The Rotten Core: Banks Need to Reinvent From Inside Out

June 10, 2018


Today we’ll discuss a huge crisis that needs attention and action.

Why is it that big banks are forced to open separate digital banks when they want to go fully digital? Why do most banks end up with lipstick on the pig pilots and POCs when trying to be truly digital?

Why are banks unable to ‘plug-and-play’ startups in or on their systems? Yes, it’s never that easy but new, neo-banks are successful: N26 has 17+ external integrations for remittance, loans, insurance, etc. Monzo, just this week, showcased integrations with IFTTT.

Digital is the new reality and that isn’t a surprise for anyone. However, for incumbents, digital transformation is a big challenge. Customers are demanding that everything must happen in four clicks on their phone, anytime, anywhere. Don’t get me wrong – banks are keenly aware that they face a customer expectations revolution. And yet, most banks are unable to successfully leverage data across application systems (listen to Philip Dodds’ EDM podcast). So you can forget about full integration between applications in a real-time environment.

The main problem is the complexity of a core banking system (CBS). And it’s important to note that this complexity is not driven by a complex problem but rather delays in innovation. A CBS has decades of technology layered on top of outdated systems that have been forced to fit the needs of modern banking.

Banks in North America and Western Europe are built on 1960s–1970s mainframe computers, running legacy core banking systems that were developed with a very different ecosystem. As banking increasingly relied on technology, the answer was rarely let’s find a new CBS but rather, can we make this one work? And, honestly, that strategy has worked (and continues to work) but it’s bursting at the seams.

A CBS’ inflexibility is a constant drag on innovation and income growth. Today, if a business line executive requests a particular type of functionality, banks have to make onerous, customized workarounds to make up for the lack of interoperability between their own applications. It’s amazing to see a pictorial representation of the 200–250 siloed mainframes (applications) communicate with each other. The entire banking stack is inefficient – slowing growth, new products & experimentation, and hampering customers.

The needs of today

Banks need very flexible and scalable systems that help in making rapid changes and allow faster go-to-market timelines for new applications. Experts believe that CBS’ have reached the point of redundancy with complex integration of outdated systems becoming too costly and often keeping banks from creating digital experiences similar to those offered by the large tech companies.

Many banks around the world have launched expensive projects to fix their core systems. Good for them, right!? The reality is that the results are questionable.

Bank insiders believe that updating core banking systems can result in various upfront charges for new hardware, system integration, new training, and new license fees. As the initial investment in a new core banking system is high, the payback period can stretch into multiple years.

According to a Capgemini analysis (see ‘Core Banking Transformation: Measuring the Value’), the payback period for core banking projects can range from 2.5 to 5.5 years with an average period of ~4.5 years.\ \ the-rotten-core-banks-need-to-reinvent-from-inside-out-1.jpg

According to some reports, banks invest more money on IT compared to other industries with significant portions of that spent on CBS. According to a Temenos survey, core banking systems (deposits, lending, and transaction processing) are the main focus area for banks for IT investments with digital channels coming in at a close second.

Even after spending that money, banks don’t achieve the desired results because they make those very archaic core systems – say 30–40% better. But that 30–40% better from bad is, well, still bad. (Next time you ask why your banking experience is so bad, you know the answer.)

Wait, so do I keep my core?

The jury is still out on whether to spend huge budgets on upgrading current CBS. Many incumbent banks are reluctant to overhaul their CBS due to the high initial investment, high execution risk, and long payback periods. Many European bank experts still stress that it does not make commercial sense to overhaul existing core banking systems.

Legacy core banking systems were usually not developed in-house but bought from vendors. Banks would buy an IBM mainframe (such as an IBM zSeries) with one purpose: support a single application, like Hogan – a deposit system that ran all of the necessary features to process deposit transactions. These are often referred to as monolithic applications. So, in one purchase, banks had a complete solution for their deposit activities, which could do one task very well and quickly. That worked for a long time, but as technology, commerce, and business changed the demands on the data, it meant more resources were needed to support the legacy CBS.

Banks have options

As a bank, should you instead be investing in the cloud to avail the real benefits of efficiency, agility, and flexibility that can help you address legacy IT? Maybe. What else could you do?

DBS in Singapore, for example, didn’t opt for CBS transformation. According to a Citi report, DBS went for transforming the bank without a core system replacement. Instead, DBS decided to reduce its dependence on its CBS by moving functions to microservices and designing systems & processes that would migrate to the cloud. Following this transformation, DBS says that its digital customers have a cost-to-income ratio of 34% (vs. 55% for traditional customers) and digital customers generate a return on equity of 27% (vs. 19% for traditional customers.) That’s significant!

There is another option: to use a third-party vendor to re-platform. In India, Kotak Bank uses Credit On’s platform to completely run the lending side of their business – a modern system built with APIs, integration, and updates in mind. In the US, banks have leveraged their mobile & internet banking providers like Malauzai, or they turn to nCino, the self-proclaimed banking OS to sit on top of their core banking system. Both solutions abstract the demands of a CBS with an over-the-top solution.

There’s one more option

Then there is always the nuclear option: a completely new, built-from-the-ground-up, agile, and scalable CBS system.

When the neo-bank Monzo evaluated all the options of available CBS systems, they were not convinced. So they went ahead and built their own modern CBS. There are a few other notable examples.

Leveris’ core banking system boasts a fully integrated, front-office-to-back-office core banking platform which was built using open standard formats, APIs, and protocols.

  • Banking Core: A comprehensive suite of fully integrated, back-end, middleware, and front-end services & applications.

  • Payments Hub: A payments solution pre-integrated with the core platform.

  • Data Science: A real-time operational control, MI & deep insights platform.

  • Operational Excellence: Delivers lower operational risk, operating costs, and increased revenues.

  • Channel & Interfaces: Suite of digital channels supported by the enterprise integration layer.

Leveris targets traditional banks, new market entrants, and consumer brands looking to enter the banking/lending space. It delivers this in four ways:

  1. Integration: Offers an extremely broad range of system integration.

  2. Cloud or on-premise: The core banking system can be deployed on-premise as well as on the cloud.

  3. Modular Platform: Allows for progressive innovation build/migration strategies which help reduce risks/time to market.

  4. Continuous upgrades: Deals with upgrades, maintenance, platform compliance, servers, and storage.

Mambu is a Software-as-a-Service (SaaS) banking engine provider. N26 is built using Mambu. Mambu has a single code-base which all customers run on around the world, and it is constantly evolving. Various options are made available for each business and the functional group to pick and choose from to fit their commercial needs.

Finxact is core-as-a-service and is built by industry veterans (and brothers), Mike and Frank Sanchez, whose previous real-time core solution was bought by FIS Global in the mid-2000s. They’ve built Finxact, a CBS designed for the cloud with full APIs and modern architecture from day one.

So is the core banking system the banking industry’s Achilles heel? It’s not the only issue holding incumbent banks back, but it’s certainly the elephant in the room. To compete in tomorrow’s tech-driven economy, banks must become much more nimble today. For now, most banks are insulated because their peers have the same problems, and the neo-banks will take a long time to gain significant market traction.

Yet, banks need to quickly meet marketplace threats and opportunities because some of their competitors will figure it out. Core systems can’t be the reason to block change and innovation. Isolated stacks of rigid processes must be transformed into horizontal, closely integrated core systems.

Data needs to flow freely both to obtain customer insights and experiment with new business models.

Ultimately, the client will let the market know who has won and with so many banks, startups, and challenges focusing on the opportunity – it’s only a matter of time before the shiny new bank-of-the-future reaches mass-market adoption.

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