More than five years on from the banking crisis, bank profitability is still materially below pre-crisis levels, according to a paper produced jointly between financial services software provider Temenos and Deloitte.
‘Restoring Profitability in the Digital Age’
, updates an earlier paper entitled
‘Bridging the Profitability Gap’
. In addition to its finding that bank profitability is still materially below historical averages, the new paper also finds that banks that have modernised their legacy IT systems enjoy superior profitability. The study goes on to forecast that the sector’s IT renewal is set to accelerate, which will include increasing digitisation.
Not only does banking profitability remain materially below pre-crisis levels, it has not improved in the past two years, despite improving macroeconomic conditions. The structural changes that initially drove down return on equity (RoE) – tougher regulation, changing customer behaviour and more intense competition – persist and have even been exacerbated by the digitisation of the industry.
The paper finds that system renewal can have a material impact on profitability. Over the past five years, banks using third-party banking applications have enjoyed on average a 19% higher return on assets (RoA), a 28% higher RoE and a 6.5% point lower cost-to-income ratio than banks running legacy applications.
In addition to restoring profitability, the paper outlines reasons to expect system renewal to accelerate from here. The continuing research and development (R&D) investment by software vendors and expanding partner ecosystems provide banks with more options than ever to move to modern core banking software in a low risk manner.
Furthermore, there is growing pressure from external stakeholders, such as investors and regulators, for banks to reduce the cost and risk of running legacy systems. Nonetheless, a more significant reason for needing to address legacy systems stems from the digitisation of banking, which is simultaneously handing more power to customers and opening up the industry to more competition from non-traditional financial services companies.
“Core system replacement can have a very material impact on banks’ profitability and so constitutes a key lever in helping to restore the industry to pre-crisis levels of returns,” said Chris McGinnis, head of strategy at Temenos.
“Furthermore, the need to address ageing IT systems stems from more than just a desire to improve profits: legacy systems represent a systemic risk to the industry and a major barrier to innovation in an increasingly competitive marketplace. Those that do not keep up with ‘new’ banking will lose out to new competitors, both non-traditional players and banks who break ranks with the status quo. Transforming core banking systems is a necessity of survival.”
Patrick Laurent, partner at Deloitte, added: “The banking industry is undergoing significant structural change in areas such as regulation and digitisation that will require a structural answer if returns of equity are to be restored to pre-crisis levels. That structural answer is technology modernisation.
“Nonetheless, banks have remained reluctant to take on the risk of core replacement. In this report, we make again the case for system renewal, but we also highlight the lessons that the industry is learning in terms of adapting its systems and in terms of formulating best practices around implementations that are enabling faster time-to-value with lower risk-to-value. As such, we predict an acceleration in core renewal projects in the coming years.”
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