Focus on Technology Spending

Advances in technology have radically altered the face of banking over the course of the last few decades. For example, it is now possible for a community bank located in Maryland to serve customers anywhere in the world, provided those customers have access to high-technology touchpoints like ATMs and Internet banking. Like all companies, however, banks need to be circumspect in spending, and technology outlays are no exception.

“Community banks over the last five to seven years have gorged themselves on technology spending,” observes Erik Hoghaug, the technology practice manager at Alex Sheshunoff Management Services, Austin, Texas. The technology imperative for 2003, he suggests, will be how to make the best use of technologies that are already in place. “You can’t be buying technology willy-nilly,” Hoghaug counsels, adding that the true cost of technology will always exceed the purchase price. “When you purchase [a new] technology, you’re taking on expenses for as far as the eye can see.”

Certainly, technology is a huge cost center in banking. The TowerGroup, Needham, Massachusetts, estimates banks worldwide will spend $38 billion to $40 billion on information technologies in 2003. But most of that spending will be for maintaining core technologies that keep the bank running, explains Lee Kidder, TowerGroup’s director of wholesale banking research. Only about 10% will be spent on new technology and strategic initiatives. “These projects are vying for a small pool of money,” says Kidder. “The decisions come down to what offers the best returns.”

Yet the decision yardstick isn’t just calibrated in dollars and cents. Regulators are sharpening the focus on bank technology initiatives. Thus there’s a very real possibility that technology initiatives poorly executed will have regulatory, perhaps even legal, consequences for a bank. The FDIC, for example, has new examination procedures for assessing information technology risks at the banks it supervises. Under the new procedures, each bank is assigned a technology risk rating based on reviews of its core processing systems, internal networks, electronic banking products, connectivity to external networks, location off sensitive information, and assorted other technology issues, the FDIC wrote in an October letter to bank CEOs. The rules apply whether the technology is maintained in-house or provided under a service bureau arrangement, the agency said.

“We’re seeing banks that are getting dinged on exams over this,” says Hoghaug. He advises banks to put in place strategic risk analysis processes, akin to the vendor analysis and contingency planning routines that were adopted in anticipation of Y2K technology glitches. “From a technology standpoint you need to know what’s in place, where the gaps are, and what issues you have to address,” explains Hoghaug. And the analysis needs to be done at least once a year. “It’s an ongoing process,” he says.

In situations involving third-party providers, Hoghaug counsels banks to develop service-level agreements and to hold vendors to those agreements. “As a director, you need to be asking if these things are being done,” says Hoghaug, a former community banker.

Compliance issues raised by the USA Patriot Act and resulting regulations will also influence technology spending this year. “Banks are going to have to spend money in order to improve the disclosure and reporting of suspicious transactions,” explains Kidder.

Integration of systems and processes will drive much of that spending. “You need all your systems to be able to communicate with each other,” says Kidder. “Without systems integration, you can’t provide services like Internet banking and check imaging.”

Adds Maggie Scarborough, an analyst with IDC, Framingham, Massachusetts: “There needs to be service consistency across all channels, in the back office as well as the front office.”

In other words, customers accessing their accounts should have the same view regardless of the access channelu00e2u20ac”ATM, branch, call center, or the Internet. Today, this is more the exception than the rule in banking. Several trends are forcing this to change, however, including electronic payment initiatives and the Internet.

More than half (53%) of community banks polled by the Independent Community Bankers of America had an Internet presence in 2002, and 74% of those banks offered banking services through their websites. Almost half (47%) were processing checks with the help of digital imaging systems, and nearly as many (41%) planned to install check imaging systems in 2003 or 2004, according to the ICBA.

Several initiatives are under way today that stop the paper shuffle associated with check clearing, including so-called “truncation” schemes, where paper checks are converted to electronic transactions that clear through the automated clearinghouse (ACH) system. And there is a growing body of evidence that consumers will embrace truncation schemes in which they forego the return of canceled checks. Dove Consulting, Atlanta, reports 36% of consumers would accept a truncation program that converts checks to electronic payments; most (85%) want access to images of paid checks via their banks’ websites.

That’s good news for banks, because “the cost of an Internet transaction is close to nothing,” (about 2 cents), according to Kidder. On the other hand, the cost of a call center or branch handling a customer’s request for a copy of a truncated check could run as high as $3 per transaction, by Kidder’s reckoning.

Top 10 Technology Imperatives

So, what are the top technology imperatives for community banks in 2003?

1. Integration. This is the number one imperative, and certainly something that warrants attention from the board. Integration is critical in back-shop operations and for customer-facing access channels, like ATMs, branches, and websites. Integration enhances customer service, promotes profitability, and helps keep banks from running afoul of new reporting requirements, like those imposed by the USA Patriot Act.

2. Understanding technology risk, especially for those technologies that touch customer transactions. With examiners paying close attention to bank uses of technology and consequential exposures to risk, it becomes ever more critical that boards of directors understand their banks’ strategic technology plans, whether those plans can pass muster with regulators, and in cases where service bureaus are used, how those vendors meet their banks’ strategic goals. “This is a continuation of what we learned preparing for Y2K,” explains Hoghaug.

3. Imaging. Nearly all community banks (88%) are expected to be using check imaging applications by 2004; 84% will have implemented document-imaging technologies in areas such as lending.

4. Internet. Experts agree: These days, banks must be Web-enabled to remain competitive. And there are plenty of inexpensive off-the-shelf products to get the job done.

5. Ensuring customer privacy and security. “There’s a lot of concern on this score on the part of customers,” Kidder says.

6. Combating check fraud. Imaging and electronic-clearing technologies will help on this front, but there are other technology toolsu00e2u20ac”like signature verification systemsu00e2u20ac”that merit attention.

7. Electronic payments. It’s the 21st century and electronic payments are coming of age. In fact, some experts believe electronic payments will soon outstrip checks. Banks need to prepare for the switchover.

8. Branch automation. While investments in branch technologies have ebbed in recent years, Kidder anticipates increases this year in funds earmarked for branch automation projects. “People will always want the option of going into branches,” he says.

9. E-mail archival. It sounds like something from out of left field, but some experts suggest that the more banks rely on e-mail for customer and in-house communications, the more critical it becomes to archive these communications. “Three years from now, if somebody sues the bank based on statements made in e-mails, you had better have a way to access those e-mails,” says Dick Poje, a bank consultant based in Barrington Hills, Illinois.

10. Getting the most from existing technologies. Good old-fashioned advice: “It’s time for banks to focus money and time on [technologies] they already own and on getting a better bang for the buck,” Hoghaug says. |BD|