Wednesday, October 24, 2007

IT and the financial sector

Globalization through global high-speed data highways has led to a significant increase in IT spending especially for financial concerns. Absorption of new technology has seen financial companies able to instantaneously transfer funds and price sensitive information across the globe, computers have enable the industry to store, process and analyze huge masses of information. Most importantly computers have led to new complex products to be devised and priced in real time.

Technology has had a dramatic effect on how banks function as well as their profitability. Facilities such as ATMs, debit cards and RTGS have reduced the staff burden on one side and also reduced the cost of servicing. In fact the marginal cost of making a transfer through a debit card is less than 5% of processing a cheque payment. Development of databases has meant that new web based services can be offered such as core banking[1] as well services can be targeted at the customer.

However this is not just software –hardware game, where in the corporate entity with the best hardware and software wins. The human capital needs are also changing. The complexity of some of the newer financial products o offer has meant that higher skill sets are needed than those of traditional traders. This in turn means a significant increase in man power costs. The shifting of back office and processing operations to cheaper locations than traditional expensive financial hubs by leveraging IT connectivity could be a way out of this.

The cost of transitioning to newer technologies is extremely high. Also the question of maintaining ‘backward compatibility’ with existing systems means that taking full advantage of latest developments is just not possible. Security issues such as identity theft and hacking also need to be addressed using expensive software’s and consultants. Most financial institutions may even find it difficult to earn an adequate return on their capital investments, especially when the advantage they may gain is usually transient as their competitors catch up.

This is where market share becomes important. Technology has changed the balance between fixed and variable cost to a great extent. The initial high capital costs of hardware and software can be offset by the low marginal costs of serving the client. This directly means that a financial concern with a large market share can cover up its high initial costs faster before competition catches up.

[1] Services such as where a customers can operate their accounts, and avail banking services from any branch

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