January 30, 2005

Entering 2004, the banking industry generally was experiencing solid growth in a number of areas, particularly in the consumer lines of business. In fact, of the top 100 global banking companies, the average pretax profit for 2003 was more than $2.75 billion, and only nine of those top 100 failed to turn a profit. Within this environment, bankers were concerned with how best to improve their ability to manage the retail customer experience; they were focused on planning for a streamlined, more secure payments infrastructure; and they were evaluating the competitive environment in wholesale banking with an eye on the transformations that are taking place, in part, as a result of declining demand for traditional corporate banking products.

In 2005, retail banking is still delivering solid returns, but in the U.S., some softness is apparent with an increase in interest rates, a slow rise in debt burdens and consistent growth in bankruptcies. On the positive side, credit quality has improved as of the third quarter 2004, with most banks reporting a reduction in both chargeoffs and loan-loss provisions. The European Union and the Asia-Pacific region have seen notable growth in demand for consumer loans of all types. However, chargeoff rates are at unacceptable levels, particularly in certain Asian countries.

Thus, growth will not be painless. Some difficulties will be self-inflicted, and others courtesy of various regulators.

First, the industry has once again caught the merger bug. As of November 2004, 20 of the top 100 U.S. banks were actively involved in a merger or acquisition. Outside of the U.S., Santander Central Hispano's acquisition of Abbey National could be the first in a series of long-anticipated mergers among big European banks; meanwhile, the ongoing competition between Sumitomo Mitsui and Mitsubishi Tokyo for the rights to acquire UFJ Financial likely will be resolved over the next few months.

As this is happening, the industry is beginning to apprehend the magnitude of the impact that recent regulations - chiefly Basel II, the USA PATRIOT Act, International Accounting Standards (IAS), Sarbanes-Oxley and Check 21 - will have on their daily operations and processes.

Going Up

Technology will play a critical role in both managing merger integration and complying with regulations. TowerGroup projects that technology spending by the banking industry in 2005 will increase by 4.4 percent over 2004 levels. Of this amount, the bulk of the spending (72 percent) will occur in the EU countries and North America. The greatest growth rates are expected in North America (5.4 percent), with slower growth in the Asia-Pacific (2.8 percent).

Within the lines of business, TowerGroup projects that this year's greatest increases in spending will continue to be seen in the areas of application interoperability; application consolidation; lower cost of development and maintenance; and risk management and regulatory compliance. Remaining resources will go to early-stage enterprise rollouts for service management, lead and referral management, payment processing, and loan origination and servicing. These efforts can combine the twin drivers of organic growth and cost reduction - which are often at odds. Bankers will also continue to implement the technologies already budgeted for in previous cycles, including branch technology, enhanced customer data analysis and management, and imaging and workflow capabilities.

Armed with this understanding and the tools to begin the journey, bankers entering 2005 are realizing the possibility of creating the flexible, responsive and diversified financial institutions demanded by their customers.