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Even Bank CIOs Don't Know the Real Cost of Their IT Resource

Calculating the accurate cost of a bank's IT resource is like pinning down the exact location of Osama bin Laden's cave. There are some ideas floating around, but they're fuzzy. Because I don't have a personal stake in this matter, I believe I can present an interesting case to explain this phenomenon.

Calculating the accurate cost of a bank's IT resource is like pinning down the exact location of Osama bin Laden's cave. There are some ideas floating around, but they're fuzzy. Because I don't have a personal stake in this matter, I believe I can present an interesting case to explain this phenomenon.But before you read any further, you should know the basis for my rather bold statements so you can quit now or spend a couple of hours figuring out how you view my findings. I owe you at least that because if you read this on company time it will cost your employer $216 based on the full absorption method of cost accounting and a presumed salary of $130k.

• I don't trust surveys because participants answer "for the good of the order" and according to what makes them look good, not what's real.

• A bank's IT costs include what the accounts payable department dispersed based on a voucher or authorization-to-pay that eventually ended up in the GL and onto the P&L.

• A clear distinction in my analysis is the difference between annual expense and capital outlays. I count annual expense. Vendors count the total amount of the check as revenue; banks expense 1/36th per month as amortization or depreciation. In the case of outsourcing, because it's a pay-as-you-go arrangement, it is automatically an expense item.

• During an era when the cost of money for a bank is nil at the Fed Window, one might believe that capital expenditures do not carry a cost of money factor. Maintaining adequate capital is the reason banks aren't spending these days, not the cost of money. And even at the Fed's rate, bankers would be negligent if they didn't consider opportunity cost in their decision to release capital. A 6% cost of opportunity factor has been reasonable in recent years.

Now, after all those caveats, here's a look at my analysis of bank IT costs.

• What's real about bank IT costs is the same thing tellers do at cutoff intervals - count, balance, look for anything that slipped under the tray, reconcile differences, and enter the results into the system. There is no such system of checks and balances for IT resources.

• Good news vs. bad news. In every client assignment I conducted, the banks' idea of their IT costs at the beginning of the project and what my spreadsheets showed at the end of the project were two significantly different totals. My spreadsheets won even though they showed higher numbers. I believe bad news has its place as long as it is true.

• Some IT costs bypass the accounts payable department because they are not tagged with a GL tran code, but instead are imbedded in what's called bank ops personnel expense. Even though he is not known today for his overwhelming correctness in regulating the banking industry, Alan Greenspan called this "the IT productivity factor or lack thereof." There are still places in some banks where IT is a better solution than, let's say, a staff of people. Banks that resist further investment in IT to keep that cost down, may be focusing on just part of a problem. The point here is that the bank that worries about its higher IT costs than its peers, may be doing a much better job because of reduced costs elsewhere in the bank.

• EVERY bank maintains bootlegged systems that never get tagged properly. In my opinion, that might be a good thing. Smart department managers acquire small systems for the benefit of their department's performance, that they disguise as office supplies or something else just to get past the procurement procedures. But it's a bad thing when it is not properly charged to a GL account. Another bad thing is if the stand-alone system isn't linked to the enterprise system. Every child needs a mom.

• Annual reports of publicly traded banks show what might look like IT costs, however, what isn't disclosed is the fact that IT personnel costs are lumped in under a different line item called "personnel." Is that a huge absence of true allocation or what? Does IT not use people? For example, page 33 of the 2009 Bank of America annual report lists Noninterest Expenses. Data Processing (their term, not mine) and Telecommunications expenses add up to $3.9 billion. Add in some other fuzzy line items that in part should apply to IT, such as occupancy, equipment, professional fees, amortization of intangibles, and the biggie, the cost of IT people, and the total IT cost as reported would more than double.

• Looking for industry standards to gauge a bank's IT cost is a lazy way to achieve comfort or concern. The only way to really know is to take an inventory of every IT resource, add an expense value to it, and calculate the total. Having the right checklists so as not to forget anything is also a good idea.

• Predictions of IT spending typically hit the pages of the trade journals, especially during down periods. So I'll add my two-cents worth to the sport. The answers are 0%, 2%, 3.5% and 7%.

A 0% increase in any bank's IT budget is impossible unless a bank elects to break certain commitments at the time it signed long term contracts. But 0% increases in a vendors' revenue actually happened in 2009. Instead of looking for a number, I prefer to describe 2010 as just a flat year to see how real the recovery is, and to make sure there are no other crunches in the banking system that were swept under the carpet.

A 2% growth increase is in my judgment a reasonable target because there are legitimate ancillary solutions available that banks have just not acquired because of FUD or because some banks take ten years to adopt a new technology.

The 3.5% increase relates to what I believe will be an awakening among vendors that they have to create new sales rather than wait for bankers to enter the marketplace. I believe the Internet has done away with the old fashioned knock-on-the-door salesperson. And in the process, has lowered the number of new sales relating to discretionary applications.

The 7% increase is probably the most interesting. When in doubt, act it out. So I acted like a bank CIO and worked on my 120-line-item IT budget. The CFO was acting also in this scene when he declared a freeze on all new spending in 2010. There were only a handful of expense items for which no one in the bank could freeze, but hey accounted for a 7% increase over 2009's budget.

And there you have it, folks. The way I see it, size of the bank will pretty much impact spending. The 136 large U.S. banks will take the lead in doing whatever it takes to succeed. And they believe strongly in technology so they'll be proactive. The 1,619 mid-tier banks will probably be the business case group that will test every decision to spend based on guaranteed payback. They'll spend moderately, but wisely. The 14,041 small banks will play it close to the vest, not because of the economy, but because of their culture. When a small bank achieves a comfort level that puts technology at the same level as its customer expectations, the bank reduces its interest in discretionary applications.

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