New Rules for Bank Outsourcing and Offshoring

New deal models and business imperatives, as well as opportunities in emerging markets, are inspiring banks to reevaluate the types of outsourcing and offshoring arrangements they make.

First, let's get real. No one is going to pretend that cost doesn't matter when it comes to outsourcing. Study after study has reaffirmed that companies -- including banks -- list reducing costs as the No. 1 reason for outsourcing and offshoring.

But, as Thomas Friedman says, the world is flat, and the cost savings from offshoring will level out -- not tomorrow, but probably in the next 20 years. Today, however, along with reducing costs, there are new drivers -- including competition for skilled workers -- that are propelling banks in ever-increasing numbers to outsource their IT operations and processes.

When outsourcing gained prominence in the late 1980s and early 1990s, it was all about developing software in a low-cost location, according to Peter Lowes, partner and leader of the London-based Deloitte & Touche outsourcing advisory practice. In the late 1990s, the use of outsourcing and offshoring "went absolutely ballistic to solve Y2K," he says. The next outsourcing driver was the telecom revolution, Lowes continues. And the final driver was technology itself -- using the Internet to provide services allowed users around the world to access the same applications, he explains.

But outsourcing and offshoring arrangements haven't always gone smoothly -- deals collapse, banks bring call centers back in-house and business processes fail to improve. Still, outsourcing has weathered the storm. In fact, the practice is stronger than ever: 89 percent of organizations plan to maintain or increase their current level of sourcing, according to the Strategic Evolution study published in June by KPMG (Amsterdam). Armed with the lessons learned from past successes and failures, banks are now ready to take on outsourcing in the 21st century.

"The first lesson learned is that [outsourcing] is not just about cost savings, and it's not just about labor arbitrage," argues Guillermo Kopp, executive director and global research fellow for Needham, Mass.-based TowerGroup. "The financial services value chain is becoming more specialized," he says, pointing to multichannel integration and mobile banking. However, it is very unlikely that a bank -- outside of the largest players -- will have the resources in-house to constantly innovate and keep up with the competition, he adds.

"The best thing is to say, 'We trust this particular function -- credit scoring, mobile banking -- to a strategic partner,'" Kopp contends. "Sometimes it takes a lot less time for vendors to develop products."

One of the most unexpected drivers of outsourcing and offshoring is access to specialized skills and talent. "The demand for engineering [talent] is going to be more than the U.S. and the U.K. can supply," Deloitte & Touche's Lowes says.

Referring to the offshore outsourcing value proposition, Daniel Marovitz, technology manager for Deutsche Bank's global business, told BusinessWeek last year, "The labor arbitrage story is temporary. ... The real story is recruiting talent."

Sunil Subbakrishna, senior adviser in Oliver Wyman's strategic IT practice, also believes that much of today's offshore outsourcing is being driven by a shortage of IT skills in the U.S. and U.K. Companies are trying to find better ways of using the talent pool offshore, he says.

Outsourcing vendors often have core competencies and skilled people on par with, if not better than, a bank's available resources, TowerGroup's Kopp adds. "Why keep something in-house if you can have it perform better at a lower cost by a third party?" he asks.