January 20, 2004

Over the past ten years, industry consolidation, fierce competition and shrinking margins have forced banks to aggressively cut costs. For many, the consolidation and rationalization of information technology were central cost-cutting initiatives. Within this context, banks have used outsourcing either to augment internal projects or to bypass internal change.

Financial institutions have been outsourcing technology projects for more than thirty years. Starting in the 1970s, the outsourcing trend began mainly with banks outsourcing software development and maintenance. Technology outsourcing included data management, application development and maintenance, and infrastructure management. Projects ranged from straightforward tasks, such as application maintenance, to complex long-term projects. Today, outsourcing large, complex technology projects is making a comeback, as evinced by JP Morgan Chase's recent decision to outsource their technology infrastructure to IBM. Banks have apparently become confident that outsourcers can provide both adequate security and privacy for their clients.

In the 1990s, after the introduction of new technology, consolidation within the industry and tight pressure on margins, many financial institutions, especially large banks, began outsourcing business processes as well as technology projects. In the banking industry, the first forays into business processing outsourcing (BPO) involved call centers and card transaction processing, areas which are now deemed mature. Likewise, a few leading banks have begun outsourcing significant portions, if not all, of their human resource divisions, as exemplified by Bank of America's human resources outsourcing relationship with Exult, which began in 2000.

Although technology outsourcing deals vary in size, business process outsourcing deals are usually large, long-term, highly complex relationships. The scope of such projects varies depending on the size of the bank, the process outsourced, and the geographic regions involved. The typical duration of a business processing outsourcing contract is three to seven years. (A straightforward project lasts, on average, three years, while a medium-sized project can last five to seven years and the most complex projects last around ten years.) However, in practice, most contracts are re-negotiated before expiration. Deals sizes range from US$150 million to several billion dollars. Contrary to the recent hype surrounding BPO, most deals range from US$100-200 million.

Recent attention to the growth of business process outsourcing overlooks more than a decade's worth of prior experience outsourcing key business processes by banks. Perhaps more interesting than the increase in the number of business processing deals is the fact that banks are now outsourcing functions that were previously considered too risky to outsource. A great concern remains about the loss of control (data and people) as well as concerns about security, privacy, reliability, and accountability.

Ever-increasing competition, however, is forcing even the largest banks to cut costs across the board and to fully leverage their technology through efficient processes. In order to accomplish these goals, the number of banks relying on outsourced processes is steadily increasing and will only continue to do so. As a result, the number of business process outsourcing deals will continue to grow, particularly in payments, imaging document management, and loan processing.

Anjalee Davis is an analyst within the banking group at Celent Communications, a financial services technology research firm based in Boston. She can be reached at adavis@celent.com.