This summer, regional bank Citizens Financial Group (NYSE:CFG) hired IBM (NYSE:IBM) to take over a portion of the bank's technological infrastructure. For investors, the deal is more significant than a simple example of a financial firm outsourcing a non-core function. It represents instead how banks are working to find new, innovative ways to lower costs and boost profits.
Why investors should be very excited about this partnership
For the next five years, IBM will manage Citizens Financial's internal IT, including data centers in Rhode Island and North Carolina. Along with traditional IT roles, IBM will also be bringing its powerful big data capabilities, like predictive analytics.
Initially, that cutting-edge technology will be used to automate and improve the performance of the bank's computer servers, which should reduce costs while also improving up times and reducing service interruptions both for internal employees and external customers.
However, down the road, the potential of this partnership is far greater. Banks have a treasure trove of customer information stored on their internal databases. Banks know income information, credit history, where customers shop, how much they spend, where they live, whom they do business with, and on and on.
There are the obvious uses for applying modern analytics to this data -- for example, increasing cross-selling opportunities and fine-tuning highly targeted marketing. However, there are far more powerful and far more valuable uses as well, starting in risk management.
Armed with technology like the predictive analytics from IBM, banks can make better credit decisions through more robust underwriting, they can monitor existing loans more accurately and uncover problems before they surface, and they can therefore improve their capital and loan loss reserve processes. Loan loss reserves are cash reserves set aside as a rainy-day fund for loans that may go bad.
Likewise, the automation this technology brings can unburden branch and back-office employees from tedious and repetitive tasks, while the predictive capabilities guide them to the most productive and valuable things to do instead.
Fully deployed, the bank can operate with considerably stronger risk management and an empowered and highly productive workforce, and it can simultaneously reduce costs from service outages and bureaucracy.
Citizens Financial: A bank unleashed
For investors of Citizens Financial, this deal with IBM is an encouraging sign that the newly independent bank is taking full advantage of its new-found freedom. Citizens was formerly a wholly owned subsidiary of the Royal Bank of Scotland, but it was spun off in an IPO last year.
The bank's return on equity trails industry averages thanks to residual problems in the bank's consumer division, but the trend is improving. Management's turnaround plan is in full effect, including this partnership with IBM, and the market has responded quite positively to the changes.
Since its IPO, the bank's stock has jumped over 12%, more than double the rise seen in the S&P 500 over the same period.
The reality of banking today is massive regulation, new and expensive costs, and new competitive challenges on all fronts. The banks that excel in the future, both operationally and in the markets, are the banks that meet these challenges head-on. Citizens Financial is one of those banks, and its relationship with IBM shows its willingness to embrace and adopt the strategies and tactics to win in today's world.