A Strategic Approach to Cost Reduction in Banking
Today’s financial services landscape is under a growing burden of rising costs.
From IT investments to the cost of compliance – banks must respond to the steady rise in operating costs. With the ongoing COVID-19 pandemic, UK domestic credit losses are estimated to rise to GBP18.5 billion in 2020. Many traditional and non-traditional players are facing the challenge of thriving in an uncertain environment with shrinking margins, increasing competition, and demanding consumers.
To survive, banks must focus on taking a strategic approach to cost efficiency and effectiveness. Traditionally, the banking sector is a tightly regulated industry, with limited scope for innovation - especially in the pricing domain. Banks have relied on a market-based approach, risk premium, or cost of funds approach for pricing factors. But these approaches are not comprehensive; missing out on crucial cost elements such as cost of technology, product development, processes, maintenance, infrastructure, and other associated costs of servicing.
Challenges to cost-efficiency
- Outdated legacy systems
Most global banks are built on legacy systems that have become complicated over time. These systems are large matrix institutions that support core banking services. Maintenance and upkeep of these systems is a costly burden. As banks grow, new products, services, and processes are regularly added to their portfolio. Outdated systems hold back organisations from attaining the full potential of their digital initiatives. As per a survey by VMware, 62% of IT leaders say legacy systems are the biggest roadblock to multi-cloud success. Considering the disadvantages of legacy systems, the way forward for banks is to modernise the system. But modernisation is an expensive and time-consuming journey that most banks are not ready to embark on.
- Cost of compliance
According to the annual Global Regulatory Outlook Survey, the cost of compliance is one of the biggest challenges that financial institutions face. Since the global financial crisis, the European Union (EU) has introduced a string of regulatory measures to protect the consumer. Keeping up with the regulatory changes is an uphill task. Banks must cover various processes that range from monitoring banking transactions to ‘know your customer’ (KYC) remediation to anti-money laundering measures.
The report states that the EU’s General Data Protection Regulation (GDPR) is estimated to have cost an average of £66 million to comply with. Add the revised Payment Services Directive 2 (PSD2) and Open Banking, and banks are re-structuring the entire industry that facilitates data sharing – increasing compliance overhead costs for data sharing norms. The cost of compliance trickles into the expanding technology landscape. Investments in regulatory technology or RegTech have significantly impacted banks bottom line.
- Evolving technology landscape
Rising competition from FinTech and non-banking financial companies (NBFC) is forcing incumbents to embrace new and emerging technology and reorganise their IT infrastructure. Operating multi-cloud networks and delivering omnichannel experiences can create a fragmented back-office architecture. Let’s not forget that different systems are used to support legacy products that further increase costs.
To improve cost efficiencies, organisations need a strategy that reduces organisational complexity, enhances customer services, and improves customer retention. The focus for new-age banks should not be solely on cost reduction, but on improving their processes, infrastructure, and channels.
Transforming cost reduction with technology
While investment in technology has gone up, its impact on cost reduction and efficiency is noticeable. Automation of business processes is helping banks rapidly scale up, improve process quality and accuracy, reduce cycle times, and improve compliance. A survey by Bain & Company found that companies report savings of 20% on average over the past two years due to automation. The uptake of automation has taken some time, but the application of robotics and artificial intelligence (AI) to banking processes is growing steadily. AI-powered chatbots are overtaking traditional customer support or contact centres for tech-savvy consumers. Chatbots provide 24/7 customer support with neuro-linguistic programming (NLP) that replicates human speech and resolves customer queries without human intervention. As per a study by Juniper Research, the operational costs savings from the implementation of chatbots will reach USD 7.3 billion globally by 2023.
According to the annual Global Regulatory Outlook Survey, the cost of compliance is one of the biggest challenges that financial institutions face
Robotic process automation (RPA) is another technological advancement implemented at banks for cost reduction. It has been beneficial in automating repetitive manual processes, data reconciliation, and transcription. Compared to other technologies, RPA is relatively low cost as it does not require new core IT infrastructure change or upgrades. With its lower costs and high-productivity model, RPA is on its way to disrupt business process outsourcing models. When implemented effectively, RPA can be applied to a wide variety of rules-based business processes or tasks. It simplifies communication and provides complete control of operations. Various outsourcing experts such as KMPG and Deloitte place the cost savings of RPA over outsourcing to be greater than 70%.
Reducing IT costs with DevOps best practices
With an increasing number of cloud services and digital channels, DevOps has been crucial for banks to optimise their costs when it comes to application development, deployment, and maintenance. Banking software is known to be complex and take forever to develop using traditional testing methods – delaying delivery timelines.
To meet the rigorous demand of the digital market, DevOps is being placed at the centre of all business processes. This convergence of business practice systems around DevOps is a new concept called the Emerging DevOps Superpattern. This best practice covers the business requirements of agility, holacracy, security, information technology service management (ITSM), and decentralises the role of leadership by creating a learning organisation. When implemented, DevOps best practices optimise and reduce IT costs:
- Infrastructure and CI/CD process automation
One way of cost reduction with DevOps is to automate the continuous integration (CI) and continuous delivery (CD) process and provisioning of IT infrastructure. Infrastructure as code (IaC) automates the provisioning and enables the development of template-based solutions. This way the CI/CD pipeline will serve as a framework for the development team to configure and launch services rapidly – with no DevOps involvement.
- Resource cost optimisation
Maintaining banking IT infrastructure is expensive and for most banks building their own services from scratch is not a viable option. To optimise costs, banks can use third-party services that can help reduce operational overhead. For instance, cloud infrastructure is a growing necessity for global banks. During the planning phase, DevOps practices would help you evaluate the cost-effective approach for infrastructure development. The DevOps team audits the infrastructure resources and services and decides which cloud approach (Private/Hybrid) would be best suited for the organisation. It also helps in reducing infrastructure usage by decommissioning obsolete or redundant processes.
According to PwC, as the market matures, banks must shift from a cost-plus pricing approach to a value-based pricing strategy. This approach advocates a customer-first strategy wherein the focus in on creating premium products and services that users would willingly pay for. A deeper understanding of customers’ needs is crucial for determining the pricing strategy for products. With an increased focus on product innovation and customer analytics applications, PwC asks banks to consider the following questions while deciding on pricing strategies:
- How to make a product differentiation strategy more relevant for their customers?
- What price point will attract customer to buy products?
- What makes a channel more desirable from the customers’ perspective?
Simplification of the value chain offers banks a clear focus on its IT and operations, streamlined portfolios, transparent processes, and better chances of profitability. With an effective cost reduction strategy, banks can create long-term sustainable approaches to efficiently manage costs and improve profitability.