One of the most surprising aspects when analyzing the extensive prudential regulations applicable to credit institutions is the apparently limited value that regulation assigns to the software investments made by banks. To date, the European regulator has required the full deduction of these investments from capital, which is equivalent to assigning them zero value. To understand what this means, if a bank were to purchase, for example, Google’s algorithm, it would have to deduct the value of this asset from its capital when computing the institution’s prudential requirements… as if it had no value.
These regulatory precautions, which stem from the nature of software as an “intangible” asset, contrast with the importance that everything related to technology investment has for the banking sector. Not only bank managers and shareholders, but even their own supervisors view investment in this type of asset as a fundamental way to optimize costs and improve the efficiency and profitability of institutions, as well as something necessary to compete with new digital players. From the customers’ perspective, software investment is equally key to facilitating banking operations and improving their user experience. To this we should add the importance of this type of investment as a defense tool against cyber risks, which have multiplied in recent times as a result of increased remote activity.
Although the digital transformation process and, therefore, investment in information systems has been one of the most characteristic and relevant elements of banks’ strategic plans in recent years, COVID-19 has accelerated this process exponentially. The digitalization process has gone from being a strategic option to a necessary requirement for the survival of institutions. It is foreseeable that in the coming years banks will make substantial investments in software with the aim of providing better services and being more profitable and competitive.
The European Parliament and Council, aware of this unjustifiably detrimental treatment for a sector that needs to invest in software to adapt to the new competitive environment and face new technological risks, gave the European Banking Authority (EBA) a mandate last year to analyze cases in which these assets might not be deducted from capital like most banking assets.
The historic aspiration of the European banking sector, given the productive nature of software and based on the principles underlying prudential regulations, has been to give software treatment equivalent to that of any other productive asset, according to its risks under a going concern scenario.
This week the EBA published the results of its analysis. The proposal develops the concept, new to date, of prudential amortization, which would function as a backstop or support for accounting amortization. This concept recognizes a certain value for software during a very limited period of two years (the estimated time it would take to migrate computer programs during an institution’s sale process). After the second year, the value of software would return to zero from a prudential standpoint and be deducted from capital as it currently is. Although the simplicity of the proposal is welcome, we believe that the lack of ambition and technical support significantly limit the impact of the reform.
Aware of the limitations of the mandate that the authorities had given the EBA and the difficulties in offering appropriate treatment to an asset with certain peculiarities such as software, it does not appear that the chosen time horizon of two years of amortization can be reconciled with the real and strategic value that software investment has for institutions. There is sufficient evidence showing that software utilization exceeds this period even in a liquidation scenario.
The last three months we have experienced serve as irrefutable proof of the value that software investments made by banks have not only for them but for society. Institutions have been able to guarantee their operational continuity and, therefore, financial stability thanks in part to the significant investments in computer systems they have made in recent years. This has allowed, on the one hand, their employees to work remotely and, on the other, their customers to execute financial transactions through virtual channels with maximum security and without incidents.
It is reasonable to call for the advisability of reviewing the EBA’s current proposal and committing to more ambitious approaches aligned with the digitalization requirements facing banking institutions and that take into account existing regulatory developments in other jurisdictions. The new times make this need even more evident.
Pedro Cadarso Palomeque, Advisor to the Spanish Banking Association (AEB)
