The New Technology Mandate: Escaping the Financial Services Margin Trap

When CEB asked financial services executives for their 12 month outlook on projected costs for the industry, the picture was not optimistic.  The majority of these senior leaders (66%) expect that cost pressures will climb higher this year.  And in the most recent survey, that number ticked up three percentage points from the prior quarter.

This uptick underscores a longer-term trend — even though the global financial crisis is well behind us, industry executives report that the financial outlook for their firms feels bleak.  While costs increase, more traditional sources of revenue shrink.  In mutual funds, for example, fee revenues are being siphoned by competition from low-cost passive funds, with the average expense ratio shrinking from 100 basis points to 75 basis points in the last decade.  Mutual funds will continue to feel the impact from declining fees.  One estimate has the global share of AuM in passive funds doubling to 22% by 2020.  Or consider the lost revenue from proprietary trading.  Before the financial crisis, proprietary trading delivered 35% return on equity.  It is now banned by the Volcker Rule.  Likewise, in the OTC derivatives market, margins are being squeezed by new regulatory mandates on trading and clearing.  These challenges require financial services executives to make tough decisions and tighten their belts.

In 2015 a majority of firms will increase their IT spend, according to CEB, but typically that increase will be 2% or less. Historically, these firms have worked with Broadridge to implement technology and operational solutions, because a perennial goal for technology and operational leaders is improved efficiency.  However, in this environment, increased efficiency takes on new importance.  To break through the financial services margin trap, firms must revisit the underpinnings of the cost and revenue structure.  Technology must play a vital role in this.  Our own research with the Economist Intelligence Unit shows how executives in leading financial services firms are investing in operational initiatives to evolve their business models and refine their strategies to tackle ongoing challenges, including intensified regulation and governance, growing globalization, and changes in industry and market structure.

Going forward, firms must get creative about how and where technology can be used to improve efficiency or boost revenues. One promising avenue for increased efficiency is next-generation sourcing of processing and other back-office functions.  In a recent CEB survey, more than 50% of financial institutions said they plan to increase their spending on such sourcing strategies by 2016.  As an example, managed services have already been shown as an effective means to externalize and mutualize costs across the industry.  Another important shift is in the line.  In the past, back-office support services provided by IT were highly specialized by product line.  As those historical separations converge, back-office functions are becoming increasingly standardized.  This presents extraordinary opportunity to realize cost efficiencies.

Many firms are also now focusing their technology investments on data management and analytics.  Fifty-six percent of firms CEB surveyed will increase their already-sizable data management investments in 2015, and well over one-third (39%) of executives in our study say that investing in risk management and analytics is the most important overall strategy for dealing with business challenges.  At the same time, these firms are finding that a larger portion of costs can be shared with managed service partnerships.  This results in lower costs for the financial services firm — but it also drives better processes, and the promise of cleaner data — an important first step in identifying and seizing new market opportunities.

Technology has historically brought incremental improvements to firm-level efficiency.  Today, the imperative and potential for technology has never been greater — it must help financial services’ firms escape the margin trap.