Industry
Hope amid fear: Indian IT and American banks
Summary
- US banks reported better-than-expected results in the recent quarter. However, Indian IT companies are not cheering yet.
In the first quarter of 2023, the banking sector in the US and Europe was facing the heat. In the US, three banks failed in quick succession. In Europe, Credit Suisse was bought by its larger competitor, UBS Group, in an emergency arrangement brokered by the Swiss government. As fears grew of a repeat of the 2008 financial crisis, the heat was felt by, among others, the Indian information technology (IT) sector, which gets most of its revenues from the banking, financial services and insurance (BFSI) segment.
The Indian IT sector's growth halved in 2008-09, following the financial crisis. Typically, when banks move to conserve cash, they cut discretionary spending on technology. However, fears of a banking crisis had subsided by Q2. Net interest income of large banks jumped, as the US central bank kept interest rates high to tame inflation. The top six banks made a total profit of $33 billion, up 18% year-on-year. The S&P Bank Index is up 15% in the past three months.
Technology spends of five of these six banks increased. However, IT companies are not cheering yet. During Wipro's earnings call, chief executive officer Thierry Delaporte said the market today “is not dramatically different from the market we saw three months ago". In general, better earnings don't immediately translate to more business for IT services. Besides, regional banks in the US are still focused on strengthening their balance sheets. The big question facing Indian IT companies today is whether the market will pick up and whether they can capture more share.
Growth Drivers
Gartner, a research and advisory firm specializing in technology, expects IT spending by the banking and investment services sector to reach $652 billion globally in 2023, an increase of 8.1% from 2022. Spending on software is expected to see the fastest growth, of 13.5%. However, there is a change in how the money will be spent. Gartner analyst Debbie Buckland, in a statement, said organizations were spending more on types of technologies that generate significantly higher business outcomes. “Spending on software, for example, is shifting away from building it in-house, in favour of buying solutions that generate value from investments more rapidly," she said.
Similarly, about 50% of banking and investment services CIOs that Gartner surveyed this year said they planned to increase investments in cloud—accessing software applications through the internet. This, in turn, will drive IT services spending, especially on consulting and infrastructure as a service.
Time Lag
The Indian IT sector gets about 40% of its revenues from the BFSI segment, according to Nasscom. However, even among leading companies, the segment’s share varies. While BFSI accounts for about 30% or more for TCS, Infosys, Wipro and LTIMindtree, it is about 20% or less for HCL Technologies and Tech Mahindra. In Q2, all four BFSI-focused IT services companies saw their BFSI revenues shrink on a sequential basis.
One reason is the time lag between banking industry performance and IT projects. Besides, during tough times, businesses tend to break up large projects into smaller chunks, keeping expenses low. Banks are also increasing in-house development, through their global capability centres in low-cost locations such as India. In a recent report, ICICI Securities observed that a few banks are shifting from “third-party consulting to investments in own technology employees", adding that Citi increased its technology headcount by about 23% year-on-year in Q2.
Digital Transformation
As concerns around the US’ banking crisis in Q1 impacted technology spending, growth was expected to slow down. According to an Insider Intelligence forecast last October, growth in US bank technology spending peaked in 2022. However, total technology spend is expected to increase from $77 billion in 2021 to $112 billion in 2026.
According to an IDC report last October, banks worldwide were set to invest an additional $31 billion on AI embedded in existing systems by 2025. Similarly, banks are expected to increasingly adopt open banking (which allows banks to exchange financial data more freely), blockchain and other technologies. Asked when he expected to see demand improve, Wipro's Delaporte said, "…a lot of banks still have reasonably good fundamentals. And they are very aware of the importance of technology for their own transformation. And so yes, it will resume at some point in time."
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