Worldwide Banking 2008 Top 10 Strategic Initiatives: CIOs Flex Their Muscles

Consumer Banking and Credit Advisory Service Corporate Banking Advisory Service Global Risk Management Advisory Service Payments Advisory Service
LOOKING AHEAD Jeanne Capachin Maggie Scarborough S e a n O ' D o wd Douglas Jaffe Dana Gould #FIN209204 Christine Pratt Aaron McPherson Michael Araneta Rachel Hunt Robert Burbach

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FINANCIAL INSIGHTS OPINION The power of the CIO is increasing, as is the CIO's ability to command more of the IT budget for enterprisewide initiatives. Banks will spend $170 billion on technology in 2008, and following are the key initiatives that will be top of mind for banks as they determine how to allocate their current and future IT budgets: Information management: moving to life-cycle management Technology refresh: continuing the quest for dynamic IT Data security: the battle continues Business process management (BPM): focus on efficiency Credit risk management: back to basics Predictive analytics: building on a strong foundation Mobility: the next big thing? Core banking renewal: gaining momentum Green: conservation as competitive advantage Channels: getting to customer centricity

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November 2007, Financial Insights #FIN209204 Financial Insights: Consumer Banking and Credit Advisory Service: Looking Ahead

TABLE OF CONTENTS
P In This Report 1

Methodology ............................................................................................................................................. 1 S i t u a t i o n O ve r v i e w 3

Regional Themes...................................................................................................................................... 3 Future Outlook 8

Information Management.......................................................................................................................... 10 Technology Refresh.................................................................................................................................. 11 Data Security ............................................................................................................................................ 12 Business Process Management ............................................................................................................... 13 Credit Risk Management .......................................................................................................................... 14 Predictive Analytics................................................................................................................................... 15 Mobility ..................................................................................................................................................... 16 Core Banking Renewal ............................................................................................................................. 16 Green: Conservation as Competitive Advantage...................................................................................... 18 Channels .................................................................................................................................................. 19 Essential Guidance 21

Actions for Financial Institutions ............................................................................................................... 21 Actions for Vendors .................................................................................................................................. 22 Learn More 22

Related Research ..................................................................................................................................... 22

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LIST OF TABLES
P 1 2 Funded Initiatives in Global Banking in 2008 by Respondent Group (Rank)................................ 2 Top 10 Strategic Initiatives for Global Banking, 2008................................................................... 8

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LIST OF FIGURES
P 1 2 3 4 North America Banking IT Spending by Segment, 20072011 .................................................... 4 Asia/Pacific Banking IT Spending by Segment, 20072011 ........................................................ 5 Europe Banking IT Spending by Segment, 20072011 ............................................................... 6 Asia/Pacific Channel Investment, 20062009.............................................................................. 21

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IN THIS REPORT Our ninth annual analysis of strategic IT initiatives for the banking industry incorporates perspectives from our global team of analysts. In this report, we identify the top 10 initiatives that will have key strategic importance during 2008 for banks around the world. These strategic initiatives lie at the intersection between business and technology. This report describes these initiatives, examines why we believe they will have an impact on both banks and the technology firms that serve them, and explains why they are on the minds of chief executive officers and other C-level executives from the lines of business (LOBs) and the technology side of the organization.
Methodology

Financial Insights surveyed banks, technologists, and other market participants to gain an understanding of the initiatives that were rising to the surface as top priorities during their budget planning for 2008. We launched a Web survey in August 2007 to capture feedback from budget discussions. In this survey, 779 respondents provided information about their spending trends, the strategic initiatives completed in 2007 and planned for 2008, and the investments that were likely to be funded in 2008. Table 1 provides data from this survey, showing the top 20 initiatives banks expect to fund in 2008. Each type of respondent had a list of 40+ initiatives from which they could choose. This survey revealed the very divergent priorities within banks. With the line-of-business respondents, customer-facing and customer support initiatives ranked very highly. Given that these are the employees within a bank who are the closest to customers, this comes as no surprise. However, with customer data management as the thirdranked initiative, it is clear that this group will support (with their budgets) enterprisewide initiatives to improve data management. With the IT respondents, top initiatives were those that are within their purview: encryption, business processing outsourcing, decision analytics, user authentication, core, server virtualization, and data security. With operations, customer data management was the clear leader. This part of the organization the bridge between IT and lines of business provides the manpower to support product delivery. This data provides insight into the competing strategies of each part of the organization. With lines of business, IT, and operations each controlling a portion of the IT spending budget, each group has projects that it will fund from its wallet. Financial Insights, in our analysis, weighs inputs from all segments within an organization, all sizes of institutions, and all major regions and determines the top 10 strategic initiatives from that analysis.

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TABLE 1
Funded Initiatives in Global Banking in 2008 by Respondent Group (Rank)
Line of Business 3 1 4 2 14 19 7 9 27 29 12 32 5 17 6 8 23 20 10 21

Overall Customer data management investment Predictive analytics for performance management User authentication Mobility (banking/payments) Increasing consistency and accuracy of customer data Financial reporting system enhancement Internet banking system refresh Credit risk management Predictive analytics (for CRM) Core and/or DDA system enhancement Operational risk management Increasing business process outsourcing New trade finance products Core and/or DDA system replacement Prepaid cards Investing in corporate portals Hiring more staff in offshore locations Investing in process redesign Refreshing cash management applications Moving processing to offshore providers n = 280
Source: Financial Insights' Top Business and IT Spending Trends for 2008, August 2007

IT 19 8 4 27 20 21 30 32 12 5 35 2 28 24 29 31 9 40 33 16

Operations 1 16 17 11 8 3 6 7 9 14 2 15 18 12 19 20 29 4 21 27

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

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SITUATION OVERVIEW 2008 is the ninth year we have produced our top 10 analysis, featuring those key technology-enabled initiatives that are of the utmost strategic importance for banks. By this we mean that senior executives are focused on these issues and must make decisions now to prepare for the future. The initiatives are not necessarily those of greatest spending, but making the right decision about these initiatives will position institutions well for the future. We offer a global perspective, focusing on trends that are relevant for banks around the world.
Regional Themes

To provide additional context for our top strategic initiatives, we present regional views and themes that are impacting banks in the three major regions North America, Europe, and Asia/Pacific in the following sections.
North America

The North American banking sector remains a very mature, competitive marketplace. The U.S. banking environment will be particularly challenging in 2008, with the softening of the dollar, deteriorating consumer credit markets, and a quickening pace of mergers and acquisitions (M&As). Investment is focusing on key back-office technologies that will allow for increased growth and improved efficiency. Key initiatives continue to include IT and business process outsourcing as well as quickly reducing costs and improving inefficient processes. With the emphasis on reducing costs, not just by outsourcing but also through initiatives such as virtualization and tighter vendor management, bank spending on IT will increase at only a 4% growth rate from 2007 to 2008. Figure 1 provides a forecast of North American banks' IT spending through 2011.

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FIGURE 1
North America Banking IT Spending by Segment, 20072011

70 60 50 ($B) 40 30 20 10 0 2007 Hardware Internal IT Services Software

Source: Financial Insights, 2007

2008

2009

2010

2011

Asia/Pacific

It is difficult to make generalizations about Asia/Pacific, a region with both mature and emerging economies. Advanced banking markets are suffering from product commoditization, hyper-competition, high costs, and legacy systems, while many of the developing economies enjoy vibrant banking markets with strong growth prospects. IT investments are driven by the realities of each market, although there are some common trends. In this region, growth in IT spending is strong. Figure 2 provides an illustration of current and future IT spending in the region. The growing presence of international banks, coupled with domestic M&A activity, is reshaping individual markets and providing customers with a broader range of choices. Key product areas that are attracting international and domestic banks alike include business banking, microfinance, wealth management, transaction banking, Islamic banking, and consumer finance. These focus areas are driving investments in traditional IT infrastructure as well as line-of-business applications. Consulting and process improvement investments, particularly around origination, are becoming more common, which is a strong sign that the region is focusing on improvements beyond the procurement of a new piece of technology.

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FIGURE 2
Asia/Pacific Banking IT Spending by Segment, 20072011

40 35 30 25 ($B) 20 15 10 5 0 2007 Hardware Internal IT Services Software

Source: Financial Insights, 2007

2008

2009

2010

2011

Europe

Western Europe remains focused on regulatory compliance. With Basel II wrapping up, the phased single euro payments area (SEPA) initiatives are now consuming resources and will continue to dominate both the IT and business organizations of leading banks as they comply with the new rules of the game. In Eastern Europe, the focus is more on technology and product refresh as these institutions invest to achieve parity with the global institutions that are either purchasing local institutions or branching into this high-growth region. With increasing use of consumer credit, growing small businesses, and strong profits, Eastern European banks are investing in all facets of technology to support their growing businesses. Figure 3 provides a forecast of European banks' IT spending through 2011.

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FIGURE 3
Europe Banking IT Spending by Segment, 20072011

100 90 80 70 60 50 40 30 20 10 0 2007 Hardware Internal IT Services Software 2008 2009 2010 2011

Source: Financial Insights, 2007

Investment Themes

As Financial Insights reviewed input from clients and other industry watchers, as well as from the global team of analysts, strong themes rose to the surface and underpin the top 10 trends in this report.
G lob al iz a t io n

The theme of globalization is a double-edged sword those well positioned are eager to expand, while the rest are fearful of more foreign competition. For institutions that are well positioned competitively, this is an opportunity. Institutions that stand to benefit from a more global banking environment are those that have already had success with a multinational strategy. Besides, institutions that have a strong local or regional footprint, generating consistent revenue with a strong technology infrastructure and disciplined approach to acquisition that allows them to reap the benefits of inorganic growth, will also see gains. All of these attributes have posed challenges for banks in the past. Now, with the relatively weak dollar, we see U.S. institutions as attractive takeover targets. Financial Insights predicts that Western European banks will be well positioned in a more global economy with the investments in their back-office systems, particularly in payment processing, in response to both Basel II and SEPA.

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($B)

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For banks that have not invested in supporting global businesses, the difficulty is in the lack of opportunity to tap into higher-growth markets when their local market experiences low growth. We expect strong regional banks to be prime acquisition targets.
P a yme n t s D i sr u p t i o n

Payments disruption was one of the strategic initiatives in 2007, but we have changed its status in 2008 because the disruption is more of an environmental issue that must be addressed than a specific initiative for 2008. In previous years, there were important initiatives around SEPA and how to prepare for it in Europe; in North America banks prepared for and invested in Check 21 and its aftermath; and in emerging markets burgeoning consumer credit led to a growth in credit cards. These initiatives are still important, but banks have addressed the most immediate concerns. The difficulty now is in waiting to see how the growth in payment options sorts itself out. On the horizon, Financial Insights sees more change and many initiatives to offer new products such as integrated financial supply chain or mobile payments, but there is no clear way forward for now.
Cus t o m e r Ce n t r i cit y

In the race to increase inexpensive core deposits and increase revenue, institutions are doing what they always do focusing on their customers (again). Although it's a known fact that it's less expensive to serve and retain existing customers than attract new ones, banks are easily distracted when the times are good and they lose sight of this truism. This time, customer-centricity initiatives are less ethereal than they were when customer relationship management (CRM) was the hot topic in the late 1990s. Now, customer centricity has the advantage of building on strong data warehouses that have been developed in the intervening years, with mature analytic tools. What banks are struggling with now is realizing a true enterprisewide approach to their customers; this remains elusive for most large institutions.
G ov e rn a nc e , Comp li a n c e, a nd Ri s k

Banking is one of the most highly regulated industries, so governance, risk, and compliance are simply the foundation of any successful bank. Banks are developing a discipline toward these three related issues and moving from tactical, reactive investments to enterprisewide approaches. Although there is no value in over-compliance, there is a great deal of value in leveraging investments that must be made to improve the operations of the institution and in embedding compliance and risk mitigation into processes, rather than overlaying additional processes.

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FUTURE OUTLOOK Table 2 lists our top 10 strategic initiatives for banks in 2008 in order of importance, followed by a discussion of each initiative. This analysis covers the entire banking enterprise. The global banking team of analysts participated in the review process, and input was solicited from banks, vendors, and other industry participants as well.

TABLE 2
Top 10 Strategic Initiatives for Global Banking, 2008
Rank 1 Initiative Information management: moving to life-cycle management Description Banks' data resources are growing rapidly, and the growth of unstructured data in particular is dramatic. This growth in data in some banks "explosion" is an apt term has accelerated in the last few years. Effective management of data has thus become a priority. The old focus was on the management of the data infrastructure itself, especially in the areas of data warehousing, storage, and security. Current initiatives, however, indicate that the banks' approach has matured; they are striving to implement an information management life-cycle approach. A complex environment of interconnected legacy applications is inhibiting banks' ability to bring new products to market and serve their clients. A group of technologies, collectively referred to as dynamic IT, is enabling CIOs to deliver increased flexibility and transparency to the lines of business without requiring a large-scale replacement of existing systems. Instead, the new technology will wrap itself around the old, isolating the legacy infrastructure while allowing new systems to be built on top of it. Banks are in the business of safeguarding sensitive, nonpublic consumer and corporate information. However, the environment is ever changing and increasingly hostile and complex, regardless of regional location. Against this backdrop, bank executives struggle with managing security with channel expansion, real-time processing, geographic dispersion, outsourcing/offshoring, and mobile workforce and customers. Business process management has become integral to building an environment that can be used to drive new revenue, create new composite services, and increase processing capacity. Banks are looking at increasing efficiency (often synonymous with staff reduction/displacement); improving business process is an approach that many are now taking seriously. Improving business processes is top of mind for operations groups but is also increasing in importance at the business level. With a combination of internal efforts and outside consultants, institutions are taking the time to examine what they do and why they do what they do sometimes in conjunction with business process outsourcing (BPO), but just as often as part of internal efficiency plays.

Technology refresh: continuing the quest for dynamic IT

Data security: the battle continues

Business process management: focus on efficiency

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TABLE 2
Top 10 Strategic Initiatives for Global Banking, 2008
Rank 5 Initiative Credit risk management: back to basics Description Credit risk management is one of the core capabilities of any bank, but there are upheavals rocking the world of credit that require new focus. In emerging markets, the rampant growth of consumer credit is for now masking credit-quality issues. Forward-thinking institutions are balancing their acquisition activities with analytics and portfolio management tools to minimize future losses. There is tremendous interest in the worldwide credit industry for technology that supports default management and a growth in the depth of analytical offerings for this processing segment. This is to be expected, given the recent upheaval over subprime mortgages that began in the United States and has spread internationally via investment portfolios. Institutions have begun to appreciate the value of better data management, not only for compliance objectives such as Basel II, but also in recognition of the critical importance of data as the lifeblood of an organization. An important factor in the growing use of predictive analytics, over and above the business rationale, has been the improvements made in information management. This has made data analysis more viable. In addition, the technologies underpinning predictive analytics have improved, making these institutions more comfortable with procuring these sorts of solutions. In the months and years ahead, we expect predictive analytics to play a more significant role in a range of banking functions, and this should help the industry move toward true risk-based pricing while concomitantly improving customer relevance. Always on the lookout for the next big thing, mobile banking and payments are the big customer-facing initiatives in 2008. Mobile payments is an exciting growth area and offers a new payment channel for consumers across all levels of society. Market conditions will determine the applicability of a specific service offering, but it is becoming clear that mobile phones are a powerful platform for growth. In the years ahead, Financial Insights believes mobile payments will become commonplace across all markets. Although the jury is still out on the right approach, it is clear that banks are making plans to reinvest in core banking applications. In 2008, tier 1 institutions are fully engaged with vendors and their internal staff to determine the right approach. What is driving this investment is not the IT side of the institution; rather, the business side recognizes that many of their business management difficulties stem from aging core systems. Product development is slowed, customer information is difficult to manage, and real-time information has been added as an aftermarket enhancement to batch-processing applications. Although the ROI is still difficult to prove, institutions are engaged in discussions, and we will hear announcements from these large institutions that will start the move toward core renewal.

Predictive analytics: building on a strong foundation

Mobility: the next big thing?

Core banking renewal: gaining momentum

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TABLE 2
Top 10 Strategic Initiatives for Global Banking, 2008
Rank 9 Initiative Green: conservation as competitive advantage Description In 2007, conservation became a subject of intense interest for the public. Like other large corporations, financial institutions found themselves under pressure to demonstrate their concern for the environment in a way that would not unduly sacrifice shareholder interests. Surprisingly, conservation is actually good business. It turns out when a company conserves resources, its costs go down, often dramatically, giving that company a competitive advantage. This can also remove hard constraints on growth, making new strategies possible. Looking beyond the IT world, conservation is also promoting new businesses for institutions such as energy credit trading and green lending initiatives. The channel refresh that began two to three years ago is on the threshold of mainstreaming around the globe across all lines of business, including consumer banking, corporate portals, cash management, and trade services and finance. The thirst for revenue, margin, and global reach fuels investment, as banks seek to extend more services and products through the Web, branches and kiosks, call centers, and mobile channels.

10

Channels: getting to customer centricity

Source: Financial Insights, 2007

Information Management

Banks' data resources grow in step with growth in their customers, business activities, and products. This increase in data in some banks "explosion" is an apt term has accelerated, due in part to Basel II and other compliance initiatives that have forced improved data and information management. Effective management of terabytes upon terabytes of data has thus become more imperative. The old focus was on the management of the data infrastructure itself, especially in the areas of data warehousing, storage, and security. Current initiatives, however, indicate that the banks' approach has matured. They are striving to achieve information life-cycle management, which includes the following activities: Ensuring that accurate, complete, and current data is captured and stored Continuously improving the quality of data Integrating data from disparate applications and touch points, seen in customer data information (CDI) exercises

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 Making data available to those who require it Enabling managers to gain visibility into who uses the data, how much of this data is utilized, and for what purposes On the other hand, banks recognize that data is also an enabler of more business; it underpins the decisioning and analytics that support business growth. Business analytics has also become more prevalent throughout the entire organization. Certainly, business analytics continues to be used in the traditional areas of performance and financial reporting by executive management, but it has also been pushed out into the entire banking operation, which can use and act on business insights promptly. Moreover, banks have made investments in analytic teams, cognizant of how the speed to develop models, the ability to use advanced scoring and segmentation methodologies, and the capacity to deal with the increasing numbers of models will be key competitive factors. Furthermore, a major component of current CRM projects is the single-customer view. Various business units in the banking organization are more ready to finally agree on the definition of "customer," understand the extent of the customer's total relationship with the bank, and map out ways to enhance this relationship through product cross-sell and customer service.
Technology Refresh

A group of technologies, collectively referred to as dynamic IT, is enabling CIOs to deliver increased flexibility and transparency to the lines of business without requiring large-scale replacement of existing systems. Instead, the new technology will wrap itself around the old, protecting the legacy infrastructure while allowing new systems to be built on top of it. With this emphasis on upgrading architecture and investing in new technologies, the office of the CIO is gaining control over more IT budget, with the support of business heads who recognize that these are the investments that will empower their efforts in the future. Dynamic IT relies on four core technological principles: end-to-end design and management, open standardsbased components, a virtualized resource model, and service-oriented architecture (SOA). End-to-end design and management cut across silos and ensure alignment of business and IT goals, so that every business process is represented by a software component that is part of a unified serviceoriented architecture. Open standards facilitate integration with software and hardware components created by third parties and by subsequent generations of employees within the financial institution, helping the IT infrastructure evolve as the business does.

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Virtualized resource models manage separate IT resources (e.g., servers, network, storage, operating system) as if they were a single entity, distributing the workload among the different components in real time as needed. This allows optimized use of resources and delivers significant cost savings. For example, if each department has its own server, only 25% of its processing power might be utilized most of the time. By eliminating half of the servers, joining the rest together, and running them as a single virtual server, the institution can save 50% of its server budget and utilize a much higher percentage of its processing power. Because different parts of an organization typically need resources at different times, a virtualized resource model can allocate resources according to need "on demand." SOA is an approach to technology architecture that allows business processes to be developed as reusable services. This allows components to be replaced or altered easily, without affecting other components. SOA is what makes the other three core technological principles possible; it also enables the gradual replacement of legacy systems through a process of planned redundancy. Over time, new components that duplicate the functions of legacy systems can be introduced; once these components have been tested at scale, the legacy systems can be retired. This gives the institution control over the cost and timing of its technology refresh, which is why most financial institutions have adopted this strategy.
Data Security

Based on our survey, data security is the single most important concern for IT professionals in banking. Banks are in the business of safeguarding sensitive, nonpublic consumer and corporate information. However, the environment is ever changing and increasingly hostile and complex, regardless of regional location. Against this backdrop, bank executives struggle with managing security with channel expansion, real-time processing, geographic dispersion, outsourcing/offshoring, and mobile workforce and customers. Although security and fraud management continue to be top of mind for IT professionals, the initiative has moved from the top position in the last two years to the seventh. This is primarily because security strategies have taken shape and initiatives are now in the execution phase. The industry, as well as the general population, has better learned to protect against phishing and other Internet-enabled crimes while also learning valuable lessons from lost data tapes and unscrupulous employees, both within the institution and at the service provider's end. Although the prominence of security breaches declined worldwide during 2007, the stakes were much higher. Banks, individuals, and corporations suffered greater financial losses and damages from a

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reduced number of events. After a slew of regulatory activity in 2006, this year ends without ceremony. These activities included the Federal Financial Institutions Examination Council (FFIEC) guidance to address multifactor authentication in the United States and similar guidance by the U.K. Financial Services Authority (FSA) and the Hong Kong Monetary Authority (HKMA). We expect 2008 to be equally quiet in terms of regulatory activity regarding security. However, mobile banking may prove to be the catalyst to spur new regulation.
Business Process Management

Banks are investing in people and technology to improve business processes for a variety of reasons, but they all lead to improved performance and increased efficiency. These motivators include: Process improvement through the introduction of end-to-end automation or people-intensive processes (This includes the growing use of business process management technologies in the consumer and corporate portals in support of automated onboarding of customers, services, and more complex payment products.) Compliance support through the introduction of business rules Reduced operational risk through improved transaction process management, moving exception management as close to the transaction as possible, and increased use of service-level agreements (SLAs) Increased understanding of the processes used to support products and services, often to develop better financial performance measures Combined processes across business lines and with partners to deliver new composite services such as healthcare savings accounts, integrated accounts payable, and supply chain financing Within business process management is a set of activities; an institution may choose one or all of the following approaches: Process modeling was originally introduced to aid custom code development and new technology implementations, but it is equally useful to document current activities and initiate improvements not wedded to a technology solution. Process modeling can also include simulations to see how proposed changes will impact an entire process.

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 Business activity monitoring is used to track performance and establish key performance indicators (KPIs), which can be used to monitor both business processes and system performance. Content management investment is frequently incorporated into business process improvement initiatives to improve workflows, increase visibility, and improve throughput. Business process management helps banks improve their business performance by focusing on improving operations and reducing risks. Focus on business process management goes in and out of favor with banks, and the pendulum is swinging back in favor of evaluating what is done within a bank's operations and why. Some of this is cyclical, but also now there is a more mature approach to business process outsourcing, which if done correctly, requires more focus on business process improvement. There has been a distinct shift in BPO contracts in 2007 and moving forward, with institutions now looking not just to wring savings through labor arbitrage, but also to improve processes as well as part of a BPO relationship. For those institutions not contemplating BPO, business process management is even more important. Banks are investing internally to spawn best practices throughout their organizations and engaging with experts to bring order and efficiency into their organizations.
Credit Risk Management

Any discussion of credit risk management has to begin with the credit issues in the U.S. market now. In the United States, consumers are spending and borrowing less than they have in years past, and banks are scrambling to deal with lower margins and lack of financial contributions from the retail bank segment that have carried them through the last decade. While institutions are reporting that it is business as usual and that they are not taking (and have not taken) significantly more risk in lending, recent regulatory reports belie that assertion. Reserve ratios are increasing, something that has not occurred since early 2002, and the U.S. banking industry reported a decline in earnings year over year. Large banks reported higher expenses for bad loans. A flat yield curve coupled with stable interest rates drove margins down for the smaller institutions. On the plus side, deposits are still growing, which will help in lowering cost of funds. We have seen a tremendous interest in the worldwide credit industry for technology that supports default management, besides a growth in the depth of analytical offerings for this processing segment. This is to be expected, given the recent upheaval over subprime mortgages that began in the United States and has spread internationally via investment portfolios. The issue with these mortgages is essentially twofold: the abandonment by some mortgage lenders of credit policies, procedures, and sound risk management practices for the promise of

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excellent returns and the embrasure of so-called exotic mortgages by finance companies. Add to this the appetite for funding nonconforming mortgages from the securities industry and a lack of lending expertise by portfolio managers or investors, and the problem has illustrated the lack of quality risk management tools in niche areas of the market. Internationally, the mortgage problem has already surfaced, as many investors from other countries (including banks) found their investment portfolios seeded with these offerings. The credit cycle in other nations, however, is at an earlier stage when compared with the mature U.S. industry; there is a resurgence of interest in Europe and Asia/Pacific in risk analytics around origination as well as customer behavioral predictors because of the limitations that privacy regulations place on credit expansion.
Predictive Analytics

Predictive analytics is an emerging form of business analytics that builds on the capabilities of traditional offerings by including more complex calculations that can provide what-if scenarios and business intelligence (BI), thereby moving to predictive modeling. Predictive analytics tools offer decision support rather than just information delivery; decisions can be made directly from the results of a predictive analytics model. Many types of statistical technologies can be employed in technological analytics, and the uses of predictive analytics are manifold. Predictive analytics is common in risk management, credit decisioning, collections and recovery, and fraud detection. In addition, banks are using predictive analytics to identify and retain profitable customers, improve the quality of marketing campaigns, identify next-best products, and even assist in tasks around branch location and security. As banks begin to rely on nontraditional data sources nonprice factors to estimate customer demand or alternative data sources for the unbanked, for example the importance of predictive analytics will grow. An important factor in the growing use of predictive analytics, over and above the business rationale, has been the improvements made in information management. In both developing and mature markets, institutions have begun to appreciate the value of better data management not only for compliance objectives like Basel II, but also in recognition of the critical importance of data as the lifeblood of an organization. This has made data analysis more viable. In addition, the technologies underpinning predictive analytics have improved, making institutions more comfortable procuring these sorts of solutions and more successful with their implementations. In the months and years ahead, we expect predictive analytics to play a more significant role in a range of banking functions and this should help the industry move

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toward true risk-based pricing while concomitantly improving customer relevance.

Mobility

Mobile banking seems to be all the rage this year and is predicted to be the big consumer initiative for 2008. Although we see increasing usage in other countries, especially in the European and Asian markets, adoption in the United States has been much slower. Many banks and processors are forming alliances to address this market, and a number of pilots have been initiated. JPMorgan Chase, Bank of America, Citibank, and Wells Fargo are among the larger banks that have introduced mobile banking services, primarily in the retail areas. These banks will be able to take guidance from Asia, where technologyadventurous Asian customers have taken to using mobile phones for payments. However, standards have not yet been established: It is unclear whether the banks will control customers or whether the phone carriers will exercise this control. Although the carriers do have a billing system already in place, it is unlikely all purchases and transactions will go that route. Indeed, the transfer of payments and the use of debit and credit information on the phone will have to go through the banking institutions. This is a natural fit to eventually replace much of the activity now being done by credit and debit cards using digital paymentenabled phones. Another big question is how quickly consumers will adopt the phone for these transactions. In the United States, about three-quarters of the population owns a mobile phone; however, it will be a considerable amount of time before these phones are replaced by the new digital ones capable of performing the more difficult transactions. It will be at least a year before these phones gain any penetration in the marketplace. We expect people will initially use mobile phones to check account balances, receive various alerts about their accounts, and initiate small payments. Another emerging area in this broader mobility initiative is the attempt by banks to reach out to customers who do not have access to branches a key initiative, especially for banks that have launched microbanking strategies in India and Indonesia. Banks are deploying personnel to do the customer outreach using notebooks or personal digital assistant (PDA)type devices that are able to process simple deposit transactions and low-value loans.

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Core Banking Renewal

Core system transformation has continued to move up the top 10 list, indicative of its importance to banking executives globally. Core banking systems are considered the lifeblood of any banking organization, and the belief exists that converting a core banking solution is equivalent to performing open heart surgery, only riskier and more complicated. However, costs of maintaining legacy core systems are escalating while the same systems hamstring other business and strategic initiatives, including many of those discussed in this report, such as customer centricity and enterprise payments. It is therefore not surprising that bank executives are carefully weighing their options as they increasingly realize that the status quo will not support future growth. The desire of these bank executives to be forward thinking and competitive will ultimately act as the catalyst for core conversion. Overall, we see two primary drivers for banks to convert core systems. The first driver, and where we are seeing the most activity, is the inability of a bank's current core processing system to continue to support the bank because of either scalability issues or lack of functionality that inhibits the institution from growing or expanding product lines. In mature nations, such as those in North America and Western Europe, these core systems are usually decades old and generally of unrecognizable ancestry. Additionally, banks are increasingly challenged with issues of recruiting and retaining talent skilled in languages necessary to develop and maintain programs for these aging, highly customized, and poorly documented systems. The second driver is strategic: The core processing technology still works, but banks find it increasingly difficult (and expensive) to maintain the infrastructure they've built while connecting new solutions into the core system. In the case of developing economies, such as those in Asia/Pacific and Eastern Europe, new institutions are establishing a core processing environment for the first time, unencumbered by legacy systems. The alternatives to core banking transformation have evolved and matured, and banks across the globe now have options that were not realistic just a few years back. Most important, these options allow banks to mitigate the huge risks associated with core transformation. The biggest technological advancement to benefit core banking is SOA, which is now an established concept with referenceable deployments in place. Software as a service (SaaS) also presents opportunities in deployment, particularly for community banks and credit unions.

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The Asia/Pacific market continues to lead in terms of core transformation activity. This diverse region requires broad capabilities such as Islamic banking, microfinance, international branch banking, and geographic expansion to establish operations in new countries, and new core systems are being chosen to fulfill these requirements. The rip and replace, SOA, and gradual transformation approaches to core transformation differ, with banks aligning the technology with growth goals. Although the deal sizes tend to be smaller at this juncture, massive opportunities exist, as exhibited by the transformation at the State Bank of India and emerging core discussions at large Chinese banks. The markets in Eastern Europe, the Middle East, and Africa are also experiencing activity with varied approaches. Eastern European banks tend to be upgrading recently implemented core technology to keep pace with growth, while activity in the Middle East and Africa leans toward rip and replace, indicative of the smaller institutions located in these regions. European banks, both Western and Eastern, are heavily focused on payments, driven by SEPA, as a potential extension of the core and/or enterprise hub. Banks in North America and Western Europe are in an evaluation phase of exploring the available and, more important, proven options of core transformation, particularly the largest institutions. Of course, these banks face increasing competition from local and international competitors with modern processing systems that tout cost efficiency, flexibility, and responsiveness. Open architecture, on the surface, holds promise as the key to the solution; however, concerns about scalability and performance have yet to be appeased. Further refinement of these products and processes will make the approach mainstream before the end of the decade, and we will begin to see these legacy systems transformed.
Green: Conservation as Competitive Advantage

In 2007, conservation became a subject of intense interest for the public as concern grew over the threat of global warming, the increasing number of hurricanes and other severe weather phenomena, and rising gas prices driven by growth in China, India, and other rapidly industrializing countries. Like other large corporations, financial institutions found themselves under pressure to demonstrate their concern for the environment in a way that would not unduly sacrifice shareholder interests. Many CEOs have been surprised to learn, however, that conservation is actually good business. It turns out when a company conserves resources, its costs go down, often dramatically, giving that company a competitive advantage. This can also remove hard constraints on growth, making new strategies possible.

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For example, Sun Microsystems estimates that 60% of datacenters in the United States are running out of power, cooling, and/or space because more powerful microprocessors run hotter. Even though a new server today runs much more quickly than just one year ago, demand for quicker processing is rising even faster, causing the datacenter to expand. Using virtualization technology, it is possible to reduce the number of hardware components used to produce the same amount of processing power, relieving the demand on the power and cooling systems. This reduces greenhouse gases but also reduces costs, not only directly in the form of electricity cost reductions, but indirectly by avoiding the expense of expanding or building a new datacenter. We expect the new focus on conservation to also impart new energy to the existing effort of moving customers to electronic statements, lending documents, and disclosures. Conservation gives financial institutions a new marketing strategy that many consumers will respond to. Financial institutions can also capitalize on the demand for conservation technologies by developing expertise in lending to the new companies that are serving this market, and incidentally gaining a public relations benefit by publicizing their activities. Now that the word is out, we expect conservation-based cost-reduction (and some lending) strategies to become a major focus of financial institutions in 2008.
Channels

The channel refresh that began earlier this decade is on the threshold of mainstreaming around the globe across all lines of business, including consumer banking, corporate portals, cash management, and trade services and finance. The thirst for revenue, margin, and global reach fuels investment as banks seek to extend more services and products through the Web, branches and kiosks, call centers, and mobile channels. Driven by the need for growth in the West and the ability to keep up with the growth in the East and South, a multichannel approach is imperative. The Web is not the only channel; the channel infrastructure must support integration with customer data, CRM, customer care, implementation, and other processing areas in the banks in a way that is more immediate, dynamic, and, in some cases, real time. Wireless channels, already important in the diverse Asian and the mature European cell phone markets, are the next big channel investment in the United States. Web 2.0 capabilities (mashups, blogs, podcasts, and rich Internet applications) are making their first appearance as well, mostly in American and Western European bank IT labs. An example is rich cash management information reporting from an Excel spreadsheet as well as new, thin desktop applications.

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Although channel refresh is a global initiative, there are variations in each region: North America. In the United States, aging branch platforms have prevented some smaller institutions from rolling out remote deposit, while other institutions have replaced the entire core in order to obtain integrated channels and roll out products of other bank subsidiaries (e.g., Principal Bank, Webster Bank). The largest banks in the United States and Canada have taken a more horizontal technology approach to channel investment by using business process management and business intelligence solutions, as essential pieces of their custom frameworks are bolstered by enterprise service buses at the back. In corporate banking, investment in channel infrastructure centers around bringing more products to existing customers and delivering specialized products to verticals. In the immediate future, banks are bringing trade services and foreign exchange to small and medium-sized enterprises (SMEs) as well as specialized products to the healthcare market. These next-generation systems incorporate a strong service component, encompassing implementation and onboarding through the Web channel in a bid to increase efficiency and improve customer service. Europe. Pan-European initiatives and growth in Central and Eastern Europe continue to maintain the impetus on multichannel renewal. The stakes are high for global players such as HSBC, which has over 130 million customers worldwide and desires uniform delivery and service, but with customization for each region and segment. On the retail side, there is reinvestment in branches with queue-busting technologies and new layouts as seen in HSBC and Lloyds TSB banks. Also in the United Kingdom, mobile banking is beginning to take off with SMS alerts on low balances being offered by some banks such as First Direct and Lloyds. Although in its early stages, greater collaboration through corporate Web portals with respect to payments, trade services, and integrated finance is the next big step for cash management services. Asia/Pacific. Growth and diversity flavor the strategic branch initiatives in this region. There is a general shift from efficiency to sales generation, with investments occurring across consumer, corporate, and asset management lines of business. Financial Insights' Fintech Asia Executive Surveys for 2006 and 2007 ranked operational efficiency, customer experience, and launching new and innovative products as important and very important. To meet these objectives, financial institutions continue to invest in infrastructure, service-oriented architecture, and additional channel capabilities. We predict that investments in channel technology will grow alongside investments in CRM (see Figure 4). More reliance on business intelligence and improved business processes
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will be leveraged to grow revenue and margins without adding people. This is evidenced by early investment in more self-service channels (e.g., the Web, ATM, kiosks) and in service-oriented architecture to link data and business intelligence to the channel. On the corporate banking side, like North America and Europe, but more aggressively so, the Asia/Pacific region is refreshing and replacing trade services and treasury management capability to extend to small and medium-sized enterprises.

FIGURE 4
Asia/Pacific Channel Investment, 20062009

14 12 10 ($B) 8 6 4 2 0 2006 Branch automation ATM and kiosks eBanking Phone banking and call center automation Delivery channels
Note: The countries included are India, South Korea, Indonesia, Malaysia, Thailand, Singapore, Philippines, Vietnam, Australia, and New Zealand only.
Source: Financial Insights, 2007

2007

2008

2009

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ESSENTIAL GUIDANCE
Actions for Financial Institutions

As noted in previous top 10 reports, the following seven fundamental screening criteria can aid management teams in making the right IT investment decisions for their bank: Ensure that IT initiatives are aligned with the business mission. Continue to leverage IT solutions to improve operational efficiency. Make investment decisions that fit an IT vision that could last for 10+ years. Be nimble and flexible with internal and external sourcing relationships. Share risk and upside with key suppliers to lower the cost of ownership. Select IT initiatives that support operational excellence or execution. Continuously review progress against plan; metrics need to drive performance.
Actions for Vendors

Vendors serving banks in 2008 will be well served to understand the tough economic environment the largest banks are experiencing. With heavy investment in SEPA compliance by the Western European banks and profit pressure on the U.S. banks, spending growth will be harnessed and must be well justified. New spending initiatives will be hard, or even impossible, at the largest institutions, with all available IT spend focused on ongoing initiatives. New IT investment will not be funded outside of the budget cycle. Enthusiastic spending does exist in Brazil, Southeast Asia, and Central Europe. These regions are profiting with their local economies and investing those profits in defending themselves against global institutions with aspirations to enter those fastgrowing markets.

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LEARN MORE
Related Research

Notes from the Philippines Roundtable: Priorities and Investment Plans (Financial Insights #FIN208452, September 2007) Payments and Finance Meet the Supply Chain: 2007 North American Commercial Payments Study Results (Financial Insights #FIN208055, August 2007) Canadian Banks Invest in Core Banking Platforms (Financial Insights #FIN207659, June 2007) Regulatory Update Europe 2007: A Year Of Execution (Financial Insights #FIBA03P, May 2007) Case Studies of SOA Adoption in Asian Financial Institutions (Financial Insights #FIN206510, April 2007) Asia/Pacific Banking IT Spending Guide, 20072011 (Financial Insights #FIN205911, March 2007) European Banking IT Spending Guide, 20072011 (Financial Insights #FIN205897, March 2007) North American Banking IT Spending Guide, 20072011 (Financial Insights #FIN205905, March 2007) U.S. Core Banking Providers, 2007: Securing Home Field Advantage (Financial Insights #FIN205887, March 2007) Saving Our Assets: European Banking Adoption of SOAs (Financial Insights #FIBA01P, February 2007)
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