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A decade of IT change since banking meltdown

With 10 years passing since Northern Rock had to be bailed out by the government, we look at how banking IT has changed since the financial crisis

This article can also be found in the Premium Editorial Download: Computer Weekly: How banking technology has changed since the crash:

In the 10 years since the global financial crisis, the core systems of banking IT have not changed much but IT departments and CIO strategies have had to.

It has been almost a decade since Northern Rock was forced to get an emergency loan from the Bank of England and was nationalised to prevent it from breaching solvency rules. Panicked customers queuing outside the bank to rescue their savings became one of the lasting images associated with the financial crisis.

Although cracks began to appear in 2007, it was in 2008 when the banking carnage cranked up a gear with bank collapses, bail outs, forced mergers and another nationalisation.

It became fully apparent that there was trouble in the financial system by September 2008 when US investment bank Lehman Brothers entered administration after 150 years in business.

This – along with other industry shocks, known collectively as the credit crunch – was the beginning of a fundamental change in the banking sector. The credit crunch put huge pressure on IT leaders in the sector as banks collapsed, merged and cut costs, and thousands of IT jobs were lost over the following years.

The Lehman Brothers collapse was the biggest headline grabber, but there were many others. The credit crunch had already caused problems for US mortgage lenders Fannie Mae and Freddie Mac, which had been bailed out by the US government only a week earlier.

In the same month as Lehman Brothers’ demise, the US government injected £47bn cash into insurer AIG to shore up its business, and initiated a takeover of investment bank Merrill Lynch by Bank of America.

In the UK, the government brokered the acquisition of Halifax Bank of Scotland for £12.2bn by Lloyds TSB, and the Royal Bank of Scotland (RBS) was nationalised when the government took a 63% share for £20bn of taxpayers’ money.

The UK was not alone, with the economies of some nations, such as Iceland, on the verge of collapse. In late September 2008, it was announced that the Glitnir bank would be nationalised, then in October the Icelandic Financial Supervisory Authority took control of Landsbanki and Kaupthing banks.

The crisis also went beyond banking. The collapse of high street retailer and British icon Woolworths in 2008 signalled that the combination of credit crunch, financial services sector turmoil and recession was claiming victims in all fields.

Fixing the system

Since then there has been regulation galore in an attempt to fix the system that had revealed its vulnerabilities during the crisis, as well as the risks posed to the global economy.

The ramifications for banking IT have been huge, with systems introduced that are essential to ensure that banks can meet strict regulations and to weed out those that cannot.

One example of a change brought about by the credit crunch is that regulators have been determined to prevent the actions of an investment bank affecting ordinary people.

The financial crisis of 2008 was caused by investment banks, but hit retail banks because they were part of the same groups. As a result, regulators introduced rules to force banks to separate the businesses and ring-fence legislation, which must be adhered to by January 2019.

“All in all, you could argue that 10 years on we are only just beginning to see the effects of the crisis on systems,” said Ovum analyst David Bannister.

“[The ring-fencing] marks a bit of a watershed, but the biggest change has been that increased regulation has forced banks of all kinds to invest the majority of their IT spend – as much as 70% – on systems to deal with improved regulatory oversight,” he added.

One senior IT professional in the UK banking sector agreed that the main change to IT has been a greater focus on risk management and regulatory related systems. “I think IT is seen as one of the main ways to detect early if a firm is running into trouble or breaking any rules, or if staff are going rogue,” the IT professional said. 

“Before the crash, I remember we were doing development around faster trading systems, better customer systems, getting on the internet, mobile services and new products. After the crash it was all about risk, control, regulation, reporting, and compliance.”

Banks rely heavily on computer systems and spend billions of pounds on IT, and any change in regulation means an IT project, which, in turn, means diverting budgets. Banks already spent 80% of their IT budget on maintaining systems and then had to find money to invest in regulatory systems.

“IT went from being interesting before the crash and changed into dull and boring afterwards,” the IT professional said, adding that the sector is no longer guaranteed to attract the cream of IT talent. “IT folks want to work for the big tech firms now rather than the tarnished financial services industry.”

But while IT departments’ work and spending have transformed, the core IT itself has hardly changed for many banks in the 10 years since the crash, according to Bannister at Ovum.

“In terms of their main IT systems, the larger banks still have a lot of ageing batch-based boxes, with all the issues that creates as their customers adopt mobile, 24/7 real-time banking,” he said, adding that this is not only a problem for the retail banks.

The fintech approach

But the changes to the work of internal teams has had a knock-on effect. The focus on regulation reduced the budget to invest in technology to improve services to customers.

This is something banks were not as worried about before the crisis because there was not a lot of competition, but things have changed and much of this can be put down to regulatory efforts to increase competition in the banking sector.

New banks were formed alongside a new technology industry when the regulators set out to reduce the dominance of the traditional high street banks by regulating to make it easier for new banks to be set up in the UK. At a time when traditional banks were extremely unpopular, this was a recipe for change.

The emergence of new banks without the scale of the big banks meant a different approach was needed – enter financial technology (fintech).

Fintech is the buzzword for digital financial services technology. This is often app-based technology that automates many banking processes and offers easy access and self-services to customers. Today entire banks are built around a mobile app.

The fintech industry is seen as way for the traditional banks to join in the fun without the need to do the work in-house. With thousands of banking IT jobs cut over the past decade, the regulatory pressure as well as the maintenance of legacy systems to deal with resources and time was scarce. This makes outsourcing development to fintechs an attractive proposition.

Although not a direct consequence of the financial crash, the environment for fintech to thrive was created. Customers were unhappy with traditional banks and were looking for more choice and digital services. Meanwhile, banks were looking for IT development from third parties while their internal teams focused on keeping the lights on and ensuring compliance.

This perfect storm meant fintech rose from an buzzword to a thriving industry sector very quickly. With a customer base including some of the biggest companies in the world, it is no surprise fintech is attracting money.

For example, US investment bank JP Morgan Chase spent $9.5bn on technology in 2016. Out of the total spending, around $6.5bn was spent on supporting existing IT, while the remaining $3bn went on new initiatives, including around $600m on fintechs – and that’s just one bank.

Figures from Innovate Finance, the fintech trade body, in February 2017 revealed that venture capitalist investment in the fintech sector globally reached $17.4bn in 2016. UK universities are even offering courses in fintech.

An IT professional in banking, who wished to remain anonymous, said the rise of fintech and the financial crash are not directly linked but a case of “banks reaching the same conclusions and starting looking outside for solutions”.

The financial struggles caused by the crisis was a factor in this as regulation and job cuts heaped more pressure on in-house IT teams. “In banking, it is hard to get IT budget for open-ended innovation that may not pay off. If you are not sure it will yield a result or how long it will take, it is hard to get funded when competing with the essentials,” the IT professional said.

“The banks decided to review what was being created by the startups and then back the ones they thought were promising. So the banks reduce risk, widen their reach and get solutions that they might never have dreamed up.”

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