Is Technology Getting Cheaper for Small Banks?

The good news is the cost of technology is going down. The bad news is, banks are spending more on it anyway.

As customers demand better technology from their banks, and banks scramble to meet the demand while at the same time increasing their cybersecurity and regulatory compliance spending, budgets for technology services are increasing. And even as the cost of data storage goes down, many organizations aren’t seeing significant cuts to spending. But there is some hope for small and midsized banks. Many software applications and cloud-based storage solutions eventually will achieve efficiency gains, and banks will reap the benefit of that. Bank boards can get involved in strategic discussions with management about the long-term role technology will play at their banks, asking questions about how the bank’s technology program fits with the bank’s strategic plan.

For now, it’s helpful to start learning about where banks may achieve cost savings in the future. The Toronto-Dominion Bank, based in Toronto, with its 90,000 employees and 110,000 Microsoft Exchange Online mailboxes, says it saved 50 percent in email costs by switching to Microsoft’s in-the-cloud Office 365 product. According to an industry publication, Commonwealth Bank of Australia said it used to take eight weeks and several thousand dollars to set up a new server. It now takes minutes to make changes in the hybrid cloud, and the bank is much more responsive to customer needs.

The problem is that banks are using more data, but they’re also using more technology, so their overall spending is increasing, says Brad Smith, who has 25 years of experience consulting on technology for community banks and is the leader of technology solutions for Cornerstone Advisors.

“We are gaining a lot more efficiencies from technology,” Smith says. “Unit pricing has come down. The cost of debit transactions has come down. The cost of core processing on a unit basis has come down. But we are buying a lot more technology.”

Smith says bank technology infrastructure costs are flat or starting to drop, in part because banks are getting larger and tend to get some pricing efficiencies as they increase in size, and because of movement to the cloud, which allows banks to outsource managing their own servers to private, dedicated servers and public, shared cloud services, such as those offered by Microsoft or Amazon Web Services. The banking industry’s core providers such as Fiserv and FIS are increasingly moving into the cloud as well.

The numbers at Cornerstone Advisors bear out the changing costs. Every year, the consulting firm does a benchmarking report for midsized banks. It found that the median spending on core systems dropped from 0.053 percent of assets in 2012 to 0.043 percent in 2017. Costs as a percentage of assets drop as a bank becomes larger, and the median size of the bank in the survey rose from $2.04 billion to $3.14 billion in assets during that time frame. Core processing includes running core deposit, lending, general ledger and member information file systems.

However, overall spending is up, both as a percentage of assets and noninterest expense. For example, the median bank’s technology spending as a percentage of noninterest expense rose from 8.3 percent to 9.2 percent in that time frame, or $5.5 million to $8.2 million.

Smith says banks are spending more on digital and strategic investments, including better loan origination systems, sales and marketing systems, internet and mobile banking, payments, and treasury management. They’ve also begun spending more on regulatory technology during the last five years, for improved fraud and anti-money laundering detection systems, and for systems that help banks keep up with the increased rules coming out of the Dodd-Frank Act.

“You’re still paying for people, but you have to spend more time and effort on cybersecurity, on computer systems, on electronic delivery,” says G. Scott McComb, chief executive officer of Heartland Bank, in a suburb of Columbus, Ohio. The $884 million asset bank spent $840,000 last year on technology, including internet and mobile banking, as well as core processing, up from about $690,000 five years ago, about a 21 percent increase, he estimates.

He’s particularly frustrated by core technology providers, which have traditionally provided the bulk of the community banking industry’s technology needs. “Technology has been hampered at community banks by the core systems,” he says. “[The core providers] are just behind.”

McComb hopes the industry will hold the core providers accountable, so community banks don’t fall behind when it comes to the technology that their customers demand. Now that the industry has recovered from the financial crisis, more small banks and their boards are asking questions about where they need to invest to move forward, he says.

“[Those who] thrive and survive are starting to say, ‘We can’t punt on this technology decision anymore. We have got to figure out where we’re going to be in the next five years,’” he says.

One bank that decided not to punt is ConnectOne Bank in Englewood Cliffs, New Jersey, a $4.7 billion asset bank that purchased nCino’s Bank Operating System, which uses a cloud-based platform built on Salesforce.com to provide a whole host of services: customer relationship management, loan origination, account opening and more.

“This is a more efficient way of doing it than the platform we have today,” says Frank Sorrentino III, the bank’s chairman and chief executive officer. “We will be able to grow more with fewer resources.”

He admits it will be more expensive in the short run to implement nCino’s platform, but believes efficiencies will be achieved later. Thinking of technology solely as a way to save money is the wrong way to think about it, he says.

“I come from a construction background, and you always had to go to a job making sure you had the right tools and [that you] sharpen your tools,” he says. Banking is no different, he says. Banks have to think about their business models and their strategy for serving their customers, and implementing the right technology is part of that strategy.

There is some hope that with all the competition in the marketplace, small banks will be able to improve their technology and lower costs, and there will be viable competition to the larger core providers. Jost Hoppermann, vice president of banking applications and architecture at the research firm Forrester, says artificial intelligence, robotic process automation and machine learning have the potential to reduce costs, and are becoming affordable for small banks as well.

Many more vendors are now selling applications off the shelf that banks can customize to fit into their existing offerings, so the internet banking program, for example, looks like the mobile platform. Some examples include nCino, digital platform provider D3, Kony, which offers mobile banking solutions, and Avoka, which offers a way to onboard new customers quickly.

Finxact is a new competitor to the traditional core providers, offering core as a service through the cloud with an open API (application programming interface) that will tap into technology vendors, making it easier for the bank to pick and choose the vendors it wants. It has two banking customers working to launch with the service early next year. Small banks are generally reluctant to try new vendors, let alone a new core processor, when those vendors don’t have a lot of customers. But for some banks, taking on risk is a part of the equation.

ConnectOne Bank, for example, doesn’t just want to save money and avoid risk, but plan for the future. “A big fear for boards is that we can never make a mistake,” Sorrentino says. “I could show you a wheelbarrow full of [mistakes] that we’ve made. We’re not afraid of small failures.”

What Bank Boards Should Ask About Technology

1. Ask questions about your technology strategy and how it fits with your business strategy.
2. Ask about your return on technology investment and how your tech spending compares to peers.
3. For the largest investments, ask about expected costs and benefits, and the vendor, technology and implementation risks involved.

u2013Brad Smith, Cornerstone Advisors