Outdated technology could lead to another crisis in banking If the money transmission system freezes, social breakdown will follow, writes Andrew Freeman The IBM Blue Gene Q Sequoia supercomputer at Lawrence Livermore National Laboratory Last year something very bad almost happened. It did not go unnoticed, but full awfulness was averted by round-the-clock work and much customer compensation: Royal Bank of Scotland's core payment systems failed to make routine transactions after the insertion of software code that sent them into near meltdown. The problem was, at last, "contained." After a pandemic that failed to materialise, should we relax? The reason lies in something arcane - the problems experienced by RBS and Lloyds Banking Group in divesting branches. Lloyds has said its final costs in separating branches through its EU-mandated Project Verde are likely to reach a staggering £1.3bn. RBS tried to sell its carved-out lot to Santander, but that deal collapsed in October; now we are heading for a flotation, incurring significant additional costs. The bank said recently it would spend £450m on its information technology systems on top of its annual £2bn IT budget. It would not be unreasonable to assess its Project Rainbow bill as heading for £1bn or thereabouts. British taxpayers - who own significant stakes in the two banks - will, in effect, have forked out more than £1.5bn on these projects. Why is this so significant? Neither bank has been able to separate out a group of branches in an attractive and practical way for a buyer, despite vast expense and considerable time. The simple, and worrying, explanation is that the banks" IT systems render these operations difficult. Much of the money has been spent on internal IT teams trying to figure out how to separate parts of otherwise integral, but multiple, systems. A bank branch, it turns out, is very different from a Sainsbury's supermarket store or a branch of McDonald's. Dig deeper and there is a disturbing truth. Banks" IT systems, in general, are awful. This is widely known - in regulatory circles, there is concern about legacy retail banking IT that is half a century old and whose programmers are retired or dead. Insiders fret about the complexity and risks. Original batch processes have been patched and built on to create the illusion of real-time banking - but the underlying reality is a vulnerable mess. When RBS's IT systems briefly failed, we caught a glimpse of the chaos that would follow a broader collapse of our payments network. Employers unable to pay staff, tenants to pay rents, the sick to pay for medicines - these were just some of the difficulties faced by part of the population in part of one large banking group. A bigger freezing of the money transmission system would quickly lead to social breakdown. It is that serious - think of that "almost" pandemic. The explanation of how we got here is simple. Just as banks benefit from the option of the implied (and too often real) taxpayer bailout, when their loan books go belly up, so they have a perverse incentive to underinvest in the core IT systems that are the backbone of money transmission. Why spend on an apparently unproductive part of the enterprise? No one will reward them for doing so; least of all shareholders. Over time, we have ended up with creaky infrastructure at the heart of an essential public utility. While the system "works," few care; but the true risk to society is very big indeed. Consider it banking's hidden non-monetary externality. To be fair, the recent report from the Parliamentary Commission on Banking Standards asks for a study of the potential for a genuine public payments and basic banking utility that takes this core function out of the big banks" hands and leaves them free to focus purely on lending. It could be funded by a levy based on volume, and the government could subsidise small banks and new entrants in order to encourage competition. It would not look like today's cobbled-together system, which also functions to stifle competition - something rightly under review by the UK Treasury and identified by the commission as an urgent priority. During the credit crisis, we all saw the attraction of keeping a little cash under the mattress. Today we have a different reason for fear. Our money could be suddenly locked in IT limbo, while the big banks wring their hands as their systems go into interlinked shock. RBS 2012: think canaries and mines. And worry. The writer is director of Demos Finance and a risk fellow at the Judge Business School in Cambridge