A new report by Deloitte found that banks are facing increasing competition from alternative lenders and technology providers and that they need to adapt how they use IT themselves if they want to maintain their position in the market.
However, short-termism, risk aversion and a lack of suppliers are factors behind banks' reluctance to overhaul their legacy IT systems, Deloitte said.
The professional services firm said there are "compelling cost advantages" for banks that decide to upgrade their core banking systems despite the "significant" costs in doing so and the fact it would be a "major endeavour" that could be considered a "'one in a lifetime' investment".
However, technology and financial services law expert Yvonne Dunn of Pinsent Masons, the law firm behind Out-Law.com, said banks need to balance cost constraints against the need to provide great customer service and the risk of reputation damage if systems fail when weighing up whether to introduce new technology into their business.
"In the financial services sector a raft of new providers have entered the market and been able to deploy new technology from more modern IT infrastructure in a bid to steal elements of traditional banking business," Dunn said. "In addressing this challenge posed by technology, many traditional banks face cost constraints that make a large scale overhaul of their legacy IT infrastructure, some of which it may have been operating for 40 years, impractical."
"However, changes to the regulatory environment and the increased focus on the customer means that banks are having to increase their IT expenditure to ensure the resilience of their systems and avoid the damage to their reputation that can be associated with outages," she said.
In its report, Deloitte said that technology and new regulation is threatening the business models of traditional European banks (32-page / 1.23MB PDF) and that they need to "redefine themselves" to meet the challenges of the digital age. It said that banks may be reaching a point where it is becoming too expensive for them to operate with legacy systems at the core of their business and that there is an ever growing business case for the companies to move to new technology platforms.
"Given the compelling cost advantages of modern, rather than legacy, core banking systems, what explains the reluctance of banks to make the change?" the report said. "The answer appears to be a combination of short-termism, risk aversion and lack of suppliers".
Deloitte said that mid-sized banks may be spending more than €100 million each year in facilitating "'non-transformational' change" on legacy systems, mostly to reflect regulatory obligations, whilst a similar amount is spent by the organisations, including on IT, just to maintain operational functionality. It said, though, that banks have chosen to avoid huge overhauls to their core IT systems because they view making small changes to those legacy systems to be "the path of least resistance".
However, the costs involved in operating and maintaining legacy IT systems can wipe out some banks' profits, it said. Whilst banks may have previously turned to mergers and acquisitions to address the challenge in meeting "the cost of capital", regulators may view this as a "step back in their ambitions to reduce systemic risk and to introduce more competition between banks", Deloitte said.
Instead, banks must radically reduce costs and "re-invent their technology infrastructure" via more outsourcing arrangements so as to address competition from new market entrants and alternative lenders, it said.
In addition to cost-cutting, banks must look to improve their offerings to, and relationships with, customers, it said. Deloitte said that banks may be able to use the data they hold on customers to offer more responsive services, such as "by optimising spending patterns, delivering tailored reward programmes and even seeking out discounts on customers' behalf".
"The central challenge is that banks have designed their IT systems to support processes that deliver products across multiple channels," Deloitte's 'Banking Disrupted' report said. "Bank systems are, therefore, arranged around products rather than around customers. Digital transformation, on the other hand, demands that customer data be leveraged to provide services at the point of need."
"[However], the rich customer data banks collect often gets lost within product silos. Turning this product-centred model on its head would allow banks to serve not just customer needs but also to capture their experience and address their future expectations," it said.