Information technology is both spurring and facilitating consolidation in the financial services sector, according to a report by the G-10 central banks.
The G-10's Report on Consolidation in the Financial Sector, which surveyed the principal forces behind merger activity, said that IT has encouraged consolidation because of its high fixed costs and the need to spread those costs across a large customer base. But at the same time, improvements in the speed and quality of communications and IT have enabled banks to extend their services across wider geographic areas.
"Technological advances have changed the competitive functioning of the financial sector at both the production and distribution levels," said the report. Other forces at work include deregulation, globalization, shareholder pressure and the euro.
Only through consolidation can financial institutions achieve the production scale required for high-volume, low-margin products like credit cards, custody and cash management. "A large firm size provides the wherewithal for continuous technology upgrades to achieve unit-cost advantage in pricing what are basically commodity products," the report said. The report also noted that online delivery channels spur competition by lowering the barrier to entry.
Independent observers have expressed similar views. "Consolidation is not only necessary but inevitable," said Mark Sievewright, president and CEO of TowerGroup. "Only a big bank has the money to buy state-of-the-art technology and develop and maintain multichannel delivery systems."
But while IT has raised the ante for competing in financial services, it's had a salutary effect on manufacturing and distribution capacity. "Far from representing a threat to the big financial institutions, technology will boost their efficiency and profitability," Sievewright said.
"Over the past 20 years, there's been a shift in how technology is used within financial services," he continued. "It's moved from being a tool to automate processes and reduce costs to a new world of delivering improved service and convenience to customers."
Technology advances combined with innovations in financial engineering have enabled service providers to unbundle and repackage the risks embedded in financial products, said the G-10 report. Through the use of data mining, banks have been able to create specially-tailored products and channel them to targeted customers.
Still, retail banks are a "secondary level of utility for customers," said Sievewright. "There's a real danger that retailers and others who provide a primary level of service can muscle in on banks' territory."
The Internet, he said, is a classic example of a technology that's suited to mass-market applications. "Firms applying it well have an almost unassailable competitive advantage."
Meanwhile, bricks-and-mortar channels aren't going away. "New delivery channels are spurring more transactions from customers without changing their usage of the branch. The Internet is actually creating more expense," said Sievewright.
That puts the onus on banks to smooth the flow of information between and among channels. "The old delivery model of silo-driven and product-centric financial services no longer works. Delivery channels have to be integrated," Sievewright said.
Customer expectations have shifted to a relationship-driven, multichannel delivery model, he said. But the $5 billion that financial firms spend each year on customer relationship management (CRM) technology won't have much of an impact unless it's accompanied by fundamental changes in culture and business processes. "CRM is not a technology. It's a sales and service business strategy."