IT FOR BANKS: Reducing the Paperwork

The heart of most banking systems continues to be a large mainframe computer, which tends to be used for transaction-processing applications. Bank mainframes are normally used to carry out simple calculations, over and over again, on huge amounts of data. The processing requirements are input-output intensive, and the architecture of a bank’s information systems’ infrastructure is designed to maximize speed of access to the data, which itself is to be found in massive databases. Batch programmes to do account updates typically run at night, so online programmes predominate during the day–these programmes are used to provide information to bank staff and customers.

In addition to the mainframe–its associated terminals and PCs–banks’ infrastructures typically include specialized machines such as cheque readers and sorters, Automated Teller Machines (ATMs), and data
capture and authorization terminals at retailers.

Why Automated?
The automation of banking process through the use of IT is intended to support transactions. In one recent year, a mid-size US bank processed: 12,100,00 cheques; 3,600,000 traveller’s cheque redemptions; 1,112,000 pieces of mail; 995,000 credit/debit card transactions; 650,000 consumer deposits; 598,000 ATM transactions; 539,000 statements; 220,000 business deposits; 77,000 customer inquiries; and 49,700 wholesale funds transfers.

What is interesting is that we can see how payment transactions predominate despite recent advances in electronic transactions and there is still a huge amount of paper in the banking system. Large amounts will continue to be invested in IT to reduce the vast quantities of paper that are still produced inside banks. The resulting investments in information systems are meant to reduce non-interest expense. It has been found that the highest cost function inside a bank is fund movement. It has been estimated that if all funds’ movement were to be entirely automated, up to one half of a bank’s costs could be eliminated.

Stages of Automation
There are three stages in a bank’s automation process.
Stage A: The first phase of automation involves a bank’s back office. It involves automated core record keeping, and the functions that were typically automated were statement preparation, nightly account updates, and general ledger maintenance. The processing methodology was batch processing.

Stage B: As online terminals were developed in the 1970s, parts of front office work could be automated and interactive processing was the main method. Transactions could be entered online, and customer service could be improved. For example, an account balance inquiry could be made against the previous night’s data, not a month-old statement. Implementing this level of automation meant that banks began to build networks to connect their data centres to many scattered devices, such as teller terminals, cheque readers and sorters, and so on. The effect of these changes was seen in applications programmes that could control workflow; some internal paper documents were rendered obsolete; there was better control of credit and fraud. Essentially, the important change was that more information could be passed around the bank and between the branches and the data
centre.Stage C: This stage is when the interface to the customer is automated; there is no intermediary employee between the customer and the bank, and customers no longer have to initiate transactions in paper form. For this to happen, the banks’ networks go beyond their own premises, and into retailers, brokers, insurance companies, and so on. ATMs are a good example of “Stage C” technology on the retail side. International funds transfer and corporate cash management use “Stage C” technology on the business banking side. The technology implementation has tended to be through a move towards client-server type architectures.
Competing with Technology

It is generally agreed that there are three levels in a bank’s technological infrastructure. We can best see how banks might compete using technology by considering these three levels individually.

Level 1, Core Technology: This level includes the hardware, systems software, and generally accepted knowledge available today. It is neither specific to a bank, nor to a business.

Hardware and software is obtained on the open market, so it provides no competitive advantage. So if it is not possible to gain a large competitive advantage by investing in this level of technology, why bother to do so? Firstly, because it is necessary to do so to be in the banking game–a bank has to create a “level paying field”. In addition it possible to gain a limited competitive advantage by seeking economies of scale. For example, a large data centre will have a cost advantage over a small data
centre.

It is also possible to gain an advantage by executing Core Technology skills well. Banks that are not capable in this level can fall behind. For example, an international bank chose a second-tier hardware company to supply all its world-wide branches. As the volume of transactions grew, the vendor’s product could not handle the amount of traffic, so the bank had to remove this hardware, and replace it completely; this was extremely expensive in time and money–and in lost reputation.

Level 2, Applications and Processing Activities: This level has two parts: the application programmes (that run on the hardware and operating systems implemented in Level 1), and the manual operations that interact with these applications, such as when a worker has to input data into a credit application to determine a customer’s credit-worthiness. Banks need to invest a great deal of money in this level in order to be able to process the information of every type of products in its portfolio. There are economies of scale at this level also: applications programmes need only be built once, no matter the size of the bank. The more aggressive a bank is with its investment, the quicker its unit costs should fall.

Banks compete using this level of their technological infrastructure by using it to get their new business ideas to market first; thus being able to capture the market and maintain high margins. One reason Barclays Bank was so successful with the introduction of Visa in the UK, is that it invested a great deal in the systems software to support it, and it took its competitors six years to follow suit. And Barclays is still the leader!Another example of how investment in processing activities can create an advantage is Society for World-wide Financial Telecommunication (SWIFT). There are over 1,600 member banks in SWIFT, which is a shared network for messages transferring funds between banks. A smaller bank that invested in the technology to join this network would gain a clear competitive advantage over a similar bank that was not a member. The same is obviously true for Plus, Cirrus and other ATM and POS-related shared networks.

“Information is power”–the technology at this level allows data warehousing and data mining, where specialized tools can be used to find specific information or find co-relations between different sets of data. The information thus acquired can then be used by the bank to improve competitiveness. For example, the bank may find that people who took out a mortgage three years ago are more likely to take out a home improvement loan than those who took out a mortgage 10 years ago. And these customers could then be the targets of a marketing campaign to increase the number of home improvement loans. This is an example of how technology enables banks to move form mass marketing to targeted marketing.

Level 3, Business Needs: This level includes the set of business requirements that drives the technology. The technology that is present in the other level is there (or should be there) because it answers the needs of the bank that are the result of the answers to such questions as:

  • What business is this bank in?
  • What products should we offer?
  • How should we provide services to our customers?
  • Which delivery channels should we use?

The Retail Line of Business
The payment system is the heart of the banking industry. As we saw above, payments have been a major target of the industry’s investments in information technology. In this section, we look at recent developments in the retail payment business, and at how technology has had a great impact.

Retail Payment Systems: Chequing accounts are the heart of the retail banking system; they represent nearly 50 percent of all banking industry costs in North America. So, the use of IT to reduce these costs has received a great deal of attention. There are three initiatives in this sphere, which are all at “Stage C” of the automation process as they remove paper from the system–ATMs, PoS/debit card systems, and home banking.

The most common method of retail payment remains the cheque. Even so, a great deal of IT is used in processing cheques. Cheque processing technology has improved steadily over the last forty years, but there have been no real breakthroughs, and cheque processing is not viewed by banks as an area where they can gain a distinct competitive advantage, and it remains a process that is in “Stage B”–front-office automation.Automated Teller Machines: ATMs have a dual role: stop bank employees having to deal with simple payment transactions and extend the hours when a bank can offer service to its customers. These days we see that more and more ATMs are being installed away from bank premises–shops, hospitals, airports and so on. New machines have such features as statement printers, touch screens, colour displays and offer a fairly wide variety of services.

Originally, banks maintained proprietary networks for their ATMs, but it began to be more economical for them to share networks; it also made more sense for their customers. As the sharing trend has grown, it has become possible for smaller banks to compete with larger banks as they can join an ATM network without having to own any ATMs themselves, and they can allow their customers to get service in locations where the bank has no physical presence.
Point of Sales (PoS) and Debit Cards: The customer for PoS systems is the merchant. On average it costs a merchant 48 cents to handle a cash transaction; 50 cents for a cheque; 97 cents for a credit card; 32 cents for a debit card. In North America and Europe, the main merchant customers for PoS systems have been convenience stores, supermarkets, and petrol stations. Obviously, a key technological challenge lies in the fact that there may be as many as 10 separate communications involved in the processing of a single debit card transaction. In addition, the generally accepted maximum for response time is 10 seconds. The most common approach to PoS/debit card systems is for a cardholder to swipe a card at the checkout, and then enter his PIN; the transfer of funds takes place in real-time.

This service is one that banks have to offer their business customers; the merchant benefits by reducing his costs and the bank can reduce its own costs. The key for a bank to gain a competitive advantage is to have a large number of its customer with debit cards, and then by having a highly reliable, efficient network connecting the PoS/debit card system.

Home Banking: There are several attractive features in home banking. Most of the cheques written at home are for recurring payments–mortgages, telephone, electricity and so on. Cost reduction will be achieved for the bank, because the most common use of home banking is precisely to make such payments. But home banking can be much more than a way of making payments; there are many examples–account balance information, stock price movements–plus the opportunity for direct marketing to the customer through the bank’s web site.

Obviously, the growth of the Internet has been crucial in many parts of the world for the explosion in home banking. In addition, it is necessary for banks to design products that take advantage of the unique features of home banking. While it is true that no one knows how big a company is based on its Internet presence, so a small bank can look like a large bank, it is necessary to have deep pockets to fully take advantage of home banking. High investment by the bank in technology (hardware, software, and human resources) is necessary to make the most of the home banking opportunity.There are other ways for customers to access their banks from home

  • Telephone Banking Services are based on either human interaction, or much more commonly, automated voice recognition systems. Computer Telephony Integration (CTI) is a key driving force of development in this area. For example, Caller Line Identification means that a bank employee can know a customer’s name and have relevant data available before the phone is even answered.
  • The Smart Phone is an intelligent device that includes some form of data display and entry device through which a customer can view an account balance.
  • Interactive TV uses the connection between a cable box and a service provider such as a bank to provide account information.

The Future
IT will continue to play a very important role in transactions, as we have seen above. However, it is very likely that computers will play a greater role in
actively supporting decision making. There are two areas where progress is being made: Expert and Neural Systems.

These will be key to the ability of bank staff to assess and minimize risk.

  • Expert Systems: These are particularly useful where there is a shortage of suitable experienced individuals,
    because Expert Systems are designed to pass on a particular body of knowledge to users. For example, an Expert System can be used to provide assistance from an expert knowledge base to a user who has to reach a decision. This decision will be based on established rules that an actual expert has taught the system. In mortgage work, for example, they used firstly to calculate rates, and secondly to assess the risk on a particular loan. This is how technology can be used to reduce credit risk, for example.
  • Neural Systems are similar in goal to Expert Systems, except that the computer system works out the roles on its own, rather than being programmed by experts. The Neural network is trained by going through many previous decisions, and making a correlation between the various inputs and the final decision.

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