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David Easthope, SVP, Celent Securities & Investment Group
Digital Transformation of IT Infrastructure
Investment and wholesale-oriented banks are transitioning their IT infrastructure to a new architecture based on a new vision: digital. To see where banks are going in the future, we should first look at the past. Fortunately, we can see the past easily. As the Hubble telescope shows us a universe already gone, by peering in the direction of an investment or wholesale banking institution, we can see a jumbled mess of outdated infrastructure.
Moving to digital has been slower in investment banking because it has not needed to be done as quickly as it is elsewhere. True, while some investment banking functions have been going digital for some time, it has often done by outsiders. But the pace is accelerating. JP Morgan wants to shrink a number of software applications it uses by 25 percent, with an increased allocation to new investments and technologies. A transformational initiative at Deutsche Bank will work to reduce the bank’s operating systems from 45 to 4 while also shifting applications to cloud computing. UBS’ Neo platform is another example of a bank moving investment banking functions to the digital age to serve clients more efficiently. Other firms like Barclay’s, Standard Chartered, RBS, and Credit Suisse are also engaged in these types of initiatives.
The goal of digital transformation is clearly to simplify IT and operations, reduce cost, and thus improve ROE. Digital is driving demand for cloud-based infrastructure, BPO, and IT outsourcing with banks moving many applications to cloud. For instance Bank of Tokyo Mitsubishi (BTMU) has embraced IaaS and private cloud to improve delivery to customers.
As all roads lead to Rome, we believe that all initiatives to optimize operations for greater efficiency lead to cloud, SaaS, IaaS, and mutualisation/utilities.
A New Architecture for a New Age
But the new architecture is about more than movement from analogue to digital. Emerging technologies like machine intelligence can not only drive efficiency, but also offer advanced analytics and insights leading to investing and trade ideas, superior compliance practices, improved customer engagement, additional revenue opportunities, and more.
In order to see what’s possible in the digital age, we need to change our perception of financial services. At its core, investment banks and wholesale banking institutions provide services such as data, confidentiality, anonymity, deal structuring, and financial agreements, analytics, processing, settlement, and custody, among other things. But they can do more. As others have said, every moon-shot needs its Apollo program to see what’s possible.
Fortunately, banks need to only look outside the industry for Apollo-style programs. Powerful, native digital companies have empowered end users with greater and greater information in real-time (Amazon, Google, Twitter, Skype). Today, internet is creating opportunities for native digital assets, shared ledgers, smart contracts, and smart networks through blockchain technology.
The blockchain design pattern is an aggressive form of digital transformation. Instead of a digital front/middle/ back office, we see digitally native financial agreements from issuer to asset owner and counterparty to counterparty. But as digital alters financial agreements, intermediaries will still be needed to sponsor networks.
Moving from Known to Unknown: Blockchange
To create this aggressive form of digital transformation, a new financial technology stack is coalescing around Internet of Things (IoT) and blockchain, powered by cloud. The blockchain design pattern allows for cryptographically secured environments upon which to conduct wholesale and investment banking functions.
We believe financial institutions will deploy blockchain networks with distributed ledgers in increasing numbers. Smart contracts, which are agreements whose execution is both automatable and enforceable (according to Barclay’s CTO Lee Braine) will be powered by the networks and backed by digital assets, legal templates, and standards. IT and open source organizations will provide the fabric for blockchain networks, including cloud, while a number of technology firms will deploy and manage these networks to support applications atop this fabric.
Smart contracts will be enabled by confidentiality, security, and digital identity. The underlying technology will incorporate cryptography, programmable digital assets, distributed ledger technology (DLT), and interledger protocols.
Yes, getting to smart contracts requires a lot of organizational change– mostly moving from a known IT architecture to a largely unknown one. Fortunately, blockchain creates some first mover advantages. So it’s not just cost reduction, but actual revenue opportunities that will encourage change. Many leading vendors believe transforming cloud for revenue through new products and customer engagement are realizable opportunities. Microsoft Azure and the R3 consortium is one example of transforming cloud for revenue.
Word of Caution: Optionality May be a Mirage
Changing IT infrastructure is hard, and we believe some incumbent financial services players are still too comfortable in their oases, predicting at what point they will need to sign up for change. However, for some of these firms, the optionality they observe in the future could be a mirage. Once they reach the spot, the opportunity to change will no longer be there and the market will have moved. Competitors will have embraced new digital channels, technologies, business processes, and partnerships.
Slow to move incumbents will be uncomfortably exposed to an unforgiving environment. Some will seek partnerships with fintech firms, a kind of hedging against the future (not a bad strategy, but an incomplete one), only to become hamstrung by the next quarter's results.
A better strategy is to decide what the future industry architecture will look like and then work toward becoming a leader by offering a new model for the future. Getting to the new architecture will take a minimum of three years, but most likely closer to 4 or 5. ‘Run the bank’ still overshadows ‘change the bank’ massively. To get from a known architecture to an unknown one requires courage.