Core banking transformation: key drivers for change

28 September 2023

Traditional banking has evolved over centuries into what we have today: digitalized products and services that keep the worldwide economic cogs turning. In pursuit of automation and digitalization banks have accrued sizeable technology estates, mostly as functionally rich in-house built platforms. Big banks continue to operate legacy core banking systems for several reasons – historical builds, customisation, vendor lock-ins and costs, to name a few. These reasons revolve around the complexities and challenges involved in maintaining, rather than replacing, these platforms.

Today however, regulation, market forces and technological advances are combining to create a paradigm shift in financial services. These converging factors are allowing a new breed of entrants into the banking sector. The rise of BigTech, Fintechs, MSPs and neo-banks are a threat to established banks – they have already started cannibalising banks’ revenue streams by going after low hanging fruit, such as the customer relationship side of the business and being an integrated service provider. Established banks are now waking up to this existential threat, but it’s not just that: the value of their businesses has been on a slippery slope for quite some time, too. (The price-to-book value of banks have fallen significantly since 2000. McKinsey reports that the P/B value of the top 30 banks, accounting for half of the industry’s value, and generating close to 60% of total banking revenues, had fallen from 2 to 1.1 by the first quarter of 2017.) The market certainly does not think banks are positioned for success in the coming decades: these new players are agile and able to innovate quickly by offering superior customer experience and choice. Conversely, big banks are hamstrung by legacy Core Banking systems, once their workhorses, which their core intellectual property is built on and around. In the main they are functionally rich and perhaps resilient systems, but typically monolithic in nature: decades old and increasingly becoming too complex, costly, and time-consuming to support and integrate with. Typical legacy cores, over time, have accreted so much code that it is now difficult to separate core from non-core functions. While banks have started to innovate on the fringes (such as working towards an omni-channel experience with Mobile banking, Chatbots/AI, and improved integration), core bank transformation is still a missing link in their strategy. It would be beneficial to review drivers that may necessitate a rethink in this space, such as:

Enhanced Customer Experience

Overall customer experience and ease of access to products and services will play a significant role in determining a bank’s brand value, perception, and attractiveness. Predictive analytics will help banks design superlative customer journeys; customer acquisition and onboarding journeys need to become more dynamic and streamlined, achieved through an interactive and seamless experience. Banks will need to invest in an omni-channel banking capability which allows for a frictionless onboarding experience. As banks are actively seeking strategic partnerships, to integrate their products to fit customer lifestyles and even roll out new products to meet future demand, they will realise the potential benefits of a lean and agile core banking platform.

Changing Ecosystem

In recent years, barrier to entry into financial services has gone down significantly, evidenced by a myriad of neo-banks and Fintechs being set up across the world. Specialised banking is on the rise – in other words, banking catering to targeted customer segments such as SMEs, millennials, children and even the unbanked. These players can innovate and address their customers’ pain points much more quickly than Full-Service banks. Devices have become ubiquitous, and society is increasingly moving towards a cashless and paperless transaction model. Customers are also used to a personalised, on-demand and real-time experience in non-banking domains, so banks are now under pressure to offer responsive digital services that are comparable with other sectors, and to be able to partner with these new players in reaching out to customers. This would necessitate a thorough review of their existing technology capabilities to assess if they are able to meet the demands of an ecosystem that is evolving rapidly.

Challenges vs Opportunities

Banks spend millions on the enhancement and maintenance of legacy and on-premise core banking platforms. That does not mean there is always a straightforward business case that can be drawn up to justify a core banking system re-platforming exercise. For instance, how can you quantify the lack of skilled resources to replace an aging SME pool to continue supporting these applications, or that it may be running on outdated technology or out-of-support vendor packages. There are indirect benefits from this exercise though – a next-gen core banking application will be modular and have API connectivity, thus improving time-to-market and cost of integration. Cloud-native applications will also help with the reduction of the on-premise estate, and optimise resource utilizations due to their dynamic, robust, and elastic architecture. Next-gen applications can enable continuous development, thereby increasing the banks’ ability to roll out new features and capabilities, quickly and regularly.

Future Ready

Banks may feel that they have a robust core banking system that is reliable and “does what it says on the tin” at present. However, are they confident that it is future-proof, to enable them to adapt and grow? Considering that core banking transformation is a multi-year journey, this assessment should be done on a medium to long-term basis. The “bank of the future” will need a fluid architecture to integrate cross-functional business processes to offer responsive digital services. It would need to modernize and simplify its architecture, adopting a minimalist and modular approach – in other words, a coreless banking architecture (a form of distributed architecture where all the core is stripped away into discrete consumable and composable services).

Define Success

Ultimately it comes down to what needs to be done to successfully transform the core. Firstly, arrive at specific business outcomes for the programme and define a set of KPIs to measure progress. Functionally decompose existing systems into a coherent business capability model, which can help the organization in creating a common language for their business, including capability stratification, ownership and establishing value stream/business process relationships. Also, it is key to draw up a digital transformation strategy to help govern progress towards business goals. Strategy should also guide the team in navigating major decisions such as buy-versus-build, product/vendor evaluation and whether the target system will follow the lines of a traditional enterprise core banking system or move to a next-gen platform. A flexible and least-disruptive migration approach needs to be devised – perhaps conduct a review of whether the life of the current core banking system can be extended by hollowing it out? This can also serve as a staging for future migration to a more strategic platform and as a medium-term hedge. There is no one-size-fits-all approach to core banking transformation, whether the approach is to do a big-bang migration, or a phased migration, or running a dual core, it will be a critical decision, nonetheless.

In such challenging times, here at Icon we believe in the value of collaboration, strategic vision, and agility. Our deep banking domain expertise and delivery track-record, combined with our mature Architecture practice, positions us to partner with clients successfully – no matter where they are in their transformation journey.

Gene Philip