Nasdaq & BCG: Bank Complexity Costs Industry $50bn Annually

Financial institutions are losing up to US$50bn annually due to excessive operational complexity, according to a comprehensive report from Boston Consulting Group (BCG), a management consultancy, and Nasdaq, the US-based exchange operator and technology provider.

The report, titled The New Growth Imperative: Cutting Through Complexity in the Financial System, reveals that organisational complexity in banks has increased 35-fold since 1955, while external business complexity has risen only six-fold during the same period.

The Cost of Complexity

Despite banks investing US$800bn annually in technology - equivalent to 50% of their net income - operating costs have not meaningfully declined. 

The research shows that major banks have accumulated US$241bn in regulatory fines over the past decade, representing 2% of total bank net income.

The study found that financial crime remains a significant challenge, with money laundering and fraud schemes accounting for US$3.5tn in losses to the global financial system in 2023, according to Nasdaq's separate Global Financial Crime Report.

Bank consolidation has continued apace, with a 30% decrease in US bank entities and a 15% reduction in branches over the past decade. 

However, these efficiency measures have not translated into improved cost-to-income ratios. 

The report indicates that banks' efforts to streamline operations through digitalisation and consolidation have been offset by increasing regulatory requirements and operational complexities.

Technology Transformation

Bank executives are increasingly embracing cloud technology - computing services delivered over the internet - for risk and compliance functions, with 93% of survey respondents indicating comfort with cloud infrastructure today, compared to 57% five years ago and 11% a decade ago.

Only 22% of banks now prefer building customised in-house solutions instead of using external vendors. 

The majority favour strategic partners who can provide integrated software suites rather than single-point solutions, marking a shift away from the traditional banking approach of developing proprietary systems.

The survey, which included 160 senior risk and compliance professionals from mid-sized to large banks in North America and Europe, revealed that among those still preferring in-house solutions, 75% cited concerns about customisation requirements as their primary hesitation in adopting third-party solutions.

The Global Regulatory Burden

Banks operating across multiple jurisdictions face mounting challenges from divergent regulatory frameworks. 

The US Federal Reserve's FR Y-9C Schedule HC-R, which comes with 123 pages of guidance, exemplifies the complexity of modern regulatory reporting. 

Banks must aggregate data from multiple source systems, often leading to manual reconciliation efforts.

The Sarbanes-Oxley Act (SOX) requirements have added additional layers of complexity. 

Large banks typically employ more than 1,000 control performers and 100 control reviewers to maintain compliance. 

These controls have grown with external complexity, and managing them becomes more complicated as new controls are implemented on top of existing ones.

Survey respondents highlight challenges including manual data collection, broken information flows, inconsistent data formats and delays in collecting data from process owners. 

One respondent notes: "There are far too many legacy processes, most of which involve tremendous manual intervention and subject area expertise."

The report also identifies “activity traps” where employees continue to perform obsolete controls that no longer serve their original purpose. 

This issue is particularly acute in banks with legacy systems and processes that have accumulated over decades of regulatory changes.

Solutions for the Future

The report identifies artificial intelligence (AI) as a key solution to reduce complexity. Traditional AI can automate routine processes, while generative AI - systems that can create content - could assist with data management and report drafting.

Research estimates suggest that reducing operational complexity could generate up to US$1tn in additional annual lending capacity through more efficient capital deployment, assuming banks maintain current risk standards.

Risk and compliance departments at large banks currently employ between 3% and 8% of total staff, according to analysis of LinkedIn data. 

The report suggests that modernising these functions could free up resources for innovation and growth.

The additional lending capacity could help address global challenges, including the US$469bn annual funding gap for digitalisation and US$286bn needed for energy transition projects identified by the United Nations Sustainable Development Goals.

The report advises banks to focus on four key areas: embracing modern digital infrastructure, deploying data collaboration models, building strategic partnerships, and accelerating AI adoption. 

These solutions could help banks reduce manual processes and redirect resources toward innovation and growth.

Data collaboration models, in particular, show promise for addressing industry-wide challenges. 

The report cites financial crime management as an example where consortium-based approaches allow banks to analyse patterns across the entire financial ecosystem rather than within individual institutions.

Adena T. Friedman, Chair and CEO of Nasdaq, emphasises the scale of the challenge: “Research revealed that throughout a half-century, while external complexity had increased more than 6-fold, organisational complicatedness in response had increased more than 35-fold.”

Looking ahead, Adena concludes: “The transformative power of AI, cloud, and modern software can foster collaboration across ecosystems, enabling organisations to adopt innovative ways of working not only to manage the challenge of complexity but transform certain aspects of it into opportunity."

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