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Banking software: Big business

Jan 11, 2003

The way people bank has undergone a sea change in the recent past. Today a visit to a branch for those banking in the metros could be termed as ‘rare’. However, goodies don’t stop here. Facilities like any branch banking, Internet banking and mobile banking are gradually becoming commonplace. The technology needs of the banks does not stop at offering exciting services to customers but like other organisations they need strong information systems in place that gives the management a real time view and therefore, control over its resources. With the advent of the Internet, the banking financial services and insurance (BFSI) industry has found a wonderful channel for delivery. Due to the nature of its business, often this industry’s deliverable to the customer is information. Using the Internet, banks can reach out customers across geographies, and at any time according to their convenience. All this at a much lower cost!

Consequently, banks have to get onto the net, have strong information systems in place that can work across different business lines and with the help of these systems understand the future requirements of the customers to cross sell services to them. The advantage the customers have is that all their needs are taken care of from a single shop. It is very common to see banks taking care of investment needs of their customers by selling mutual funds. HDFC Bank recently has launched Any Time Mutual Fund (ATMF) service in which a customer can make cash withdrawals (using an ATM card provided by the bank) against a certain minimum amount of investments in HDFC Mutual Fund.

All this means information technology requirements are burgeoning rapidly. Banks have been forced to re-think their core transaction architecture and replace this with systems that meet the requirements of ‘modern times’. Perhaps the key differentiating factor between ‘new-age’ banks (and those who are not) is the kind of the technology they deploy. Thus, as banks race against time and each other to gain a larger share of the retail and corporate pie, there is big business in offing for technology companies.

This is one of the spaces where Indian IT services companies have met with a tremendous success. According to IBS, a market research firm, two of top three firms for retail banking solutions globally (based on new names added during the year) in 2001 were Indian. The companies to achieve this distinction are Infosys and i-flex Solutions. It is interesting to note that his feat has been achieved by Indian companies in a space where global majors like IBM (Alltel), SAP and CSC have offerings. However, considering the specialized nature of the business even these global players are not well established. This business has been traditionally been dominated by focused firms like Temenos and Kindle.

Product Supplier New named
customers signed (2001)
Olympic ERI Bancaire 18 160 230
Flexcube (retail) i-flex Solutions 16 100+ 63
Finacle Infosys 11 22 22

What creates the high entry barrier is the domain expertise required to create a mature product that can run the mission critical operations of a bank. i-flex for example, was incorporated as Citicorp Information Technology Industries Limited. Thus, the company availed the domain expertise and experience of the Citigroup for creating its solutions for the banking business. Infosys’ head of the banking business unit, Mr. Girish Vaidya, was the Head & Director (operations) at ANZ Grindlays in his previous employment.

While getting the right domain know-how is one thing, creating products that can be installed without the presence of a vendor is another. Not many companies have been able to graduate to the level of maturity in software development where they can create comprehensive products (large enough to run operations of an organisation across a number of locations). However, Infosys has reached such a level of maturity that it has appointed two companies, Telesis Technologies and Software Technology Group (STG) International, as service partners for its flagship-banking product ‘Finacle’. These companies deliver training and implementation services to Infosys' customers for the product. Companies in general can hope to achieve this feat after a considerable amount of stability comes into their products.

What makes the business so interesting is that while its is extremely difficult to create a banking product due to the domain expertise and maturity in software (this limits the number of players), the business opportunity is huge. According to a report by Gartner, worldwide banking and credit industry was expected to spend US$ 29 bn (Rs 1,392 bn) on software and US$ 95 bn on external services in 2002. This means with revenues of Rs 1,041 m in FY02, Infosys had a market share of 0.1%. i-flex Solutions with revenues of Rs 2,462 m from its products business in FY02 had a market share of just 0.2%. Like other market estimates, the size potential of the markets could be grossly over estimated. However, even if we cut the market size to half, with less than 1% penetration of the markets, a huge opportunity lies in waiting for the Indian IT services industry.

(Rs m) FY01 FY02  
Company Revenues % Of total revenues Revenues % Of total revenues YoY change
Infosys 475 2.5% 1,041 4.0% 119.2%
i-flex Solutions 1,729 53.4% 2,614 60.0% 51.2%

The revenues from this business come from three sources. Firstly, the license fees. This is what makes the product business so lucrative. After the company breaks even on the development cost for its product, additional license fees goes straight to the bottomline. Equally large is implementation and customization fees that are earned after the software is implemented on client sites and custom modifications are carried out on the request of the clients. And finally there is a component of annual maintenance fees that is paid to keep the software up and running. A look at the table below highlighting i-flex’s revenue pie will give a better picture of what we mean.

i-flex product revenues break-up FY00 FY01 FY02
License Fees 53% 39% 35%
Implementation and Enhancement Fees 32% 47% 50%
Annual Maintenance Contracts 16% 14% 15%
Total 100% 100% 100%

With corporates increasingly looking at one-stop shops for all their IT requirements, companies like Infosys that have strong skills in IT services space and can offer end to end solutions are likely to have an edge when selling their products. The revenue break-up for i-flex points to the fact that the share of implementation and enhancement fees has increased sharply. Also, as pointed out before, as banks evolve to universal banks, a number of software will have to work in tandem to support technologies that work to make all services under one roof a reality. Therefore, companies like Infosys that have a significant expertise in enterprise application integration can not only make their product more flexible to such requirements but also provide the services when required by the client. These skill sets would make the Indian IT firms that have a product offering, a preferred choice.

However, both the aforementioned Indian companies have yet to break into the big league. This is evident from the size of their product revenues and their market share. i-flex solutions had only 9% of it product revenues from the US in 2002. The most dominant geography for the company was Middle East and Africa. While numbers for Infosys are not available, the most dominant geography for Infosys also seems to be Africa and the Middle East. Both companies also have wide acceptance for their products in the Indian markets. The retail banking products for both the companies are yet to make a significant headway in the European and Western markets. i-flex, however, has managed some success in the European and US markets on the treasury and wholesale banking module of its product ‘Flexcube’. In June 2002 Infosys acquired Trade IQ. The acquisition was made to extend the product for the wholesale and investment-banking segment. The treasury system of the existing product was also enhanced. After extending the functionalities of Finacle, the company now plans to focus on the treasury and wholesale banking businesses in the European markets. This is likely to generate strong growth in revenues for the product going forward.

I-flex in the past has been restricted by Regulation K under the United States bank regulatory frame work from doing business in the US as 47.5% of the outstanding equity capital is held by Orbitech Limited, a Citigroup entity. However, a subsequent Act has amended the Regulation K and restructuring by i-flex to comply with the new provision of the amendment, will now enable the company to offer products in the US markets. It expects revenues from this geography to increase going forward.

Thus, we are looking at a business that requires specialized skills sets and therefore, has relatively smaller number of players. The Indian players in the business have hardly any presence in the largest market for their products. Thanks to their offshore development facilities Infosys and i-flex enjoy pricing power. Further, companies like Infosys have globally proved their credibility when it comes to services. With banks globally, being forced migrate to the ‘new-age’, Infosys and i-flex have big business awaiting them.

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