that banks runningmodern, third party core systems enjoy signiicantly better proitabilitymetrics. And i we extrapolate this dierential in proitability, weestimate that core replacement could reduce the proitability gap bybetween 25% and 60%.

It is imperative or banks to act quickly on core replacement. The caseor core banking renewal is evidently compelling, but its beneits

have been known or a long time and yet relatively ew banks haveundergone core replacement. The reason is two-old: on the one hand,the programmes can be expensive and risky and, on the other, bankshave been able to deer action. In respect o the latter, the regulatoryand operating environment has not punished banks or ineiciency, butthis is now changing. In developed markets, the absence o historicalrates o revenue growth will expose structural ineiciency, while in theemerging world, more highly contested markets will orce banks to raisethe level o customer service at the same time as lowering pricing.

Not only have core banking systems matured signiicantly over recentyears, but so too have implementation methodologies and there aremany large system integrators operating in the sector today. In thelast section o this paper, we mine our experience rom a large numbero core banking implementations to share a set o best practices to

maximise return and minimise risks rom core renewal projects.


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For a period spanning almost 3 decades, the average RoE across theglobal banking industry was around 16% per year. However, theinancial crisis o 2008 has ushered in a period o re-regulation which,together with changes in bank unding, competition and customerbehaviour, has reset industry proitability to much lower levels.

1980-2007: High Sustained RoE, Averaging 16%

Between 1980 and 2007, banks enjoyed high returns on equity; better,in act, than at any other time1. Such high levels o return were madepossible by the conluence o several actors:

Government Deregulation - across many o the major markets(e.g. the Thatcher governments Big Bang reorms in the UK in1986, the repealing o the Glass-Steagall Act in the US in 1999,etc.) which allowed banks to diversiy outside o traditional retailand corporate banking into businesses and products that oeredhigher returns (albeit also higher risks)

Strong Economic Fundamentals - or a host o reasons2 , the globaleconomy enjoyed both below-trend inlation and above-trendGDP growth. During the period, world economic growth averaged3.0%3 compared to the pre-war average o 1.7%4 and globalinlation averaged 2.6%

High Leverage - not only did regulators permit this, but wholesalemarkets were prepared to provide the unds and at very low rates ointerest. During the period, global assets as percentage o GDP roserom 94% in 1980 to over 160% in 20075

The Proitability Gap

Sources

1 Between 1920 and 1970 the return on equity o UK Banks averaged below 10% with very low volatility, the trend was similar globally. (Source: Bank or International Settlements, Andrew G Haldane: Banking on the state).

2 Principal reasons included advances in inormation technology, which acilitated above-trend productivity growth and aster globalisation o production, and the rapid industrialisation o emerging economies,especially China.

3 Thomson Datastream average annual Global Real GDP growth rom 1980-2007.

4 Angus Maddison, Monitoring the World Economy. Real GDP growth averaged 1.0% rom 1820-1870, 2.1 % rom 1870 to 1913 and 1.9% rom 1914-1950, giving an overall average o 1.7%.

5 Source: WorldBank Database. Assets measured as domestic lending by banking sector.

6 IMF Global Financial Stability Report, April 2010: Between 2007 and end o 2009 $1.5 trillion in bank writedowns had been realised.

7 Examples o banks nationalised (partly or ully) include Northern Rock, Royal Bank o Scotland and HBOS-Lloyds TSB in the UK, Anglo Irish Bank in Ireland, the Dutch activities o Fortis in Holland, and Icelands largestcommercial banks. The US governments support o Citigroup, Federal Home Loan Mortgage Corporation and Federal National Mortgage Association are considered by many to have been orms o nationalisation.

8 Examples o illiquid/toxic assets taken on to government balance sheets include: The Swiss National Bank taking USD 38.7 billion o toxic assets rom UBS, and the United States Treasury Departments $700billion Troubled Asset Relie Program (TARP) although this programme was later changed and the unds were used to inject capital into troubled banks.

Fig.1

Global Banking Return on Equity (%)

18%

2%

1980-2007 2008 2009 2010

4%6%

8%

10%

12%

14%

16%

16%

4%5%

10%

Historical Protability = 16%

Protability Gap = 6%

2008 And Beyond: Proitability Has Been Reset

Since 2008, the structure o the banking industry has been changedsuch that RoE has been reset to materially lower levels.

The Financial Crisis: In 2008, the inancial crisis hit, triggering - in theirst instance - massive write-downs on inancial instruments whereliquidity had evaporated and which were rendered worthless, ollowedby a squeeze on unding and then, via the real economy, urther write-downs on corporate and domestic (especially housing) loans. Betweenthe third quarter o 2007 and the end o 2009, banks had written downthe value o their assets by approximately USD1.5 trillion6 (equivalentto 2.4% o global GDP). Given this context, it is not surprising that globalbanking RoE ell precipitously, rom 18% in 2006 to just 4% in 2008.

The Aftermath Of The Financial Crisis: History is likely to judge avour-ably governments response to the inancial crisis (probably much moreso than its response to the later sovereign debt crisis) in that it was ast,coordinated and eective. Governments took stakes in banks (nation-alising banks in some instances7) where these banks could not raisenew capital; they took illiquid assets onto their balance sheets8; andthey encouraged central banks to provide cheap sources o short termunding as well as boost liquidity by printing money to buy governmentdebt. As a consequence, the inancial crisis was short-lived and by 2010,global RoE levels had recovered somewhat to around 10%.

Source: BCG, Thomson Datastream

}


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More Intense Competition: The competitive landscape is changingdramatically. Incumbent banks ace competition on many ronts. Firstly,there is competition rom new banks, such as Metro Bank in the UK.Secondly, there is competition rom existing banks setting up new operations:or example, developed world banks expanding to oer services inemerging markets or retail banks pushing into mass aluent privatebanking services. Thirdly, there is competition rom non-banks oeringbanking services, in particular retail companies providing retail banking

products and services, such as Wal-Mart in the US. Lastly, there is thephenomenon o consumers bypassing traditional inancial institutionsaltogether, using, or instance, a peer-to-peer intermediary to borrowdirectly rom each other14 or a non-bank intermediary like PayPal to makepayments to each other.

Whatever the orm o additional competition, however, the outcome isthe same. More competition in a market allows customers more choiceand, in turn, causes prices to all. In banking, this means that net interestmargins will come under pressure, causing aggregate levels o RoE to all.

Nonetheless, despite access to cheap lines o credit, improvingeconomic conditions and the non-cash boost o lower loan provisioning,RoE levels peaked at 10%. Part o the explanation lies in the act thatthe global economy enjoyed a mini-bounce, rather than enteringinto a new, ull expansionary cycle. However, the more undamentalexplanation is that banking has changed and, or the ollowing reasons,RoE is likely to remain depressed vis--vis pre-crisis levels:

New Capital Requirements: Governments and regulators want tomake banks saer. Arguably the simplest and most eective way to dothis is to require them to hold more capital relative to assets as a bueragainst any uture losses. Accordingly, new and tougher rules on capitalare being introduced. Globally, the Basel III accord will require banks

to hold tier 1 capital equal to 6% o risk weighted assets (plus a 2.5%capital surcharge) and banks deemed to be systemically importantwill be subject to a urther surcharge. To meet the requirements (andoten stricter local rules such as in the Eurozone, UK and Switzerland)banks will need either to raise signiicant levels o new Tier 1 capital(about EUR1.1 trillion or European banks and USD870 billion orUS banks9 ) or they will need to shrink signiicantly the level o risk-weighted assets or, most likely, a combination o both. Regardless ohow banks comply (growing the denominator or shrinking the numerator)the eect on global RoE will be sizeable. McKinsey estimates that justthe eect o complying with Basel III will lower long run RoE by 4.0percentage points in Europe and 3.0 points in the US 10.

Changing Customer Behaviour: Customers have become moredemanding, more savvy and less loyal, pushing up their cost to serve

at the same time as eroding banks pricing power and thus, ultimately,lowering RoE.

Customers want to do banking on their terms, across their preerred channelsand now, given heightened competition, banks are ceding to these demands.Like other retailers, banks are opening or longer and oering services overmore channels. This is making it more expensive to serve customers.

Customers have access to more inormation than in the past. Theadvent o the internet and, more particularly, price comparison sites hasmade product pricing in banking very transparent (although ees are stillsomewhat opaque). Thus, customers are able to shop around easily orthe best deals, increasing demand elasticity.

And, compared to historical levels, customers really are shopping

around. For instance, in 2011, US customers had relationships withon average 1.9 banks compared to an average o 1.6 banks11 in 2010:that is, customers are taking products with multiple banks in pursuito the best deals. Similarly, customers are now beginning to switchbanks, dissatisied either with prices or the level o service: in 2011, 9%o US banking customers switched banks compared to 8% in 201012.Furthermore, the actions o consumers in this regard have to someextent been ostered by regulators in developed countries who havesought to introduce greater price transparency at the same time asreducing the barriers to switching accounts13.

Fig.2Euro-Area Bank Lending To Their EMU Financial Institutions (% o Assets)

Higher Funding Costs: The wholesale unding market is shrinking inrelative terms, aecting some banking markets more than others, butoverall pushing up unding costs as competition or deposits and otherorms o unding intensiies. As illustrated, Fig.2, the proportion oEuropean bank unding coming rom the interbank market has beenalling or a protracted period o time. It is thus a secular, rather than atemporary phenomenon, although the rate o decline has acceleratedwith the onset o the banking (and sovereign debt) crisis. I undingcosts are rising and banks are not able to pass on the costs (see above)then Net Interest Margins (NIMs) come under pressure leading tolower RoE.

Sources

9 McKinsey Basel III and European banking: Its impact, how banks might respond, and the challenges o implementation November 2010

10 McKinsey Basel III and European banking: Its impact, how banks might respond, and the challenges o implementation November 2010

11 JD Power and Associates 2011 Retail Bank Study

12 JD Power and Associates 2011 Retail Bank Study

13 Consider, or instance, the actions being taken by the UK government to allow individuals and small businesses to switch to another bank within seven days and or all the direct debits and credits to be transerred or them at no cost.

14 Peer to peer lending is primarily a retail banking phenomenon but also exists or corporate customers. Examples include Zopa, Prosper and Kiva.

24

19

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21

22

23

1999

18

17

16

15

2000

1999

2000

2001

2001

2002

2002

2003

2003

2004

2004

2005

2005

2006

2006

2007

2007

2008

2008

2009

2009

2010

2010

Source: ECB


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The Industry Needs A Structural Answer

Operating as usual will not bridge the proitability gap. The responseswe have seen rom banks so ar, which include sta reductions, hiring reezesand tighter procurement processes, are the usual responses to a cyclicaleconomic downturn and do not address the root cause o high costs.They will likely produce a modest improvement in cost to income (andby extension RoE), but as soon as macroeconomic conditions improve,these costs will ind their way back into the business. In some cases,there will even be a short term increase as banks catch-up, or example,undertaking delayed capex projects. Any improvements in cost toincome (and RoE) are thus unlikely to be sustainable .

Instead, the industry needs a structural answer to a structural problem.

For the reasons set out in the previous section, proitability in bankinghas been reduced to a structurally lower base. Banks need to improverevenue generation per asset and lower cost to income in a systematicway that will yield sustainable improvements in RoE across the businesscycles; a structural solution is required.

Modern Core Banking Systems Give Banks Four Key LeversTo Raise RoE

In this section, we set out the our key ways in which banks can usemodern core banking technology to raise RoE.

Enabling Banks To Move Into More Profitable Markets And Segments

An important means o improving RoE is or a bank to reposition a

greater part o its business in segments and markets that generatehigher margins. Clearly, i all banks move into the same segments andmarkets in pursuit o higher returns then, all else being equal, marginswill all. So the key is to reposition the banks operations eectively andquickly.

A modern core banking system can help on both counts. The keyto entering a new market successully is being able to dierentiateproducts and services. Modern systems can enable this by aordingthe complete view o customers needed to understand what productsand eatures will appeal, and the lexibility or banks to be able to tailorproducts and services accordingly. Modern core banking systems permita bank to launch new products by constructing them rom existingcomponents which speeds time to market. In addition, they enablebanks to rapidly open new branches and to launch new channels, such

as mobile, while maintaining consistency to enable a true multi-channelexperience.

As a recent example, Temenos was able to help Credit Agricole launcha new private banking concept, called BorBank. The attraction oprivate banking is clear: it has high margins; it oers a rich source odeposits; and, much o the income is ee-based (higher margin andgenerally not tying up bank capital). In this case, not only was CreditAgricole able to launch this new bank quickly, in less than a year (withthe system implementation taking just 6 months), but BorBank hasleveraged technology to successully dierentiate its oering. The bankprovides very rich, value added and interactive content like comparisontools, product simulators and expert videos which enable customersto become their own private bankers. And, consequently, BorBank isenjoying notable success: in its irst year, it attracted on average more

than 7m a day in new deposits.

Enabling Banks To Raise Asset Yield Within Existing Business

In an era o higher capital requirements, raising asset yield (withoutintroducing higher risks) is an important route to higher returns.This can be achieved in two main ways: managing risk better, such thata bank takes lower provisions against its assets (improving per assetproitability) and by selling more to existing customers, since themarginal cost to capture and cost to serve is lowered with everyadditional product taken. However, increasing asset yield is not easy. In acompetitive environment, it is necessary to optimise every element ooperations to enable this. It requires a bank, amongst other things, tohave complete, rich and real-time customer and risk data or, in otherwords, a single view o customer and credit risk. A modern core bankingsystem on its own will not raise asset yield, but the inormation it

provides, and the ability to provide it in real time is a necessary precondition,and is thereore essential to ull optimisation o this lever.

Techcombank, the astest-growing and most proitable bank inVietnam, is an almost textbook example o how to raise asset yieldwithin an existing business. By being irst to market or many newproducts and services and by being able to tailor products and servicesaccording to individual proitability, Techcombank has engendered veryhigh levels o customer satisaction that, in turn, have made possibleits above-average NIMs (Fig.3). Furthermore, Techcombanks sophisticatedcredit scoring techniques, which take into account amongst other thingsindividual customer exposure, have allowed it to reduce its level o non-perorming loans (NPLs) despite extremely rapid asset growth. In total,Techcombanks proitability per customer is rising by on average 25% ayear, contributing to a compound annual growth in operating proit o82% since T24 was introduced in 200315.

Sources

15 A detailed case study on Techcombank can be downloaded rom the Temenos website:www.temenos.com/proft.

How Modern Core Banking SotwareCan Address the Proitability Gap

Fig.3

Techcombank Has Increased Deposits by a CAGR o 70% WithoutHaving to Sacrifce NIM

Source: Company annual reports

6%

1%

2%

3%

4%

5%

2004 2005 2006 2007 2008 20090%

10,000

0

20,000

30,000

40,000

50,000

60,000

70,000

Techcombank NIM

Vietnamese Banks Average NIM

Techcombank Deposits (VNDbn)


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Enabling Banks To Cut Costs Sustainably

Cutting costs is easy. Cutting costs in a way that is both sustainable andsupportive o a banks uture growth prospects is more challenging. Itrequires streamlining and automation o processes, which enables thebank to optimise their operations rather than simply paring them back.

Replacing legacy banking applications with a modern third-partysystem is the principal means o extracting these cost reductions,while also rendering a bank more lexible and agile to exploit uturegrowth opportunities.

In our experience, the most signiicant cost savings typically arise romreductions in the number o, and productivity increases rom, IT and

back oice employees (through greater automation and ewer errors)and rom hardware and sotware maintenance consolidation.In addition, urther and ongoing eiciencies should also be achievablerom optimising operations overall, or example, by reducing the time ittakes to introduce new products.

To give an indication o the level o immediate savings that a bankmight enjoy through core replacement, consider the example oSchroders Private Banking. In 2006, it centralised its IT and back oiceunctions into one hub using Temenos T24 and in the process was ableto cut its total operating costs by one third. Roughly 60% o the costsaving came rom a reduction in headcount, with the remainder comingrom lower inrastructure costs like IT and rent. As regards the IT costsavings achieved, the bank was able, or instance, to reduce its numbero sotware applications rom 32 to 12 and its number o datacentres

rom 6 to 2 as part o this exercise 16.

Enabling Banks To Extract Economies Of Scale

Modern technology is essential or banks to be able to realise the scaleeconomies that should arise rom growth, both organic and inorganic,and so deliver higher productivity and, by extension, higher RoE.

Nonetheless, banks have a very poor record o extracting economieso scale rom IT. Various studies17 have illustrated that increases in ITspending by banks have ailed to yield correspondingly higher levels oproductivity improvements and, in act, or protracted periods o time,have produced even negative returns on investment. We suggest thatthis phenomenon o diminishing and negative productivity returns owesto the nature o IT systems that most large banks run today: complex,siloed, badly documented and with signiicant manual workaroundswhich preclude meaningul productivity gains.

Having an integrated and scalable technology inrastructure allows abank to add more and more customer and processing volume withoutexperiencing a commensurate increase in hardware, sotware or labourcosts, thus reducing its IT costs relative to income. Take the exampleo Bank o Shanghai, currently one o the largest volume users o T24,which is adding around 700,000 new retail and corporate customers ayear on its IT platorm. Bank o Shanghais productivity gains have beenimpressive, its ratio o IT costs to total assets, or instance, is 44% lowerthan its domestic peers18.

Sources

16 A detailed case study on Schroders Private Banks implementation o T24 is downloadable rom the Temenos website: www.temenos.com/proft

17 See or example McKinsey Global Institute, US Productivity Growth 1995-2000: Understanding the Contribution o Inormation Technology Relative to Other Factors, 2001

18 A detailed case study assessing the impact o T24 at Bank o Shanghai is downloadable rom the Temenos website: www.temenos.com/proft

19 We undertook a study o the 20 largest banking M&A transactions between 1995 and 2005, which we intend to publish shortly

20 We develop and illustrate this point much more prooundly in our report

The same ailure o banks to generate economies o scale rom organicgrowth is also evident in M&A transactions. In a recent study 19, weound that a clear majority o banking M&A transactions destroyshareholder value. The reason is the same as above: margins posttransaction ail to improve because banks ail to deliver on costsynergies, particularly in the areas o IT and back oice spending. Ourconclusion, again, is that this is because legacy systems make thesesynergies all but impossible to realise.

Where banks operate modern systems, their record on value creation

through M&A is demonstrably superior

20

. Take EFG Bank, or example:a Temenos customer since 1993, the bank has made 24 acquisitionssince that time - on top o rapid organic growth. Nonetheless, sinceit has successully integrated the IT and back oice inrastructures oall acquisitions (and new locations) onto its global platorm, the bankspends less than 6% o total costs on IT; roughly one-third o theaverage or European private banks.

Fig.4

Bank o Shanghai: G&A as a % o Total Costs

30%

5%

10%

15%

20%

25%

2005 2006 2007 20080%

35%

Source: Company Annual Reports


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Banks running modern core systems have taken advantage o theseproperties to generate higher returns than their peers.

For the last 3 years, we have used inormation rom The Bankerdatabase to carry out analysis regarding the relative perormance obanks using modern core banking systems compared to banks usinglegacy sotware. In short, we use a third-party source to identiy the listo banks using sotware rom the biggest vendors in the marketplaceand then we compare the average values or these banks against allothers21.

What this analysis shows is that banks running modern core bankingsystems have materially better proitability metrics. Over the last 3

years, banks using third-party banking applications have enjoyed onaverage a 25% higher return on assets, a 37% higher return on capitaland a 7.4% lower cost to income ratio than banks running legacyapplications22. What is more, this dierential in proitability holds notjust on average over the three years, but or each year and or eachregion. In other words, the correlation exists across a large data series,over time and across regions, the last being particularly important giventhe signiicant disparity between the recent perormance o banks romemerging and developed economies.

Banks Using Modern Core Banking Systems DemonstrateSigniicantly Higher Returns

Sources

21 Our third-party source or the dierent vendor installed bases is the IBS BOSS guide, which we acknowledge may not be completely up-to-date or accurate. For Temenos customers, we have used the Temenoscustomer list. We have made the calculations based on the customers o the ollowing vendors, who we believe to be the biggest by value o sales and number o on-premise installations: Temenos, Oracle, Inosys, TCS,Misys, SAP and Avaloq

22 In act, we compare the perormance o banks running systems rom the top 7 vendors against all others, that is to say that the comparative population o banks is likely to be mostly banks running legacy applications butwill also include a small number o banks running applications rom other third-party vendors

23 We conducted an extensive survey o our customers in 2010 in order to ascertain their ratio o IT costs/total costs. We did not, however, ask customers to provide a breakdown o their spending on packaged sotwarerelative to total sotware spending and so we have estimated the percentage to be around 60% in fgure 5

Third party banking applications Temenos

Return on assets +25% +30%

Return on capital +37% +46%

Cost to income ratio -7.4% -8.5%

Perormance over 3 years relative to banks running legacy applications

The dierential in perormance between Temenos customers and all otherbanks is even greater. Over the last 3 years, Temenos customers haveenjoyed on average a 30% higher return on assets, a 46% higher returnon capital and an 8.5 point lower cost to income ratio than banks runninglegacy applications. Compared to banks running other third-party bankingapplications, this dierence is smaller but still signiicant: over the lastthree years, Temenos customers have demonstrated a 9% higher returnon assets, an 11% higher return on capital and a 1.8 point lower cost toincome. Moreover, in common with the analysis on the ull population obanks running third-party systems, the superior perormance o Temenoscustomers exists across all 3 years, across all regions and even acrossdierent segments: that is to say, normalising or any inherent biases in theTemenos customer (towards, say, emerging market banks or private banks),

we observe that this correlation still holds.

Thus, we believe that this analysis oers highly compelling support oradopting third-party core banking sotware as a means o improvingproitability. Through our research, we have demonstrated a strong andsustained correlation between third-party sotware usage and superiorperormance. In short, we position that using third-party systems is asignicant actor in superior bank perormance and using core bankingrom Temenos can drive even more pronounced outperormance.

Fig.5

Purchased Sotware Penetration vs. IT Spend As % O Costs

Source: BCG, Forrester, Gartner and Temenos

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0% 5% 10% 15%

Banking

Industrial

Goods,

Energy

Insurance,

Telecoms

Public

SectorHealthcare

Consumer

Temenos

Customers

Pre-packagedsoftwarespendin

g

as%o

ftotalsoftwarespending

The correlation we have observed between packaged sotware usageand higher proitability in banking also holds across industries. In Fig.5,we show the strong inverse correlation (minus 84%) that existsbetween industries relative IT expenditure and their relative spendingon packaged sotware. In other words, the more an industry spends onpackaged sotware relative to in-house development the lower its levelo IT spending relative to other costs (and, all else being equal, the higherits proitability). Anticipating the objection that, since banking is a highlyIT-intensive industry (where products and services contain high levels oinormation and use o technology is pervasive), banking will always havehigher relative IT spending, we include the average IT spending igures orTemenos customers. While it is unrealistic given the degree o IT intensityto assume that banks relative IT spending could ever reach the levelso, say, the industrial goods industry, we would point out that higherrelative IT intensity in an industry should give greater scope or extractingIT economies o scale. As we have argued above, this has not happenedlargely because o the antiquated systems in use. In the case o Temenoscustomers, their IT spending (at 5.7% o total costs 23) is lower than thecross-industry average.


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To What Extent Could Core System Replacement HelpBridge The Proitability Gap?

In this section, we quantiy the proitability gap and apply the analysisabove, regarding the higher proitability o banks running modern coresystems, to try to determine the extent to which core replacementcould help bridge the proitability gap.

As discussed above, our contention is that the gap between the levelo RoE in 2010, when the banking sector was riding a wave o cheapcentral bank liquidity and improved economic undamentals, and thepre-crisis average o 16% represents the structural proitability gapthat has arisen rom structural changes in the industry, notably re-regulation, since the onset o the inancial crisis.

We can quantiy this proitability gap. RoE in 2010 was 10% compared

to the pre-crisis average o 16%, that is to say, the gap in RoE equates tosix percentage points24. The level o equity held by banks at the end o2010 was approximately USD5.4 trillion25. Applying 6 percentage pointsto this equity igure implies that banks net income would need to riseby USD308bn26 globally or pre-crisis RoE levels to be restored.

Extrapolating the quantitative analysis above, we postulate that i allbanks globally adopted modern core banking systems, the proitabilitygap could be reduced by between 25%-60%. I banks adopted moderncore systems rom the major vendors in the same proportion to whichthey have historically, we suggest that the proitability gap wouldreduce by around 25%27 and, i all banks globally adopted modern corebanking sotware rom Temenos, they would generate $180 billion ohigher annual post-tax proits, reducing the gap by 60%28 (Fig.6).

Sources

24 The pre-crisis average was actually is 15.7%, so in our calculations we use 5.7%, not 6%

25 This fgure represents the total Tier 1 capital o all banks in The Bankers Top 1000 World Banks 2011 (or the year ending 31 December 2010). Even though this list captures only a small subset o banks, it captures thelargest and we estimate that this equity fgure constitutes approximately 90%+ o the total or all banks

26 Calculated as: Proftability multiplied by total equity (i.e. 5.7% multiplied by USD5.4trillion)

27 Based on our analysis in 2010, banks running third-party core banking systems had a ratio o pre-tax proft to equity o 14.28%. To arrive at a RoE number, we have assumed a tax rate o 20%, giving 11.4% - i.e. 1.4percentage points higher than all banks. Expressed as a proportion o the 5.7pp gap, this is 25%

28 Based on our analysis in 2010, banks running Temenos core banking systems had a ratio o pre-tax proft to equity o 16.6%. To arrive at a RoE number, we have assumed a tax rate o 20%, giving 13.3% - i.e.3.3 percentagepoints higher than all banks. Expressed as a proportion o the 5.7pp gap, this is 58%, which we round up to 60%

Third party banking applications Temenos

Pre-tax ROE 14.28% 16.6%

Post tax ROE (assume 20% tax rate) 11.4% 13.3%

2010 average ROE 10.0% 10.0%

Core systems uplit to ROE 1.4% 3.3%

As % o the 5.7% proit gap 25% 58%

Fig.6

An illustration reconciliation o post-crisis to pre-crisis proftability levels

18%

8%

10%

12%

14%

16%

6%

4%

2%

10%

3.3%

2.4%

16%

2010 ROE Benet romusing Temenos

Benet rom consolidation/divestment/other

Target ROE

Source: Thomson Reuters, Temenos and Deloitte estimates


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The need to replace core systems in order to raise RoE and restorethe banking industry to historical proitability levels has beenmade clear. However, what is still to demonstrate is the danger oexcessive procrastination.

Even though core replacement has become more urgent in the contexto lower post-crisis proitability, the advantages o taking moderncore systems have long been espoused and yet relatively ew bankshave actually undergone core replacement29. Part o the explanationlies in the high real and perceived risks o undertaking this kind otransormative IT project (which are discussed in the next section), butpart o the explanation also lies in the act that banks have not neededto act. In the developed world, up until very recently, the economic,

competitive and regulatory environments have been suiciently benignas not to penalise banks too seriously or ineiciency: essentially, moreincome could always be ound to cover up or structurally high costs.In the developing world, a buoyant backdrop has allowed practicallyall banks to enjoy high growth, regardless o operational eiciency andagility. However, the picture is changing and in both cases we estimatethat delaying system replacement will begin to have much moreproound negative consequences.

Developed World Banks

Developed world banks are acing slower income growth prospects dueto increased competition and reduced customer loyalty. However, theircost bases remain structurally high and, since mainly composed o stacosts, are likely to grow by at least the rate o inlation. In act, costbases are likely to grow even aster than this given the need to invest to

meet heightened customer demands, to protect market share againstmore intense competition and to provide banking services over anincreasing number o channels. Thus, it is quite likely, not to say certain,that costs will rise aster than revenues over the coming years or banks in the absence o technology modernisation.

In the chart, Fig.7, we demonstrate how taking the industrys currentstarting point the compounding eect o aster cost than incomegrowth could render unproitable developed world banks as soon as 10years rom now. And since, on average in our experience, it takes 2-4years to ready an organisation or, and implement, core system change,it is incumbent on banks to move immediately.

Emerging World Banks

Emerging world banks are not restricted by the same lack o growthopportunities as their counterparts in the developed world but,nonetheless, are also constrained by their legacy core banking systems.In short, banks can no longer rely on the phenomenon o a rising tideliting all boats.

In the emerging world, banking assets are expected to grow at acompound rate o 9% through to 2030, which would imply over $40trillion o asset growth in absolute terms31. The attractiveness o thesemarkets will attract new entrants, such as start-up banks, non-banksand banks rom overseas. This will orce incumbent banks to improvecustomer service at the same time as lowering pricing.

Take a concrete example: the sizeable opportunity arising rom providingbanking services to the large unbanked population in emerging markets.It is estimated that 2.5 billion people, hal the worlds population, areunbanked, and the vast majority o these people are in the developingworld32. The provision o basic banking services to this large unbankedpopulation is one o the major actors underpinning asset growth in theemerging world. Thus, exploiting this secular growth trend banking theunbanked, so to speak is key to enduring success or emerging market banks.

Why Banks Need To Act Now

Sources

29 Based on recent industry analyst data, still only 18% o banks licensing and maintenance spending on core systems is spent with third-party vendors like Temenos

30 For our starting point, we have taken the present cost to income ratio o developed world banks rom The Banker Top 1000 banks and modelled a 1% growth in income compared to a 4% growth in costs.

31 PWC: Banking in 2050

32 Financial Access Initiative: Hal the World is Unbanked

Fig.7

Income vs. Cost trends or developed world banks30

180

80

100

120

140

160

2011

60

40

20

2013

2015

2017

2019

2021

2023

2025

2027

2029

2031

2033

Income Costs

Source: The Banker, Temenos and Deloitte Estimates


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However, what prohibits banks rom taking uller advantage o thisopportunity is not demand or services, but the cost o providingthese services. The issue or the unbanked population is the cost obanking services relative to their income: that is, they would opena bank account today i cheap enough, but or incumbent banksit is uneconomical to provide services. Because banks are runninginrastructure that is inherently lacking in scalability and lexibility, themarginal cost to serve customers is not reducing as it should, makingthese customers who require (today) only the most basic services tooexpensive to serve.

However, i incumbent banks do not seize this opportunity, someonewill and the opportunity could be lost orever. Given the massive

potential economies o scale in serving such a large untapped market ocustomers who require largely homogenised services, the opportunitywill attract new entrants. Any new entrant would likely buy one o themany core banking packages available and so be unencumbered by thelegacy systems that make serving this market unproitable today.Banks have an urgency to act now and win as many lower incomecustomers in emerging markets as possible beore new entrants beginto capture these customers.

As an illustration, consider the example o M-Pesa in Kenya. In 2007,it launched a set o simple and inexpensive banking services such asmoney transers, bill payments, deposits and withdrawals, which couldbe originated over a mobile handset. Since then, its subscriber numbershave grown to 14m (Fig.8), which equates to approximately 68% o theadult population

Fig.8

MPesa Subscriber Numbers Since 2007 (LHS) Expressed As % o Adult Popluation (RHS)

0%

10%

20%

30%

40%

50%

60%

70%

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

Apr-07

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

SubscriberNumbers(m)

Asa%o

fAdultPopulation

Source: Safaricom, Unicef


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Running A Successul CoreBanking Implementation

Sources

33 A topic explored in the Deloitte white paper Making the case or change: How to create a business case or core banking replacement

ProcessingSilos

BatchOrientation

IncrementalInvestments

HeritageTechnology

OperationalPerormance

Limited single customer view

Data changes required in several places

Compliance always a challenge

Small changes always have a high impact

Dependency on a ew key resources,oten contractors

Manual Workarounds, exceptions, aliures

Large back oce departments supportingnon-customer acing activities

Cost o ownership is out o control

Products processed by silo applications

Several customer databases

Range o very old to very new systems -oten the oldest are the most critical andrarely touched

Extensive mix o applications (1000 to 5000)and spaghetti interaces (5000 to 20000)

Poor documentation or code annotation

Data synchronisation a challenge acrossmultiple systems

IT spend ocussed upon bug x / tactical spend

Legacy Symptoms Root Causes

As discussed banks ace a number o undamental challenges:

Amassiveregulatoryburdenthatisdrivingtheneedtoreducecosts,raise capital and improve risk management

Increasingcustomerexpectationssuchasreal-timebankingdrivenbythe explosion in the use o smartphones and mobile payments and therise in the sophistication o corporate cash management

Competitiononprice,servicelevelsandproductfeaturesfromthosebanks that have already rationalised their platorms or new entrantswith lexible and low cost platorms

Highoperationalcostsandoperatingriskdrivenbytheuseofmultiplelegacy platorms, oten in a range o product silos, with poor automationand major challenges in providing an operational single customer view

A compelling case has been made in this paper or the need to replace systems, yet relatively ew banks have undergone the process. In our viewmost banks realise that rationalising and replacing their core platorms is probably the only way to eect a undamental reduction inoperating costs and operational risk and enable uture business lexibility. However, there are two major challenges to embarking on this journey:

1.Creating a positive business case to undertake such a transormation is

notoriously diicult

33

, the costs o core replacement are signiicant andcrystallise well ahead o the beneits, which are likely to accrue over a longperiod o time, typically longer than most banks planning horizons o1-3 years. Cost savings are relatively easy to model and to track and ourexperience has shown that IT cost reduction alone is highly unlikely to givea ast enough payback time and that operational cost reduction is oten thekey driver o a positive case. The beneits o core replacement in terms oadditional revenue are more diicult to model and measure and cases thatare only made positive by such beneits tend to have less credence with de-cision makers. Alternatively, there may be some undamental limitation oa banks existing platorms (such as the inability to scale urther or supportreal time banking) that means the cost o retaining the existing platormsis prohibitive, although we note that banks typically have great expertise inkeeping legacy platorms going.

2. Changing a core banking system is a major endeavour or any organi-

sation and could be considered as a once in a lietime investment.There are many examples o replacement programmes that havemassively exceeded their original budgets and timetables or ailedcompletely, which tend to overshadow the successul programmes.

Nonetheless, banks are struggling to make the changes to overcomethese challenges. The normal obstacle to change inside a bank is theragility, complexity and high change cost o banks IT estates, drivenby dozens o dierent technology platorms, hundreds or thousandso applications and thousands or tens o thousands o interaces. Thisresults in a number o symptoms illustrated below.


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Sources

34 For example see the IBS Journal - How to Run a Core Banking Project Supplement February 2012 atwww.ibsintelligence.com

35 For a general review o IT projects, see Why Your IT Project May Be Riskier Than You Think, HarvardBusiness Review, September 2011

Given that personal careers can be at stake, remaining on the path oincremental changes to legacy platorms is usually an easier decision thanaccepting a replacement is necessary. Below is a list o some o thecommon reasons why banks core banking modernisation programmes ail:

Lack o business leadership or involvement: many programmes under-invest in business change and programme management and lack eectivedecision making. This is oten because they lack suicient business involve-ment or leadership, and oten because they have originated out o the ITorganisation or only one area o the business. It is not uncommon to see ITorganisations being blamed or poor delivery when in act the right condi-tions have not been established to enable them to deliver successully

Initial planning and budgeting is too optimistic: in the interests o gaining

approval or a replacement programme, to win the platorm selection or towin the implementation partner procurement, overly optimistic plans andbudgets are oten produced by the proponents o a core banking replace-ment programme, whether by those proponents inside a bank or the thirdparties bidding to supply the technology or undertake the implementation

Poor scope management and governance: programmes oten do not man-age requirements eectively, oten characterised by the number o require-ments exploding due to unwillingness by the business to compromise onscope and unctionality or to rationalise product oerings in the interests odelivering the programme within budget and on time

Complexity: the true complexity o implementing a replacement platormdriven by aspects such as the number o interaces to be built, the number oproducts to be migrated, the millions o customers and accounts and thenumber o sta to be trained is oten only revealed ater the programmehas started

These challenges oten come together and recent analyst surveys34 on corebanking implementation programmes show that no single reason dominates,which doesnt surprise us given the complex and all-encompassing nature osuch programmes35. Those banks that ind themselves part way through aprogramme where these risks have materialised are in the diicult positionwhere the choice is either to give up and write o the investment or to keepgoing and spend much more money, oten without having a irm guaranteethat the programme will have a successul ending.

International Corporate BankA number o large banks are rolling out corporate bankingbusinesses around the world, in order to service their internationalclients and attract new corporate customers in developing markets.

Deloitte and Temenos have been working jointly with onesuch bank to support its ambitious expansion plans. The bankoriginally selected Temenos T24 as its core banking platorm andimplemented this in a global hub to support a number o countrybranches.

In order to accelerate its expansion into new countries, the bankthen asked Deloitte to assist with a review o banking regulations

and practices, employment conditions and the corporate bankingmarket in a range o countries and to deine a standard operatingmodel or each branch that would provide maximum economies oscale by using global operations and platorms wherever possible.

It became apparent through this review that use o a singleglobal banking hub would not be permissible in countries whereregulations required data to be held locally and a hub and spokemodel would be required.

We then worked with the bank to deine the end-to-end processmodels and business requirements or a country branch and thearchitecture or a branch where the banking platorm, T24, had tobe deployed locally. This gave the bank a detailed description o theoperations and systems it had to set up or each new branch and

thereore enabled it to adopt a repeatable approach to rolling out anew country branch.

This bank now has branches in a number o countries wherepreviously it did not oer corporate banking services, and is able toservice its existing international customers in these locations andattract new local corporate customers.

Case Study


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Select a great core banking product

Find the right partners and get them all aligned

Dene clear business requirements

Manage scope, with a ocus on adopt not adapt

Design the end-to-end solution with the aim o minimising complexity

Dene quick wins to sustain internal buy-in

Go step by step

Strong governance with executive sponsorship

Deliver smartly and put in place eective communication

Invest in a good business case and use it

Best Practices For Core Replacement


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Best practices or core replacement

Sources

36 For a general discussion o good practice in major programme delivery, see Start smart, fnish strong: Engineer your major programs or success, Deloitte, December 2011, available at www.deloitte.com/view/en_CA/ca/services/consulting/ac1d1498a69c4310VgnVCM3000001c5600aRCRD.htm

There is no silver bullet or a successul core banking platormimplementation, as it will depend on the characteristics o a bank andits particular context in the market. However, there is now much moreexperience in undertaking such implementations successully and in ourview there is a set o best practices that should be ollowed by banks inorder to reduce implementation risks36:

1. Select A Great Core Banking Product

There is oten a heavy ocus on unctionality during the selection o anew core banking platorm. This is, o course, important and somethingwe would regard as a minimum bar or selection. However, there areseveral areas that need a close examination as poor support or anyo them is likely to lead to severe problems during implementation,

including excessive customisation. Areas to examine include: Multi-channel architecture Support or all existing channels and

provision o a general ramework or supporting uture channels in amanner that minimises rework or each channel and supports cross-channel servicing

360 customer view Provision o an operational customer-centricview o product ownership and balances, even or products that arenot maintained in the core banking platorm itsel (e.g. oten creditcards), including support or credit risk management and corporatehierarchies and relationships

Product catalogue A ramework or deining new products andproduct variants and managing the lie cycle o products, providingaster time to market with support or governance around productdesign, launch and retirement

Integration Provision o a consistent integration ramework or realtime and batch interaces, ideally driven primarily by coniguration othe platorm rather than customisation. Speciic interaces such as orpayments and inance/GL should be supported out o the box

Management of data The ability o the platorm to manage hugevolumes o data that will be generated as it is used. This shouldinclude enabling historical data to be archived and deleted, supportor eeding downstream analytics platorms and operational datastores and support or master data management

High availability multi-entity architecture The architecture shouldenable 24x7 operation and a high availability dual site architecture,minimising or avoiding any impact on service due to end o day/end o period processing, supporting real time straight throughprocessing, and supporting multiple entities, jurisdictions, countries,

currencies and time zones Product architecture There should be a clear paradigm or what is

in the core product, what is regional customisation, what is nationalcustomisation and what is speciic or the bank, and what can beconigured versus requiring product customisation. Related to this,there should be a clear approach or implementing core productupgrades and a track record o existing users o the product updatingtheir implementations to the latest version

2. Find The Right Partners And Get Them All Aligned

Core banking suppliers should have a range o credible partners that canimplement their platorms, which reduces the risk o being locked intoa single provider. Invest time and eort in selecting the implementationpartner or partners that will work with you, bearing in mind that it isnot possible or even desirable to oload all the risk onto them. Considercareully the use o a single ixed price contract or the implementation in our experience these can give banks a alse sense that they havehugely reduced their risks and generate the wrong sort o incentives orsuppliers. Once you have selected a partner, aligning all parties aroundapproach and methodology is important and this process shouldinvolve the core banking platorm vendor as they will have their ownprocesses particularly around core product customisation.

3. Deine Clear Business Requirements

Clearly identiy the business requirements that should be addressedby the new core banking platorm, and do this as part o a thoroughprocess o reviewing the core banking platorm that has been selectedin order to gain a clear understanding o the target platorm. Businessrequirements should be the main ramework to manage the scope othe programme and be the common thread throughout all aspectso the programme delivery. In order to capture requirements and tostart evaluating the business change to be undertaken to adopt thenew platorm, a process-led approach should be used, taking end toend processes that cover not only the core banking platorm but alsosatellite systems and manual operations. This was an approach weollowed at a global bank that was rolling out corporate banking into

dozens o countries, giving it a standard process blueprint that it couldthen tailor to each country as required.

4. Manage Scope, With A Focus On Adopt Not Adapt

Making sure scope is properly managed is one o the key success actorsin ensuring delivery on the expected timelines. The entire organisationmust be aligned on the principles o scope management, ocusingon opportunities to optimise scope rather than inlating it. The keyprinciple or this is to adopt the new banking platorm, not to try toadapt it to legacy processes and unctionality.

5. Design The End-To-End Solution With The Aim OMinimising Complexity

One o the actors contributing to implementation challenges is the

complexity o integrating a new banking platorm into the existingtechnology landscape at a bank. A common approach to reducingcomplexity and the overall eort is to undertake a big bang migration orat least a series o big bangs by customer segment, which can avoid theneed to operate dual interaces with complex routing o data betweenold and new systems. We also recommend optimising the ootprinto the new platorm to minimise the amount o integration a biggerootprint can be easier to implement than a smaller ootprint withmore interaces. Finally, its also important to deine the end-to-endsolution which will cover many more systems than just the core bankingplatorm and using the end-to-end process approach described abovecan help with this.


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6. Deine Quick Wins To Sustain Internal Buy-In

Deine a roadmap with early deliveries to ensure the program hasachievable short term milestones. A transormation journey is a hardendeavour and needs these key intermediate milestones to ensure pressurepoints are present, motivation is continuous, and beneits are recognised.

7. Go Step By Step

Avoid jumping in to a new phase without having the sign o o thecurrent milestones. Starting new phases with previous deliverablesunder discussion is a real temptation and in most o the cases rework isthe reward.

Executive Sponsor

Steering Committee

Set the strategic direction or the programme

Manage executive communications

Operating Commitee

Make decisions aecting risks and issues

Manage executive messaging

Programme Management Oce

Coordinate activities across projects and assist inresolving issues, risks, actions

Facilitate programme communications

Technology Leads

Dene solution and identiy delivery issues

Project Managers

Collect status updates and escalateissues when required

Cascade key messages / decisions romprogramme leadership to the project team

Monitor and manage project progress

Dene business needs and identiy issues

Business Leads

Guidance On Overall Programme Executive Messaging

Programme Status,Including Risks, Issues,Actions And Decisions

Prioritisation And Direction

Provide Insight And Guidance Provide Insight And Guidance

Status

Status Feedbackand

Guidance Status

8. Strong Governance With Executive Sponsorship

Executive support and sponsorship must be present every singleday. This is not a side-project. It must absolutely be at the top o theexecutives agenda. Lack o management commitment is one o themain causes or programme ailure and is oten characterised by lacko scope control the principle o adopt not adapt covered abovegets compromised. A core banking programme needs business andmanagement support on a ull time basis and should not be labelledas an IT programme.

Below is an illustration o a typical governance structure:


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Sources

37 Metro Bank: Launching the UKs frst new high street bank or 100 years Deloitte case study dated 2011 available atwww.deloitte.com/view/en_GB/uk/services/consulting/strategy/0b6968e84aed210VgnVCM2000001b5600aRCRD.htm

9. Deliver Smartly And Put In Place Eective Communication

In the words o Paul Marriott Clarke, MD Retail Banking at Metro Bank,The big lessons or me are to work to challenging but achievabledeadlines, encourage institutional honesty about where we are, andensure eective communication37. Deine an eective communicationstrategy as well as a clear vision o the main beneits o the programme.Share with all people how they will beneit rom this big change.

The communication plan should:

Outline key communication priorities and needs o keyleadership groups

Ensure an integrated overall approach to programme governance,

ensuring that time is used as eiciently as possible to support a ast-tracking environment

Deine a detailed schedule or communication both within and betweengroups, including key inputs, outputs, and requency or meetings

Set guidelines and standards or communication developmentand delivery

10. Invest In A Good Business Case And Use It

The business case should be able to demonstrate cost savings (suchas lower operational costs) and increased revenue (such as a newoer range and a aster time-to-market). Metrics are undamentalto eectively measure the real value o the programme thus givingcomort to the banks shareholders and sponsors, and the business casecan be a key tool to support decision making during the programme.

Its interesting to compare core banking replacement programmeswith two other scenarios. The irst is the post-merger or post-acquisition integration o two banks, where there is typically anextensive programme to rationalise systems including core bankingsystems; typically the merged bank in this situation will chooseone o its existing core banking platorms as the strategic platormand migrate customers and accounts onto this, with the leadershipo the bank mandating acceptance o the unctional compromisesthat this may impose. The second is the Greenield scenario,where the IT estate has to be built and there is no data migration,and there is a ocus on getting to go live typically with a smallset o product variants, oten with a small, close-knit leadershipteam running the implementation. Both o these scenarios have

the common eatures o leadership ocus and drive to implementquickly, cutting through complexity and orcing rationalisationo both products and technology. We think an existing bankplanning on replacing its core system(s) could learn lessons romthese scenarios, and even adopt a similar approach, setting up aGreenield operation and IT estate and then migrating its existingcustomers onto it.

Benet

Growth

RegulatoryRisk

Customer /Brand

BusinessAgility

Cost /Eciency

Capacity /Eectiveness

Credit andOperational Risk

Description

Assets under management; top-line revenue;number o customers

Ability to adhere to changes in laws or regulations(e.g. SoX, AML, SEPA, etc)

Customer experience; quality o service; externalbrand; customer insights and analytics

Business changes and innovation; M&Aactivities, major project delivery; uture fexibilityand extensibility

Eciency o on-going operations; run-timecosts; application portolio complexity; STP

Capacity and eectiveness o the bank to delivertechnology-enabled solutions

Ability to manage credit (e.g. loan losses,

receivables) and operational risks (e.g. raud etc.)

Indicators

New Revenues Deposit Base

Regulatory ComplianceCosts

Net Promoter Score Share O Wallet

Net Promoter Score Share O Wallet

Operational Costs Eciency Ratio (NIX) HW/App Reduction

#Changes Supported #Major Incidents #FTEs Required

Loan Loss Provisions

Traceability #Security Breaches

RUNthe Business

MANAGEthe Business

CHANGEthe Business


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Metro Bank38

In October 2007 the banking industry was in meltdown. It hardlyseemed an auspicious time to launch a new bank. However, theounders o Metro Bank thought dierently.

In 2008, Vernon Hill and Anthony Thomson asked Deloitte to helpthem write a business case or a new breed o bank. It would openseven days a week, allow you to set up an account instantly, and yourdog would be welcome too.

Metro Bank then selected the Temenos T24 banking platorm andsubsequently asked Deloitte to support its UK banking licenceapplication and run over a period o 8 weeks the selection o an

IT hosting partner. Following this achievement, Metro Bank askedDeloitte to supply an Acting CIO to manage the delivery o all ITinrastructure and services up until launch.

Despite the economic downturn, Metro Bank launched successully on29 July 2010. Using the Temenos T24 banking platorm means thatMetro Banks IT is undamentally less complex than those o other UKbanks. This has enabled Metro Bank to achieve a number o marketirsts - including allowing customers to open current and credit cardaccounts, and receive their debit and credit cards, and a cheque bookon the spot.

The press welcomed a genuine alternative to high street banks thatcould raise the bar or service in the industry. Meanwhile Metro Bankacknowledges Deloittes IT expertise as core to its success in launching.


38 Both Temenos and Deloitte have written detailed case studies about Metro Bank, which can bedownloaded at: www.temenos.com/proft and http://www.deloitte.com/assets/Dcom-UnitedKingdom/Local%20Assets/Documents/Services/Consulting/UK_C_Metro-bank.pd, respectively

Case Study


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Between 1980 and 2007, the banking industry enjoyed somewhat o agolden age, during which strong economic undamentals, coupled withderegulation and high leverage, sustained higher returns on equity thanat any other time in the industrys history.

However, the proitability outlook or banks has deteriorated. In thepost-crisis context, governments are seeking to make the industrysaer by introducing tougher regulations, or example, enorcing highercapital adequacy levels. Funding costs have increased in line with arelative shrinking in the wholesale market. Markets have become morehighly contested with the arrival o new competition, such as retailersoering retail banking services, and banking customers are takingadvantage o more competition and ever greater pricing transparency

levels to oblige banks to improve service at the same time as loweringprices. All in all, banks RoE levels have come under pressure and,compared to pre-crisis, a proitability gap has emerged, which weestimate to be around USD310bn.

In this report, we have set out the ways in which core bankingreplacement could help banks to raise RoE. We have argued, givingconcrete examples, that modern, third-party core banking systems giveour levers to improve RoE, namely, the ability: to cut costs sustainably to raise asset yield with existing businesses to move quickly and easing into more proitable banking segments to extract economies o scale rom organic and inorganic growth

Banks running modern core banking systems have taken advantage o

these characteristics to generate superior proitability. In this report,we have shown, using publicly-sourced inormation, that banks runningmodern, third-party core banking system enjoy higher proitabilitythan banks running legacy systems a 37% higher return on capital,or instance while the relative proitability o Temenos customers ishigher still.

Applying this analysis to the proitability gap has led us to concludethat universal adoption o modern, third-party core banking systemscould enable the banking industry to reduce its USD310bn proitabilitygap by between 25% and 60%; that is, in the scenario o all banks usingsotware rom Temenos, we have argued that the banking industryspost-tax proits could rise by c.USD180bn.

Although these indings are compelling, ew banks in relative terms

have acted to modernise systems to date since there has beenminimal market sanction or not doing so, but we believe banks canno longer wait. In the developed world, given structurally higher costsand the compounding eect o aster growth in costs than revenues, webelieve that the industry could be rendered unproitable within 10 yearsi it ails to act. While in emerging markets, more rigorous competitioncoupled with growing customer sophistication will oblige banks toraise service standards at the same time as lowering costs to serve,meaning that they will need to tackle technology ineiciency to staycompetitive.

In the inal section o this report, we have looked at why core bankingreplacement projects have tended to ail in the past and haveoered a comprehensive set o best practices to minimise risks andmaximise returns rom these modernisation projects. We have given

some concrete examples o where banks have adhered to these bestpractices to realise highly successul outcomes rom their core bankingreplacement projects.

Summary


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Authors

TemenosBen Robinson is Director o Stategy at Temenos, based in Switzerland,and can be contacted at [email protected]

Chris McGinnis is an Associate Director in the strategy team at Temenos,based in London, and can be contacted at [email protected]

DeloitteTim Walker is a Partner in the inancial services consultancy practice atDeloitte UK, based in London, and can be contacted at [email protected]

Joo Sales Caldeira is an Associate Partner in the inancial servicesconsultancy practice at Deloitte Portugal, based in Lisbon, and can becontacted at [email protected]


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www.temenos.com

TEMENOS, TEMENOS , TEMENOS T24 and are registered trademarks oTemenos Headquarters SA

2012 Temenos Headquarters SA - all rights reserved.

W i Thi d i d b i h l d i i l i U h i d d i hi d

Founded in 1993 and listed on the Swiss Stock Exchange (SIX: TEMN),Temenos Group AG is the market leading provider o banking sotwaresystems to retail, corporate, universal, private, Islamic and microinance& community banks. Headquartered in Geneva with 64 oicesworldwide, Temenos has over 1500 customer deployments in morethan 125 countries across the world.

About Temenos

According to IBS Intelligence, which maintains an annual league table,TEMENOS T24 has been the irst or second best selling core bankingsolution or the last 14 years and in 2010 was the best selling solutionor the ourth year in a row. Forrester ranks Temenos as its sole globalpower seller (Forrester Global Banking Platorm Deals Report 2011)and Temenos has been the winner every year since its launch o theBest Core Banking Product in Banking Technology magazines ReadersChoice Awards. In 2011, Temenos also received two Financial SectorTechnology magazine awards - Best Use o IT in Retail Banking or theMetro Bank project and Technology Provider o the Year.

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Deloitte LLP is the United Kingdom member irm o DTTL.Deloitte & Associados, SROC S.A. is the Portuguese member irm oDTTL.

About Deloitte

This publication has been written in general terms and thereore cannotbe relied on to cover speciic situations; application o the principlesset out will depend upon the particular circumstances involved andwe recommend that you obtain proessional advice beore actingor reraining rom acting on any o the contents o this publication.Either Deloitte LLP or Deloitte & Associados, SROC S.A. or would bepleased to advise readers on how to apply the principles set out in thispublication to their speciic circumstances. Neither Deloitte LLP norDeloitte & Associados, SROC S.A. accepts a duty o care or liability orany loss occasioned to any person acting or reraining rom action as a

result o any material in this publication.

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