Banking StandardsWritten evidence from Intellect

1.0 Executive Summary

1.1 In this response to the Parliamentary Commission on Banking Standards call for written evidence on the Banking Reform Bill, Intellect, the technology trade association for the UK, highlights an important consideration which should be considered alongside the existing provisions of the Bill—the underpinning infrastructure.

1.2 The operational reality is that many banks have overly complex infrastructures that are no longer “fit for purpose”, and as a result threaten to undermine the objectives of the draft Bill and any future regulatory or business change by;

Preventing banks from knowing their own operations across their disparate businesses and accurately assessing what and where their losses are, whether they can be absorbed, and therefore what constitutes as excessive risk;

Preventing regulators from assessing the true exposures of individual banks, the wider financial system, and therefore inhibiting their ability to make precise and timely market interventions to reduce the impact of failing banks;

Causing business and regulatory change to take unnecessarily long periods of time to implement;

Perpetuating a high cost of implementing regulatory change, fuelling banks’ resistance to reform;

Increasing the operational risk of implementation large scale businesses change, such as the ring-fence set out in the draft Bill.

1.3 Intellect therefore proposes that the Bill should empower regulators to set a minimum infrastructure standard—to ensure that banks’ infrastructure is fit for purpose and are able to better support the proposed reforms, wider financial stability, and reduce the cost and risk associated with the implementation of all future regulatory reform. The Bill is an ideal vehicle to establish these standards as its provisions already imply significant structural changes for banks that will have to be implemented.

2. Taking the technological reality into account

2.1 Intellect recognises the importance of a healthy financial sector as a catalyst for economic growth, and therefore welcomes the reform of the financial sector as a government priority. Reform of the UK’s financial sector is important in order to uphold financial stability, avoid a repeat of the events which led to the 2008 banking crisis, and enable better tools to deal with such events in their wake. It is an opportunity to ensure that the UK’s financial system returns to its original primary function of serving its customers and the economy, rather than providing short term dividends to investors.

2.2 It is important, however, that in doing this the technological reality of the financial system is taken into account at an early stage of policy development. It is the technological reality of the system which provides the foundations that the UK’s financial services industry is built upon. Failing to fully take this into account fails to account for the full context within which the financial system operates—rendering policy blind to the system’s full capabilities and weaknesses. This risks restricting the scope of policy considerations for financial reform, as well as poorly thought out implementation and operation strategies—with the danger of adding further complexity to an already complex myriad of systems (see paragraph 3.2 & 3.3).

2.3 Intellect therefore believes it is essential that the technological reality of the financial system receives appropriate consideration at primary stage of the legislative process.

3. The technological reality: a complex infrastructure, unfit for purpose

3.1 It is an operational reality that the financial system is underpinned by overly complex infrastructure that is no longer “fit for purpose”. By “financial infrastructure” we refer to the “plumbing” that allows data—the lifeblood of the financial system—to flow within and between financial institutions. In reality, financial infrastructure refers to a complex myriad of systems, networks, applications servers, data bases, physical storage system, and end-user computing systems and devices.

3.2 As the independent analysts JWG Group reported in March 2012; “Decades of ad hoc technology investment, combined with merger and acquisition activity has left [many financial institutions] with disconnected silos of information and duplicative processes”. It is estimated that 90% of the technology budgets of North American and European financial institutions is spent on managing and maintaining legacy systems, leaving little more that 10% for innovation and programme development1.

3.3 Today’s legacy systems and processes consist of multiple layers of technology platforms that, as banks and the technology available to them have evolved over the past 20 to 30 years, have been built on top of each other to facilitate changes and new requirements. These legacy systems are at the heart of established financial institutions’ operations, are business critical, interdependent upon other elements of a bank’s IT infrastructure and are often running 24 hours a day. Adding new elements or removing them from these systems is a complex and expensive process that will impact upon a multitude of different aspects of the banks’ systems. It is not unusual for integration testing to account for 50% of the cost of implementing new systems. Banks are therefore unable to clearly differentiate layers of operation and system functionality, rendering the introduction of additional change increasingly complex and costly to implement.

3.4 These complex, entwined systems often exist in support of business silos. This inhibits the ability of banks to have a holistic real time view of their own operations and financial exposures. In turn, it makes it impossible for regulators to build a macro view of the financial system as a whole that allows them to identify and mitigate systemic risks.

3.5 The legacy of underinvestment is an infrastructure that is inefficient, siloed, overly complex and an obstacle for cost effective business changes. These factors combined are at the heart of many of the failures we have seen in recent years in the financial system.

4. Timescale

4.1 As outlined in paragraph 3.3, making changes to the operations of banks’ legacy systems is a complex and expensive process that impacts upon the day-to-day operations of a bank. Any such change holds operational risk (see paragraph 6.2.2) and therefore can take a significant time to implement if no unintended disruption is to be caused. It is important that this is taken into account when mandating large scale operational changes—such as a retail banking ring-fence.

4.2 Intellect has noted that there are three proposed operational models for implementing a ring-fence, from the ICB Recommendations and government White Paper.

(a)The ring-fenced bank accesses the operational infrastructure used by the rest of the group, but at an arm’s length bases.

(b)The ring-fenced bank and the rest of the group both independently access a detached subsidiary for their operational infrastructure (operational subsidiarisation)

(c)The ring-fenced bank buy’s and operates its own independent infrastructure.

4.3 Each of the three proposed operational models demands a different strategy and implementation timeline. However what connects them all is that, whichever option is chosen, banks will face a significant challenge to implement them as a result of their overly complex infrastructure. HM Treasury should understand that one of the largest obstacles to the implementation of effective and timely reform is this infrastructure

4.4 It is important that a decision is made on which operational model should be implemented as soon as possible, and the demands of this model are clearly and carefully communicated. To minimise operational risk, banks need to start planning their implementation strategy at the earliest possible opportunity. Delayed decision making will either result in missed deadlines or rushed implementation and increased operational risk.

5. Setting minimum infrastructure standards as a foundation for reform

5.1 As set out in the draft Bill’s policy document, the main objectives of the proposed reforms are to:

(a)Make banks better able to absorb losses;

(b)Make it easier and less costly to resolve banks that still get into trouble, and;

(c)Curb incentives for excessive risk.

5.2 Intellect recognises the value of achieving these objectives in promoting a stable financial system, able to serve its customers and the economy. However, Intellect believes that one of the most significant reasons that many banks currently fail to meet objectives a) and b) is the result of their complex financial infrastructure which fails to allow banks to sufficiently “know their own businesses”.

5.3 The complex and siloed nature of established banks’ infrastructure (a result of years of mergers and acquisitions and “bolted-on” updates to “always on” business critical systems), prevents banks from achieving an accurate picture of the whole of their operations and exposures—limiting the ability of banks to make informed strategic decisions. Banks do not fully know their operations enough to recognise, with a great degree of certainty, what and where their losses are. As a result, they cannot accurately know whether they are able to absorb specific losses and therefore whether they are taking excessive risks.

5.4 The affect of entwined, complex financial infrastructure limits the efficient flow of data within and between institutions. This means regulators can currently have little confidence in their ability to receive data in suitable time frames and with any great confidence that it accurately reflects the exposures and positions of each financial firm, and therefore the financial system as a whole. This means that when banks do get into trouble, or are likely to do so, regulators struggle to assess the true exposures of individual financial institutions and therefore the financial system as a whole, and will be unable to make precise and timely market interventions to reduce the wider impact of a bank’s failure.

5.5 Critical to ensuring that infrastructure at institutional level (and therefore also at a macro level) is fit for purpose and supportive of the draft Bill’s three core objectives, is a commitment from individual institutions to address their underpinning infrastructure. Complex legacy systems inhibit the flow of data throughout the financial sector preventing banks from sufficiently “knowing their businesses” and regulators from successfully monitoring and intervening to promote stability. As voluntary renewal has so far been resisted, there is a strong argument for the regulatory authorities to set minimum standards for banks’ systems (as part of wider minimum standards for infrastructure)—to minimise unnecessary complexity, potential downtime and the risks posed by future updates to these systems. The work being undertaken by the Monetary Authority of Singapore in setting guidelines for technology risk management provides an example of how this could be undertaken.

5.6 By setting minimum standards for financial infrastructure, a sufficient foundation could be laid to support and promote the draft Bill’s three core objectives.

6. Reducing the cost and risk of implementing reform

6.1.0 Cost of implementing reform

6.1.1 Minimum infrastructure standards would also serve as a foundation for wider, ongoing reform of the financial system

6.1.2 Resistance from banks to complex business change often stems in part from the impact that such changes will have upon the bank’s increasingly complex core systems; the resource that will have to be applied to achieve compliance; and the potential disruption that there will be to everyday banking activities.

6.1.3 If there is opportunity to reduce this cost in the future, there is a strong argument for banks to factor this into what are already significant change programmes to implement ongoing reforms. For instance, significant “unbundling” of systems will have to take place in order to implement a retail banking ring fence where both investment and retail banking operations must be, to all intents and purposes, structurally separate.

6.1.4 The proportion of the cost of implementing business change (be it regulatory or commercially driven), that is attributable to integrating new functionality into these existing systems is extremely high at approximately 70% (according to Intellect’s members). By addressing the complexity of the systems that underpin a bank’s operations now, the cost of (and level of resistance to) ongoing reform will be significantly reduced, freeing up additional budget to innovate, improve services and deliver greater value to customers and their businesses.

6.1.5 The Bill is an excellent opportunity to address the underlying problems facing the financial system—not just the symptoms. If the Bill is to succeed in fulfilling the three objectives above, there needs to be a focus on ensuring that this underpinning infrastructure ceases to be an obstacle to change, but instead becomes a foundation upon which the ongoing reform and evolution of the financial system can be based.

6.2.0 Reducing operational risk

6.2.1 The scale of change set out in the Bill poses significant operational risks to banks during the implementation phase.

6.2.2 Operational risk, generally defined as the risk of loss due to failures of people, processes, systems and external events, is a perpetual threat to banks as a result of the constant need to update systems and processes. As more updates are “bolted on” to systems, their complexity grows and with it, so does the risk associated with further future updates.

6.2.3 In a recent speech to the Exchequer Club in the U.S., Thomas J Curry, Comptroller of the Currency, (US Treasury Department) stated that “Operational risk is heightened when these systems and procedures are most complex. Given the complexity of today’s banking markets and the sophistication of technology that underpins it, it is no surprise that the OCC [Office of the Comptroller of the Currency] deems operational risk to be high and increasing.”2

6.2.4 The cost attached to implementing changes to existing infrastructure—especially core legacy systems—stems from this risk to the continued provision of services that any mistakes or systems failures as a result of these updates pose.

6.2.5 The effects of systems failure have been no more visible to the public than in recent months with the issues surrounding RBS batch payments processing. While the exact causes of this are not yet publically known, the disruption of services to customers has been widespread and plain to see. Across all banks the more complex there systems become—as a result of “bolt-on” updates to existing infrastructure and systems—the greater the operational risk.

6.2.6 The draft Bill’s flexible approach to expanding “core” and “excluded” activities, runs the risk of being treated by Banks as yet another “bolt-on” compliance solution, further adding to the complexity of the system and increasing operational risk. Setting a minimum standard for banks’ underpinning technology infrastructure—and by doing so reducing its complexity—will not only support the draft Bill’s three core objectives (see 4.0) but would also reduce the operational risk posed by implementation of the provisions of the draft bill and crucially, all future regulatory and commercially driven business change.

7. Conclusion

7.1 Intellect believes that in reforming the financial system, policies should be evaluated against the operational realities of the financial system and against a long term objective of reducing the complexity of the system—in order to ensure the effectiveness of reforms and ensure future financial stability.

7.2 The current reform of the financial system provides a once-in-a-generation opportunity to tackle the underlying fallibilities that the financial crisis has exposed. Specifically this is an underlying problem of banks’ overly complex infrastructure which is no longer “fit for purpose” and inhibits both the reform and the evolution of the system so that it can better serve customers and the wider economy. Intellect believes that setting minimum infrastructure standards for banks—as has been addressed by the Monetary Authority of Singapore—is necessary to support the Bill’s objectives and the future stability of the financial system.

About Intellect

Intellect is the UK trade association for the IT, telecoms and electronics industries; industries that generate around 10% of UK GDP and 15% of UK trade. Our Members include blue-chip multinationals as well as early stage technology companies and play a crucial role in virtually every aspect of our lives. Intellect articulates a cohesive voice for these industries across all market sectors, and is a vital source of knowledge and expertise on all aspects of the technology industry.

Alongside the technology industry’s considerable footprint in the UK, Intellect also enables many other industries to operate efficiently in today’s economy including:

financial services;

creative industries;


transport and logistics;


defence and aerospace;


We are a trusted partner for Government, both in terms of policy development and policy implementation across numerous sectors. We look to ensure that all relevant engagement of policymakers and regulators with industry is both easy and as valuable as possible in order that the technology industry may play the fundamental role it merits in the success of UK plc.

Intellect’s Financial Services Programme brings together over 180 suppliers of information systems, services and consultancy to the banking and insurance sectors.

Many of Intellect’s members are heavily involved in providing the fundamentally important technology platforms upon which the UK’s financial services industry is built. For example, these Members help facilitate the 5.7 billion automated payments that are made through the banking system on an annual basis. Similarly, the 40 million online bank accounts that are registered in the UK will not function without the technological capability that our members design and supply.

The relationship between the financial services industry and the technology sector is one of fundamental importance. As the Office for Fair Trading has recently stated, “IT systems are the backbone of retail banking activities and are essential to the safety and resilience of financial systems”. Technology not only plays a critical role in the functioning of the full spectrum of financial services, it is a hugely important factor in ensuring that the individual institutions within it can operate more responsibly and remain competitive in the global marketplace. The right technology can help depress costs, reduce risk and increase the confidence of lenders and investors, all of which are of paramount importance in the current economic environment. Applied inappropriately or to the wrong ends and it can contribute to systemic risk, lead to reduced inward investment and ultimately have a detrimental effect on the economy.

Consequently, if the UK’s banking sector is to be reformed to meet the challenges posed in recent years and provide the backdrop to economic recovery, policy not only needs to reflect what technology can facilitate today, but what it will enable in the future. Reforms will only be effective and durable if they take into account how it will be implemented and how the application of technology can be complementary. For an industry like financial services that relies so heavily upon technology, it is essential that regulatory authorities are equipped with a full understanding of it.

For further information on the case for financial infrastructure renewal, please see the Intellect paper, “Biting the bullet—why now is the time to rebuild the foundations of the financial system”.

5 November 2012

1 P3. “FS infrastructure: ready for G20 Reform?”, JWG, March 2012.

2 Remarks by Thomas J. Curry Comptroller of the Currency Before the Exchequer Club; 16 May 2012.

Prepared 2nd January 2013