Staying Ahead of the Technology Curve

Here’s a piece of sobering news: Within three years, all but 25% of U.S. commercial banks will offer small business customers the ability to initiate electronic payment instructions via the Internet, according to a report just released by Meridien Research, a Newton, Massachusetts-based financial technology research firm. “What that means,” says Maggie Scarborough, the Meridien analyst who authored the report, “is a lot of banks will soon be in the position of having to adopt electronic ACH [automated clearinghouse] and wire-transfer-initiation capabilities. The question is: Are they prepared?”

Scarborough says research and experience (she spent about 20 years in bank cash management services) suggests that for large numbers of banks, especially community banks, the answer is no.

Take wire transfersu00e2u20ac”the same-as-cash, large-dollar electronic transactions used to fund everything from automobile loans and real estate transactions to multicurrency deals. While the customer interface to the bank may appear to be electronic, often, once the wire initiation request reaches the bank, it gets printed out in the operations area where someone then turns around and re-enters the information into a standalone computer which feeds the data to the Federal Reserve’s wire transfer system, FedWire. “That can get real risky, especially when transaction volume builds,” explains Scarborough. “Plus, PATRIOT Act compliance, when done manually, further slows the process and creates opportunities for serious errors,” she warns.

The U.S. PATRIOT [for Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism] Act, enacted in the wake of the September 11, 2001 terrorist attacks, imposes tough new federal reporting requirements on banks and other financial institutions, with the intention of staunching funds flows to terrorists.

Yet, it’s not just PATRIOT Act compliance that should make bank board directors take notice of their institutions’ technology investments and strategies. All too often, experts say, financial institutions are simply ill-prepared, technologically, to respond to customer demands, especially in the face of new regulatory requirements and market changes.

Technologies related to demand deposit accounts (DDAs) are perhaps the most obvious example. DDAs long have served as the lifeblood of the customer-bank relationship. And because of this, banks invest billions of dollars a year in the encoding and high-speed sorting equipment, transportation and correspondent relationships necessary to quickly and efficiently process and exchange checks, the negotiable instruments most commonly used to access DDA funds.
The payback, historically, has been satisfactory, if not excellent. Various studies by the Federal Reserve, including the Functional Cost Analysis Studies from the mid-1990s, suggest that it costs a bank about 14 cents to clear and settle a checku00e2u20ac”roughly the same, if not a tad less, than it costs to process an ACH transaction. A 2002 report by The Boston Consulting Group estimates that payments (which most commonly originate from DDAs) account for up to 35% of total U.S. bank revenues.

But like so many other things in business and life in general, the cost dynamics of checks changed dramatically after September 11, 2001. With millions of paper checks sitting on runways as U.S. air traffic came to a halt for days, the Fed reportedly had to pump billions of dollars of liquidity into the banking system. The most obvious consequence: After years of lackluster support, electronic check clearing suddenly was nudged onto the Fed’s legislative agenda. A Fed-authored bill pending in Congress now, and given a decent shot at passage during the 2003-04 Congress (the “Check 21 Act”) seeks to dismantle the legal barriers that have so far thwarted nationwide electronic check collection schemes.

If that isn’t enough to create cause for concern the next time your board takes up a relatively routine request for check processing technologies, consider that after years of escalating usage, even as they adopted new and emerging electronic payment instruments (like debit cards), Americans are writing fewer checks, but still, they’re writing a lot: about 42.5 billion checks in 2000, the most recent year for which Fed data is available. (By comparison, retail electronic payments, like credit and debit cards and ACH transactions, totaled about 29 billion in 2000.)

“Definitely, electronic payments are gaining critical mass, and that’s going to make a difference in bank technology budgeting decisions,” says Steve Ledford, president of Global Concepts Inc., an Atlanta-based research firm that was commissioned by the Fed to help gather and analyze data for its 2000 retail payments survey. “But you can’t afford to just walk away from checks, because they’re going to be around for quite some time.”

It’s a tricky balancing act: understanding when to turn off the money spigot that supports legacy technologies and open the spigot wide for new and emerging technologies, say, for example, wealth management tools.

“Commercial banks compete in the marketplace on the basis of face-to-face service,” explains Jim Eckenrode, group director for consumer banking research at TowerGroup, a Needham, Massachusetts-based research and consulting firm. “The problem today is there’s not a lot of money available to spend on technologies that will support banks in continuing to compete on that dimension.”

The technologies needed to support new levels of customer expectation are out of reach, financially, for many community banks. TowerGroup, for example, estimates commercial banks will spend $2.3 billion this year on information technologies that support wealth management; in 2005, TowerGroup expects the toll will reach $2.7 billion. That’s why Eckenrode and others expect many community banks will turn to third partiesu00e2u20ac”outside companies that already handle banks’ core functions, like transaction processing and accountingu00e2u20ac”to support and supply an increasing share of new and emerging banking technologies.

In anticipation of the trend, many of these core processors are expanding product and service lines. For example, Metavante, the technology subsidiary of Marshall & Ilsley Corp., Milwaukee, recently purchased Spectrum, an electronic billing switch launched in 1999 by a group of large banks to compete with non-banks like CheckFree Corp., which dominates the electronic bill-payment and presentment business.

“A bank today can get a much broader footprint of technology from core processors than it could five years ago,” says Eckenrode.

“It just makes sense,” adds Jeanne Capachin, a research director with Meridien. “With a third party, you have predictable operating costs, and that’s critical.” Plus, there’s no overhead and no outlays for retraining staffers on new technologies, Capachin adds.

Tom Gorman, president of Fiserv Custom Outsourcing Solution, a Pittsburgh-based business unit of Fiserv Inc., says in the past two years his company has delivered 107 enhancements across the various applications it supports. The design of these enhancements, as well as priorities for delivery, were worked out in partnership with client banks, he adds. Among the enhancements: new and improved services designed to help banks capture more of the wealth management market, that looming cache of investment income now controlled by aging baby boomers.
Fiserv also developed a new cash management service, with the assistance of an $8.1 billion client bank and its calling officers, Gorman says. That service is now available through 10 customer banks, which combined, offer it to 2,100 different business clients.

Fiserv uses an IBM mainframe to support its outsourcing operations, and browser-based technologies for customer access/delivery. It’s a pretty standard configuration, and one that offers an outsourcing company and its clients a lot of capacity for growth. For example, it makes a bank’s decision to grow by acquisition easier to justify. “From a pricing perspective, they can grow that way and the direct costs from us don’t go up,” explains Gorman.

It’s also easier to plug and play with other companies’ technologies. “We’re not pushing a Fiserv-only solution,” says Gorman.

In the long run, experts agree, it will be this degree of flexibility that differentiates the technology winners from the losers on the community bank front. “Banks need to be looking at the investments they’ve made in technologies and determine if they still make sense,” says Capachin. It may just be time to retire a few of them.