By Aaron McPherson, Financial Insights, an IDC Company
In December 2008, Financial Insights released its Worldwide 2009 Top 10 Predictions for Financial Services, which were summarized in a column on the BS&T website on Feb. 9, 2009. The predictions are also referenced in the sidebar. They were a fairly pessimistic list, predicting that the financial storms that began in 2007 would not abate until 2010.Since then, we have seen this pessimism confirmed, as forecasters continue to bring their numbers down and familiar names from 2008 (Citi, AIG, GM) have reappeared in the news begging more funds from the government. However, there are some areas that appear to be doing better than our predictions would have suggested. For example, while 16 FDIC-insured institutions had failed as of Feb. 27, 2009, this is below the rate that would be required to reduce the total number below 8,000, as we predicted. According to the Fourth Quarter 2008 FDIC Banking Profile, two-thirds of financial institutions were actually profitable in the fourth quarter of 2008, but these were outweighed by losses at a few large banks. To be sure, the industry results as a whole were abysmal compared to prior years, but so far we are not on track to lose the 300+ institutions required to go below 8,000. Community banks that were not as involved in subprime lending and derivatives trading are showing continued strength.
Ironically, the FDIC itself is contributing to the pressure on sub-top 100 institutions by raising its premiums in order to replenish its depleted insurance fund. On Feb. 27, 2009, the FDIC announced a special assessment of 20 basis points (or 20 cents for every $100 of insured deposits), to be collected on Sept. 30, 2009. We have heard reports from banks of expected premiums quadrupling over their 2007 levels, effectively wiping out whatever profit might have been expected this year. If this pushes some healthy institutions over the edge, or the deepening recession increases the rate of failures, we might get to 8,000 yet.
With regard to spending, all indications are that financial institutions have indeed stopped spending on all projects but those with the most immediate payback. More significantly, a paralysis has hit the industry, with many projects that have not been cut having been delayed until the second half. We believe that the Treasury's Financial Stability Plan has in the short run exacerbated the financial crisis by introducing a major new source of uncertainty in the form of "stress tests". In principle these are supposed to help the government direct its resources to those institutions that have a hope of surviving, but there has already been debate about whether the government's worst case assumptions are tough enough, and about the methodology for forecasting chargeoffs based on factors such as unemployment. Until the stress tests are resolved, many of the top 20 banks will be afraid to pursue significant spending initiatives, and these are the banks that account for the majority of IT spending. As with industry profitability, it may be only a minority of institutions experiencing most of the difficulty, but these institutions are particularly large and influential.
We predicted a surge in outsourcing in 2009, as financial institutions seek to cut costs. However, the growth rates of offshore providers have so far not surged, probably due to the fact that many of them are still heavily reliant on application development, which has shrunk by 10 percent to 20 percent at top customers, according to TCS and Infosys. Outsourcers are also under pressure to cut prices, which can reduce the real growth rate. The Obama administration has indicated it wishes to bring jobs back to the US, and it may use its influence over the banks in which it has taken ownership stakes to push this policy. However, we believe that the government's practical ability to affect outsourcing trends is limited, and that the government will not be willing to interfere so deeply in the banks' internal operations. While there has been some pullback in terms of customer service jobs, overall offshoring is continuing to grow, and we see no reason why this should change in 2009.
In short, while there continue to be signs of strength in the middle market and below, these are being overwhelmed by the losses at the upper levels, and the smaller banks are now being directly hurt by the FDIC's need to replenish its reserves. Unemployment continues to soar, and with it the rate of defaults and bankruptcies will rise. Against all this, however, it remains important to stick to strategic fundamentals, and not let the bad news get in the way of taking what opportunities there are. It would be just as bad to be overly pessimistic in 2009 as it was to be overly optimistic in 2007. To whatever extent possible, financial institutions should continue to invest in customer-facing technologies and business analytics that will help them find profitable opportunities and capitalize on them. Once the recession is over, a lot of deadwood will be cleared away, and the remaining institutions will thrive.
Aaron McPherson is practice director, financial services, for Framingham, Mass.-based Financial Insights, an IDC Company.