Reducing Complexity in European Banking

In its fourth quarter 2008 results presentation, ING Group, the European banking and insurance conglomerate, has clearly identified that reducing its operational complexity was key to weather through the crisis and reduce dramatically its operational cost.

However, ING is certainly not an exception in the market, and the issue of complexity reduction is core to the cost reduction strategy of numerous European banks.

In fact, while most of the European banks have implemented best practices to reduce their operating cost and increase revenue, very few have addressed an issue well identified by industrial organizations: reducing operational complexity.

In the past decade, in order to decrease the impact of commoditization on their revenues, banks have dramatically increased the complexity of their product offering, their distribution reach, their pricing structure, etc. In addition, the level of complexity in European banks has dramatically increased during this period because of consolidation and acquisitions. An apparent paradox exists between scale and complexity (i.e., larger financial institutions are not able to consistently leverage economies of scale to mitigate the effects of complexity or reduce the amount of proliferation/duplication). In fact, as financial institutions grow, they tend to get more complex because of :

- Complexity of business model: Larger financial institutions tend to have more variety and differentiation in the customer segments served, products/services provided, and the countries/regions (and their respective regulatory requirements) covered.

- Incomplete or inadequate integration: Many large financial institutions are an amalgamation of smaller businesses that have been acquired over the years; however, in many cases the integration of processes and systems is incomplete or inadequate, thereby increasing complexity.

- Decision-making process: Decentralized decision-making is more common in larger banks, but this allows (and often rewards) business leaders to optimize their own products/services, channels, geographies, and business units vs. optimizing for the corporation.

- IT System strategy: Some organization grow so quickly that applications don't keep pace. This often leads to IT customization, patchwork, and add-ons to support product/geographic and channel proliferation, leading to more complex systems

While implementing best practices at the operational level has certainly generated cost reduction, it has often failed to achieve the full potential of a strategic approach to cost management by not solving the consequences of complexity. Therefore it is crucial for banks, especially retail, to address the issue of complexity in a full front-to-back approach. However, this will require fundamental changes (e.g., change of business model) which are essential to achieve the long-term cost optimization of financial institutions.