As banks respond to the twin pressures of regulatory and customer-driven market changes, shifting legacy code to modern digital core technologies has rocketed from almost zero IT interest to an imperative.
The need to move on from ancient platforms that were developed in the 1960s has been debated for a long time, but buyers have, until recently, been reluctant to undertake what is a non-trivial project. Reasons cited are many and varied but come down to three factors: time, money and risk. Why would you change something that ain't (essentially) broke?
According to CDO at Temenos, Dharmesh Mistry, the difference is that today, banks face a whole new level of demand around system scalability and flexibility. This is prompted not only by new regulations such as PSD2, which dramatically increases the number of customer interactions and transactions, but also the way people do business with banks. He says:
The need for banks to change to support their customers is so crucial now because the pace of change is much faster than at any other period of time - and that's not just from a technology perspective, but also from a regulatory point of view and also in the ways in which customers are interacting with those institutions.
The last great change milestone was the introduction of Internet banking, launched in Europe during the late 1990s. While sentiments around meeting customer demands were similar at the time, there were not as many market pressures.
Depending on factors such as the size of the customer base as well as product and service portfolio, banks will go for different approaches to core system modernization or replacement. Mistry, identifies three main approaches:
Build and migrate: Under this approach, banks establish a brand new bank entity, often a new name and a product and service offering, all underpinned by a fully digital customer interface and back end. Once the new set up is ready, the goal would typically be to migrate as many customers as possible to the new platform by attracting them with better offerings. This, says Mistry, allows not just change of the banking platform but also helps introduce a culture that supports digital lifecycles.
Progressive renovation: Here, banks will not replace the core platform - rather, they will change systems incrementally, such as a commonly supported layer of APIs that allows, for example, the aggregation of data from other banks behind money management capabilities. This approach, where some new platforms sit on existing legacy, gives banks the opportunity to introduce new services and, at a later date, a new core to where customers can be migrated.
"Big Bang" replacement: In this case banking organizations support legacy systems while a new core is defined, then maintain two cores until the migration is complete. While a Big Bang approach works for firms with smaller customer bases and product portfolios, Tier 1 banks with millions of account holders and multiple product lines tend to go for the build and migrate approach.
Open Banking introduces a fresh set of challenges that until now have made limited progress in the core transformation front. That is because creating API connectivity between fintechs and legacy core platforms is technically complex and because this new marketplace also requires inter-bank connectivity, also difficult for non-Tier 1 banks.
Unless you are a very large bank, trying to bring in all the innovation that customers expect is hard - things like API layers often don't use the same kind of interfaces as their existing platforms and there are also scalability and security issues to consider.
But if a bank decides to carry on as they are, they risk being disintermediated - at some stage [competitors] will aggregate more data and be able to say to customers that they can manage their money better than anyone else as they are providing a more copmlete view of customer resources - that's very valuable, aggregation is a threat and banks will need to protect themselves.
Mistry argues that alongside the intricacies of the technical process around renovating a platform, smaller banks which don't have the same firepower as large institutions with their own fintech communities, will often struggle to curate which companies and services should be on offer on their platform.
For a small bank to bring in a layer of fintechs is a big ask - finding the fintech, curating them, validate their models and integrations is a long and heavy investment.
In order to smooth the path for these customers who do not have the conditions to select open banking functionality and partners themselves, Temenos has its own fintech platform of about 50 companies, built over the last three years through yearly 'beauty contests' worldwide.
From planning to execution
In a year's time, Mistry expects that most banking organizations will have moved beyond the planning stage around regulation and customer-driven core transformation and will have started entering delivery mode. The CDO says:
I expect more people to be executing rather than formulating their plans. At the beginning of last year, there were still many banks trying to work out what their strategy for digital was.
When you look at the pace of change of recent months, you understand that this is not the time to look at [modernizing] individual platforms - banks should instead introduce a holistic approach that transforms not only the technology but how the organization works and the way people they employ can drive change.
Mistry predicts that over the coming months, the industry will also start seeing that core transformation projects of first movers will start bearing fruit. According to the executive, the sector is in a transitional period where fast followers will also start ramping up their initiatives.
Additionally, Mistry expects that as regulatory and market pressures continue to mount, banks will become increasingly open and willing to use more packaged systems. He says:
No matter how big you are, you won't have the bandwidth, creative resources or ecosystems needed to drive innovation. In this context, packaged systems are almost a given if you want to move fast and stay ahead of the game.
The Temenos approach of making architectures more upgradeable and breaking down components into micro-services allows faster change to occur, says Mistry, while helping banks address many system challenges they struggle with.
The reality is, banks running packaged software are more efficient because they spend less time on maintenance activities and more time on innovation. That is what any organization that wants to stay competitive should be doing.
It's important to understand this is but one person's view coming from a vendor that has an established agenda. Even so, the issues Mistry raises are well-known if rarely discussed in open forums.
Traditional core banking is the natural enemy of true end-to-end digital banking transformation. In the current Open Banking scenario, it has become clear that fintechs are no longer a threat but potential allies of established banks. But how can banks take advantage of these communities if their underlying technology does not allow them to do so? Having an API layer is also no longer a luxury - it is now mandatory for those operating under PSD2 rules.
It's understandable that none of this was considered important until recently and besides, the culture of bespoke core systems being a company's "Crown Jewels" is still very much ingrained in the culture of banking IT. Much as it is in other industries.
Whether people like it or not, these perceptions will have to change as packaged core banking systems could well be - for many organizations - the only route to the adoption of digital core banking. The clock is ticking and new entrants are not hanging about.