Reference no: EM132275141
Case Study: Deutsche Bank: The Cost of Legacy Systems
Deutsche Bank AG, founded in 1870, is one of the world’s top financial companies, with 2,790 branches in 70 countries. It offers a range of financial products and services, including retail and commercial banking, foreign exchange, and services for mergers and acquisitions. The bank provides products for mortgages, consumer finance, credit cards, life insurance, and corporate pension plans; financing for international trade; and customized wealth management services for wealthy private clients. Deutsche Bank is also the largest bank in Germany, with 1,845 retail branch locations, and plays a central role in German economic life. In many ways, Deutsche Bank is the embodiment of the global financial system.
Deutsche has the world’s largest portfolio of derivatives, valued at around $46 trillion. A financial derivative is a contract between two or more parties whose value is dependent upon or derived from one or more underlying assets, such as stocks, bonds, commodities, currencies, and interest rates. Although Deutsche Bank had survived the 2008 banking crisis, which was partly triggered by flawed derivatives, it is now struggling with seismic changes in the banking industry, including recent regulatory change and fears of a global economic downturn. The bank was forced to pay $7.2 billion to resolve U.S. regulator complaints about its sale of toxic mortgage securities that contributed to the 2008 financial crisis. In addition, the Commodity Futures Trading Commission (CTFC) complained that Deutsche Bank submitted incomplete and untimely credit default swap data, failed to properly supervise employees responsible for swap data reporting, and lacked an adequate business continuity and disaster recovery plan. A credit default swap is a type of credit insurance contract in which an insurer promises to compensate an insured party (such as a bank) for losses incurred when a debtor (such as a corporation) defaults on a debt and which can be purchased or sold by either party on the financial market. Credit default swaps are very complex financial instruments.
Deutsche Bank is in trouble with U.S. regulators for its inability to fulfill swap reporting requirements under the Commodity Exchange Act and CFTC Regulations. The CFTC complained that on April 16, 2016, Deutsche Bank’s swap data reporting system experienced a system outage that prevented Deutsche Bank from reporting any swap data for multiple asset classes for approximately five days. Deutsche Bank’s subsequent efforts to end the system outage repeatedly exacerbated existing reporting problems and led to the discovery and creation of new reporting problems, for example, Deutsche Bank’s swap data reported before and after the system outage revealed persistent problems with the integrity of certain data fields, including numerous invalid legal entity identifiers. (A Legal Entity Identifier [LEI] is an identification code to uniquely identify all legal entities that are parties to financial transactions.) The CFTC complaint alleged that a number of these reporting problems persist today, affecting market data that is made available to the public as well as data that is used by the CFTC to evaluate systemic risk throughout the swaps markets. The CFTC complaint also alleged that Deutsche Bank’s system outage and subsequent reporting problems occurred in part because Deutsche Bank failed to have an adequate business continuity and disaster recovery plan and other appropriate supervisory systems in place.
In addition to incurring high costs associated with coping with regulators and paying fines, Deutsche Bank was a very unwieldy and expensive bank to operate. The U.S. regulators have pointed out Deutsche Bank’s antiquated technology as one reason why the bank was not always able to provide the correct information for running its business properly and responding to regulators. Poor information systems may have even contributed to the financial crisis. Banks often had trouble untangling the complex financial products they had bought and sold to determine their underlying value.
Banks, including Deutsche Bank, are intensive users of information technology and they rely on technology to spot misconduct. If Deutsche Bank was such an important player in the German and world financial systems, why were its systems not up to the job?
It turns out that Deutsche Bank, like other leading global financial companies, had undergone decades of mergers and expansion. When these banks merged or acquired other financial companies, they often did not make the requisite (and often far-reaching) changes to integrate their information systems with those of their acquisitions. The effort and costs required for this integration, including coordination across many management teams, were too great. So the banks left many old systems in place to handle the workload for each of their businesses. This created what experts call “spaghetti balls” of overlapping and often incompatible technology platforms and software programs. These antiquated legacy systems were designed to handle large numbers of transactions and sums of money, but they were not well suited to managing large bank operations. They often did not allow information to be shared easily among departments or provide senior management with a coherent overview of bank operations.
Deutsche Bank had more than one hundred different booking systems for trades in London alone, and no common set of codes for identifying clients in each of these systems. Each of these systems might use a different number or code for identifying the same client, so it would be extremely difficult or impossible to show how the same client was treated in all of these systems. Individual teams and traders each had their own incompatible platforms. The bank had employed a deliberate strategy of pitting teams against each other to spur them on, but this further encouraged the use of different systems because competing traders and teams were reluctant to share their data. Yet the Bank ultimately had to reconcile the data from these disparate systems, often by hand, before trades could be processed and recorded.
This situation has made it very difficult for banks to undertake ambitious technology projects for the systems that they need today or to comply with regulatory requirements. U.S. regulators criticized Deutsche Bank for its inability to provide essential information because of its antiquated technology. Regulators are demanding that financial institutions improve the way they manage risk. The banks are under pressure to make their aging computer systems comply, but the IT infrastructures at many traditional financial institutions are failing to keep up with these regulatory pressures as well as changing consumer expectations. Deutsche Bank and its peers must also adapt to new innovative technology competitors such as Apple that are muscling into banking services.
In July 2015 John Cryan became Deutsche Bank’s CEO. He has been trying to reduce costs and improve efficiency, laying off thousands of employees. And he is focusing on overhauling Deutsche Bank’s fragmented, antiquated information systems, which are a major impediment to controlling costs and finding new sources of profit and growth. Cryan noted that the bank’s cost base was swollen by poor and ineffective business processes, inadequate technology, and too many tasks being handled manually. He has called for standardizing the bank’s systems and procedures, eliminating legacy software, standardizing and enhancing data, and improving reporting.
Cryan appointed technology specialist Kim Hammonds as Chief Operating Officer to oversee the reengineering of the bank’s information systems and operations. Hammonds had been Deutsche Bank’s Global Chief Information Officer and, before that, Chief Information Officer at Boeing. Hammonds observed that Deutsche Bank’s information systems operated by trial and error, as if her former employer Boeing launched aircraft into the sky, watched them crash, and then tried to learn from the mistakes.
In February 2015 Deutsche announced a 10-year multi-billion dollar deal with Hewlett-Packard (HP) to standardize and simplify its IT infrastructure, reduce costs, and create a more modern and agile technology platform for launching new products and services. Deutsche Bank is migrating to a cloud computing infrastructure through which it will run its information systems in HP’s remote data centers. HP will provide computing services, hosting, and storage. Deutsche Bank will still be in charge of application development and information security technologies, which it considers as proprietary and crucial for competitive differentiation. Deutsche Bank will most likely build mobile, Web, and other applications tailored to its customers’ banking preferences, as well as computer-based trading software.
Deutsche Bank is withdrawing from high-risk client relationships, improving its control framework, and automating manual reconciliations. To modernize its IT infrastructure, the bank will reduce the number of its individual operating systems that control the way a computer works from 45 to 4, replace scores of outdated computers, and replace antiquated software applications. Thousands of its applications and functions will be shifted from Deutsche Bank’s mainframes to HP cloud computing services. Automating manual processes will promote efficiency and better control. These improvements are expected to reduce “runs the bank” costs by 800 million Euros. Eliminating 6,000 contractors will create total savings of 1 billion Euros.
Deutsche Bank is not the only major bank to be hampered by system problems. IT shortcomings were one reason Banco Santander’s U.S. unit in 2016 failed the U.S. Federal reserve’s annual “stress tests,” which gauge how big banks would fare in a new financial crisis. According to Peter Roe, Research Director with TechMarket View LLP in the UK, banks now spend about 75 percent of their IT budgets on maintaining existing systems and operations, and only 25 percent on innovation.
A 2015 Accenture consultants report found that only 6 percent of board of director members and 3 percent of CEOs at the world’s largest banks had professional technology experience. More than two fifths (43 percent) of the banks have no board members with professional technology experience. Since many of the biggest challenges facing banking are technology-related, that means that many banks lack sufficient understanding of technology required for making informed technology decisions. Financial technology innovations, security, IT resilience, and technology implications of regulatory changes are now all critical issues for bank boards of directors, but many lack the expertise to assess these issues and make decisions about strategy, investment, and how best to allocate technology resources.
Sources: Geoffrey Smith, “Things You Should Know About the Deutsche Bank Train Wreck,” Fortune, September 28, 2016; Hayley McDowell, “System Outage Sees Deutsche Bank Charged over Reporting Failures,” The Trade News, August 19, 2016; Derek du Preez, “US Regulator Charges Deutsche Bank over Multiple Systems Failures,” Diginomica, August 19, 2016; Kat Hall, “Deutsche Bank’s Creaking IT Systems Nervously Eyeing Bins,” The Register, October 27, 2015; Martin Arnold and Tom Braithwaite, “Banks’ Ageing IT Systems Buckle Under Strain,” Financial Times, June 18, 2015; Martin Arnold, “Deutsche Bank to Rip Out IT Systems Blamed for Problems,” Financial Times, October 26, 2015; Ben Moshinsky, “Deutsche Bank Has a Technology Problem,” Business Insider, October 20, 2015; Edward Robinson and Nicholas Comfort, “Cryan’s Shakeup at Deutsche Bank Sees Tech Restart,” Bloomberg, December 20, 2015; Accenture, “Bank Boardrooms Lack Technology Experience, Accenture Global Research Finds,” October 28, 2015.
1. Identify the problem described in this case study. What people, organization, and technology factors contributed to this problem?
2. What was the role of information technology at Deutsche Bank? How was IT related to the bank’s operational efficiency, decision-making capability, and business strategy?
3. Was Deutsche Bank using technology effectively to pursue its business strategy? Explain your answer.
4. What solution for Deutsche Bank was proposed? How effective do you think it will be? Explain your answer.