Analytics in Banking Services

JANUARY 15, 2013

by Sushil Pramanick
Associate Partner, Consultative Sales, IoT Leader, IBM Analytics
Follow me on Google+, LinkedIn, Twitter

The banking industry is data-intensive with typically massive graveyards of unused and
unappreciated ATM and credit processing data. As banks face increasing pressure to stay
profitable, understanding customer needs and preferences becomes a critical success factor.
New models of proactive risk management are being increasingly adopted by major banks and
financial institutions, especially in the wake of Basel II accord. Through Data mining and
advanced analytics techniques, banks are better equipped to manage market uncertainty,
minimize fraud, and control exposure risk.

According to IBM’s 2010 Global Chief Executive Officer Study, 89 percent of banking and
financial markets CEOs say their top priority is to better understand, predict and give customers
what they want. Financial metrics and KPIs provide effective measures for summarizing your
overall bank performance.

But in order to discover the set of critical success factors that will help banks reach their strategic
goals, they need to move beyond standard business reporting and sales forecasting. By applying
data mining and predictive analytics to extract actionable intelligent insights and quantifiable
predictions, banks can gain insights that encompass all types of customer behavior, including
channel transactions, account opening and closing, default, fraud and customer departure.

Insights about these banking behaviors can be uncovered through multivariate descriptive
analytics, as well as through predictive analytics, such as the assignment of credit score.
Banking analytics, or applications of data mining in banking, can help improve how banks
segment, target, acquire and retain customers. Additionally, improvements to risk management,
customer understanding, risk and fraud enable banks to maintain and grow a more profitable
customer base. The importance of these measures has been implied in the Basel II accord that
explicitly emphasizes the need to embrace intelligent credit management methodologies in order
to manage market uncertainty and minimize exposure risk.

While analytics aren’t exactly new to the world of banking, plenty of banks are gearing up for their
next big analytics push, propelled by a load of data and new, sophisticated tools and
technologies. Why has business analytics jumped to the top of the priority list for banks? Pick a
reason. Regulatory reform, managing risk, changing business models, expansion into new
markets, a renewed focus on customer profitability – any one of these is reason enough for many
banks to reconsider what today’s analytics capabilities can offer.

A host of significant, recent changes in the banking industry have resulted in a long list of
business challenges that the practice of business analytics may be positioned to address. A
number of financial institutions have been quick to recognize and adopt this emerging technology
– and it is changing the banking landscape and giving banks and financial institutions previously
untapped savings, margins and profit. For example, Bank of America Merrill Lynch is using
Hadoop technology to manage petabytes of data for advanced analytics and new regulatory
requirements.
 As per Deloitte research, three business drivers increase the importance of analytics within the
banking industry

 Regulatory reform – Major legislation such as Dodd-Frank, the CARD Act, FATCA (Foreign
Account Tax Compliance Act) and Basel III have changed the business environment for banks.
Given the focus on systemic risk, regulators are pushing banks to demonstrate better
understanding of data they possess, turn data into information that supports business decisions
and manage risk more effectively. Each request has major ramifications on data collection,
governance and reporting. Over the next several years, regulators will finalize details in the
recently passed legislation. However, banks should start transforming their business models
today to comply with a radically different regulatory environment.
 Customer profitability – Personalized offerings are expected to play a big role in attracting and
retaining the most profitable customers, but studies show that a small percentage of banks have
strong capabilities in this area. The CARD Act and Durbin Amendment make it even more
important to understand the behavioral economics of each customer and find ways to gain wallet
share in the most profitable segments.
 Operational efficiency – while banks have trimmed a lot of fat over the past few years, there is
still plenty of room for improvement, including reducing duplicative systems, manual
reconciliation tasks and information technology costs.

Here is another study done by IDC in 2010 by surveying over 6000 decisions makers from 280
banking firms.
Let us consider some of the prominent use cases for banking analytics:

Fraud Analysis
The Association of Certified Fraud Examiners’ 2010 Global Fraud Study found that the banking
and financial services industry had the most cases across all industries – accounting for more
than 16% of fraud.

Fraud detection in banking is a critical activity that can span a series of fraud schemes and
fraudulent activity from bank employees and customers alike. Since banking is a highly regulated
industry, there are also a number of external compliance requirements that banks must adhere to
in the combat against fraudulent and criminal activity.

In a sample study conducted by ACFE, it was observed that most of the fraud occurred due to
Corruption and Cash on Hand. Here is the breakdown of the results:

Banking/Financial Services – 298 Cases

 Scheme Number of Cases Percent of Cases

Corruption 101 33.9%

Cash on Hand 64 21.5%

Billing 37 12.4%

Check Tampering 35 11.7%

Non-Cash 33 11.1%

Skimming 32 10.7%

Larceny 29 9.7%

Expense Reimbursements 20 6.7%

Financial Statement Fraud 16 5.4%

Payroll 9 3.0%

Register Disbursements 8 2.7%

The following techniques are effective in detecting fraud. Auditors should ensure they use these,
where appropriate.

 Calculation of statistical parameters (e.g., averages, standard deviations, high/low values) –

to identify outliers that could indicate fraud.
 Classification – to find patterns amongst data elements.
 Stratification of numbers – to identify unusual (i.e., excessively high or low) entries.
 Digital analysis using Benford’s Law – to identify unexpected occurrences of digits in naturally
occurring data sets.
 Joining different diverse sources – to identify matching values (such as names, addresses,
and account numbers) where they shouldn’t exist.
 Duplicate testing – to identify duplicate transactions such as payments, claims, or expense
report items.
 Gap testing – to identify missing values in sequential data where there should be none.
 Summing of numeric values – to identify control totals that may have been falsified.
 Validating entry dates – to identify suspicious or inappropriate times for postings or data entry

Customer Analytics
Banks and credit unions are constantly at risk of losing customers or members, and in order to
stem the flow, they may offer their best customers better rates, waive annual fees and prioritize
treatments. However, such retention strategies have associated costs, and you cannot afford to
make such offers to every single customer. The success and feasibility of such strategies is
dependent on identifying the right action for the right customer. Consumers today want to bank
anywhere, anytime with the convenience of using their smartphones and iPads at their fingertips.
 As we move toward a cashless society, the future of banking will be shaped by how the physical
and virtual worlds of banking converge. Smarter banks will increasingly invest in customer
analytics to gain new customer insights and effectively segment their clients. This will help them
determine pricing, new products and services, the right customer approaches and marketing
methods, which channels customers are most likely to use and how likely customers are to
change providers or have more than one provider.

Risk Analytics
Accenture recently completed a global study capturing and synthesizing the insights from more
than 450 risk management analytics professionals in three industries to examine how they use
risk analytics to tackle industry challenges and market volatility. The study was intended to
assess companies’ current level of risk analytics maturity—their quantitative and qualitative tools
and techniques designed to estimate the impact and frequency of specific risks, as well as their
ability to use analytics to drive business outcomes and proactively manage risks and rewards.
Across the industries studied, banking is predicting the greatest increase in risk analytics
investments, with 73 percent of banking respondents foreseeing more than a 10 percent rise in
expenditure. In terms of specific capabilities, risk analytics spending is expected to increase most
in areas of data quality and sourcing, systems integration and modeling. Here are other key
findings:

 Forty-two percent of banks calculate risk indicators by collecting data from the execution
environment that feeds monitoring dashboards.
 Better modeling is a critical component of credit risk analytics, with European banks more likely
to use only internal models (18 percent versus 13 percent globally), while Chinese banks are
more likely to use only external models (14 percent versus 7 percent globally).
 Most banks have a dedicated risk analytics group with between one and 20 people deployed.
 Eighty-five percent of banks have a risk analytics group for credit risk validation.
 Significant majorities of banks across all regions have quality controls in place over the collection
of historical data. ASEAN institutions are most likely to do so at 85 percent, and Europe is least
likely, at 64 percent.
 More than three-quarters (77 percent) of banks across all regions use stress-testing regularly to
verify capital adequacy.

American Banker Research recently set out to discover the demand and usage for customer
analytics throughout the banking industry. To their surprise, most (71%) of the 170 bankers in the
weighted survey do not use customer analytics, but within a year that might not be true. Among
those non-users, the plans to buy analytics are not impressive. Only 2% plan to buy customer
analytics in the next six months, 4% in the six to 12 months and 14% in more than a year from
now.

Cost was the biggest barrier, noted by 36%. Another issue is more pressing IT issues taking
precedence – about 32% of bankers surveyed said a focus on other initiatives was the primary
obstacle to using customer analytics at their institution. The third primary reason for not using
customer analytics, given by 23% of these bankers, was skepticism about the ability of the
software to provide business value or a return on investment. On the other hand, 33% of bankers
who do use customer analytics say they plan to increase spending on such programs by a mean
of 15% in 2013. About 35% of these users are interested in adding social media content to the
data they analyze.

And these bankers reported several benefits to using the software. More than a third (37%) said
the software improves the impact of marketing efforts. About 28% of respondents said that an
increase in wallet share was the top benefit their institution reaped from customer analytics. A
smaller group, 18%, identified improved underwriting and/or a reduction in loan loss rates as the
primary benefit.
 Banks are realizing the importance of analytics and data-savvy competitors like Amazon and
American Express are sure to push banks to get better at customer analytics, it's just a matter of
time.

There have been many exciting advances in analytics and business intelligence recently
including:

 IBM’s Watson platform, which beat human champions on the trivia show Jeopardy! by using
natural-language analytics to understand questions, context and semantics, then analyze
terabytes of data to identify and rank likely answers
 Algorithms that measure their own accuracy and feed that information back into the model to
create self-improving predictive analysis
 Unstructured data analytics that can incorporate information from online discussion forums,
social networks and call scripts to determine customer sentiment or market opportunities
 Real-time analysis of data sources, such as financial markets, stock exchanges, or news.

Implementing business analytics across the bank can be a daunting and potentially expensive
prospect, due to:

 Complex, heterogeneous technology architectures

 Operationally optimized but siloed processes and systems
 Data fragmented across multiple databases
 Constrained investment budgets with competing agendas
 Lack of skilled resources
 Perception that the data available is of insufficient quality to support analysis.
 All of these are genuine obstacles, but it should not be assumed that analytical insight cannot be
extracted until they have all been resolved. That road leads either to major programs striving to
create perfect data able to answer any question, or to an acceptance that any such efforts are
futile. Organizations do not necessarily have to solve all of these issues before a successful
analytics project can begin.

A more pragmatic approach starts with selecting a critical question or objective, identifies the
necessary data and, recognizing that the data is not perfect, and derives the answer and
information correlations with a corresponding confidence level. This approach does not replace
the strategic architecture investment required to reach accuracy, but it provides a framework for
business owners to control the level of their expenditures in a way that is commensurate with the
benefit to be unlocked.

References
1. Accenture 2012 Risk Analytics Study: Insights for the Banking Industry
2. Analytics in Banking by Deloitte
3. 2010 Global Fraud Study: Report to the Nations on Occupational Fraud and Abuse, Association
of Certified Fraud Examiners
4. Global Technology Audit Guide: Fraud Prevention and Detection in an Automated World. The
Institute of Internal Auditors, 2009.
5. The shift to analytics: the next wave for transaction banking by IBM
6. IDC Financial Insights, 2010
7. IDC’s Vertical Research Survey, 2010

TOPICS:
Analytics, Use Cases
TAGS:
Analytics, Banking, fraud, financial services

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