A Deep Dive Into the Viability of European Mid-Size Banks
Can They Survive the Pandemic Without Massive Change?
This Blog is based on the findings of the White Paper: Modernising Banks in Europe – Technology Trends and Challenges for Small and Mid-sized Banks.
The European banking industry has been going through a difficult phase over the last couple of years, with declining profit margins driven by lower interest rates and an increase in credit losses. The COVID-19 pandemic has further exacerbated the situation with the European Central Bank (ECB) warning that prolonged impact of the crisis could impact the minimum regulatory capital levels of banks. Now that we have a vaccine for the virus, itself a magnificent achievement and a tribute to European co-operation, it looks as if 2021 may see the whorl starting to rid itself of COVID-19.
As the white paper points out, with banks’ revenues slowing down, the emphasis is now on cost efficiency, better risk management, and building digital platforms to enhance service and value from customers. This has, in turn, accelerated the need to scale up technology investments.
While the spotlight has generally been on the large and systemically important banks in Europe, the banking segments that are in greater need of modernising their technology infrastructure are small and mid-sized banks in the region. This segment of banks has struggled with profitability compared to their larger counterparts. To add to this, these banks are facing significant pressure from new competitors in the form of digitally-native challenger banks. They also face FinTech startups and big tech companies that have the advantage of a broad customer base and technological sophistication to provide a hyper-personalised customer experience.
Modernising Fast
Against this backdrop, modernising the technology infrastructure seems to be the way forward for small and mid-sized banks. However, technology modernisation is always easier said than done, especially when these banks have to work within the constraints of limited budgets, outdated infrastructure and traditional banking mindsets.
With all of this in mind, Temenos and IBS Intelligence have taken a deep-dive into understanding the challenges, trends and strategic implications for small and mid-sized banks based on discussions with banks and the European banking industry.
Small and mid-sized banks are vastly different from their larger counterparts. A number of these banks are retail-focused with single country operations, while larger banks have a broader universal banking model with a multi-country footprint. This difference in business structure poses specific challenges.
Cash Limitations of Smaller Banks
Unlike large banks, net interest income has been the primary source of revenue for small and mid-sized banks in the region. While large banks are able to diversify their revenue stream through income from credit cards, trading account assets and other types of consumer and corporate financing, small and mid-sized banks have to rely on income primarily from their retail loan assets.
Additionally, the cost of switching banks for a customer has diminished in today’s growing digital banking environment, which in turn, has impacted the small and mid-sized banking segment’s reliance on deposits as a source for bank funding.
It is no surprise then that a low interest-rate environment has significantly strained the spending capacity of these banks, especially on ‘Change the Bank’ initiatives such as technology transformation or system replacement projects. This is also evident in the core banking system deal volume recorded by IBS Intelligence, which dropped by nearly half over the 2017-2019 period.
The cost of technology modernisations is a major hurdle for banks and a key consideration when deciding on strategy and the solution approach. Small and mid-sized banks that are far more cost-sensitive than large banks. The white paper suggests that they might be better off exploring alternative modernisation approaches such as a SaaS platform which is capital-light and provides advanced digital banking features without the need for infrastructure investments in-house.
Other Options Are Available
Other options include employing smart middleware which helps banks with legacy infrastructure to consolidate disparate back-office systems into a single entity which can integrate seamlessly with its front-office channels or even with external digital platforms. This option, while not a long-term solution, is a starting point for modernisation, that helps banks to replace their legacy infrastructure in a phased manner within the constraints of their budgets.
Many small to mid-size banks in Europe are still struggling with legacy core systems, some of them reportedly over 20-30 years old. Back in the ’90s, the majority of core banking systems in the European region were deployed and maintained internally. Over the last 15 years, there has been a strong trend of moving the core banking systems and their servicing to third-party providers. The global financial crisis of 2008 triggered many core banking replacement programs, and banks that bucked the trend are today struggling because of the intense regulatory burden that translates to complex and costly changes to IT systems along with increasing market competition.
Monolithic legacy systems in turn impact the front-office layers of the banking architecture. The most evident impact of this constraint is seen in the customer on boarding experience of a small bank which still involves manual processes and is time-consuming. Despite these limitations, most of these banks are reluctant to replace their legacy core due to the complexity of the data migration process as well as the cost of switching to a new vendor.