The Brave New World Of Banking Technology

This article originally appeared on Wall Street & Technology.

Nicholas Carr, in a 2003 Harvard Business Review article, pitched the idea that technology doesn't matter. While initially, Carr argued, technology provides competitive advantage, over time it becomes commoditized.

The challenge, I would argue, is divining the difference. And given our regulatory environment, divining the difference between advantage and waste will become increasingly more important -- and more difficult.

Under the Volcker Rule, proprietary trading will need to be wound down. Under Dodd-Frank, the swaps business will be transitioned from a profitable OTC model to a more competitive, less profitable, centrally cleared business. Under Basel III, bank capital ratios will be raised from 2 percent to at least 7 percent (and possibly as high as 15 percent). And under the recently discussed Basel liquidity standards, banks will need to hold enough liquid assets to withstand a 30-day credit squeeze.

If these rules are enacted as written (or considered), it will constrict banks' most significant profit engines while reducing their financial leverage. It will transform the "modern" financial institution that profits from trading and turnover into a cash vault -- the modern-day equivalent of a financial Roach Motel, where cash "checks in and never checks out." It will force banks to reduce their exposure, eliminate capital-intensive businesses and drastically reduce their cost structures.

As institutions transform their organizations, infrastructures, processing systems and virtually anything that hints at non-differentiating technology will be shipped up to the cloud and provided by large processing-enabled vendors. While this historically has involved core back-office platforms, it increasingly will be true for mid- and front-office platforms. Any technology that does not provide a significant competitive advantage will be assimilated.

That said, the competitive advantage won't be the same for everyone. Some firms will focus on relationships, some on cost, some on ideas and others on execution. Some will focus on the U.S., and others will focus elsewhere. All firms, however, will need a low-cost, highly efficient and scalable global IT environment. But not all firms will be able to afford to build this environment from scratch, and those with existing built-from-scratch environments will need to reexamine if they can afford the maintenance.

This will force firms into shared technology environments. We have seen the progression of back-office systems into hosted and service-based models, and now we are beginning to see the development of shared trading and mid-office processing ecosystems. For example, the NYSE and Thomson Reuters just launched cloud initiatives; the NYSE's Capital Markets Community Platform and Thomson Reuters' Elektron each provide a secure network linked to a private community-based hosting/ASP environment. Add that to the BT Radianz's community offering as well as other exchange colocation initiatives and we are beginning to see the development of a new model for financial markets processing in which locational infrastructures attempt to provide a greater supply of services to their ecosystems at drastically differentiated cost structures.

While these new platforms may not kill banks' existing technology and/or service models overnight, the technology, business models and ecosystems are being built. And if the regulators have their way, the new economic paradigm for banks may not leave them much choice.

About the Author: Larry Tabb is the founder and CEO of TABB Group, the financial markets’ research and strategic advisory firm focused exclusively on capital markets.