Before elucidating what drives banks to modernize their core banking systems and how to start a major project like this it is important to understand what the term core banking refers to and how a core banking system is defined. The answer to the question “what is a core banking system? ” varies by whom you ask. However, the answer is significant for the scope of a core banking modernization initiative and the expectations stakeholders hold. What is core banking? The term core banking describes the business conducted by a banking institution with its retail and small business customers.
Core Banking comprises the fundamental functions of a bank. The banking business known today emerged from the very basic functions ‘accepting deposits’ and ‘lending money’. Today’s banks offer a wide range of products and services that go far beyond these two functions and require a combination of a bank’s core banking functions and other elements of a bank’s operation. This often leads to different perceptions and interpretations when referring to core banking. On a very basic level core banking is understood as the management of customer’s financial transactions and their impact on accounts. 1 What is a core banking system?
Correspondingly Core banking systems are the IT systems and applications that manage a bank’s most fundamental activities and are thus the heart of a bank’s IT infrastructure. While historically core banking systems only had basic account management features and information about customers and account holdings (Customer information file), core banking systems nowadays can be defined as back-end system that allows banks to effectively develop, process and manage basic financial products and services, including data on clients, clients, deposit accounts, loans, mortgages, payment transactions and credit cards.
Also included may be complementary products and services (also from external providers), securities and workflow and business enablement systems. Another essential function is to maintain the bank’s own books (general ledger) that provide information about normal business activities (e. g. staff costs) along with the balances of customer accounts, interest, charges, other assets, liabilities, income and expense items. 3 Fig. illustrates how Core Banking systems are in fact the core of a bank’s IT infrastructure and shows all surrounding applications, networks and systems interacting with it. Fig. 1: Core of the matter Shift in importance The importance of core banking systems as well as their functionality has changed over the past decade. 20 years ago customers only expected to deposit or withdraw cash at a branch during business hours, today Core banking is about knowing customer’s needs, providing them with the right products at the right time through the right channel 24 hours a day, 7 days a week.
Core Banking Systems are no longer only of interest to IT and demand far greater involvement of business. An industrialized bank requires a robust system that provides an insight into the customer’s relationship with the bank for those who are servicing them. 5 Core banking systems will be increasingly important not only regarding costs but also regarding overall competitiveness and profitability in the future. Drivers There are a number of external drivers that force a bank to act and modernize their core banking systems.
To answer the question why banks are replacing their core banking systems, this point focuses on three major external forces as well as one internal force, which is overhauled legacy applications which directly affect the flexibility to react to the remaining three, shown in Fig. 2. The impact of the drivers may differ between banks, but most certainly all of them influence the decision to modernize a bank’s core banking systems. regulatory demand increased competition Bank legacy applications Mergers & Acquisitions Fig. 2: Driving Core Banking Modernization . 2. 1. Regulatory demands Tighter regulatory controls are one indicator of the transformed banking sector that financial institutions are facing nowadays. A significant amount of regulatory requirements were introduced during the past few years in response to the credit crunch, including, but not limited to: Basel II and III, SEPA, PSD (Directive on Payment Services) and EU Settlement and Clearing. Basel II was issued by the Basel Committee on Banking Supervision in 2004 and came into effect for all members of the European Union in 2007.
It revised Basel I and introduced new regulations for the determination of capital requirements as well as banking supervisory control procedures and disclosure requirements. 6 The new recommendations in Basel III are based on experiences with Basel II and respond to the credit crunch by demanding banks to further increase their capital to back risks that have been assumed in conjunction with the introduction of capital buffer. Basel III is planned to come into effect step-by-step starting 2013.
The Single Euro Payments Area, also known as SEPA, was launched in January 2008 and aims to implement standardized instruments and standards for euro payments in the future so that all payments are treated as domestic transactions. 8 These two examples of important regulatory requirements, that all banks are affected by, give an outlook what banks have to respond to. Taking the current market developments into account more regulations are likely to come, requiring banks to be able to react correspondingly. The previously mentioned compliance requirements drive banks to more agile platforms.
Achieving or maintaining regulatory compliance features predominantly on the agendas of banks throughout the world as Ovum, an independent analyst and consultancy firm, conducted in their latest end-user research among a representative cross section of banks in Europe, North America, Australia and Asia. Fig. 3 illustrates the business drivers affecting investments in core banking systems in 2010, naming compliance with new regulatory requirements as most important business driver. Fig. 3: The technology drivers, which influence investments in core banking systems To help ensure integrity of their regulatory reporting and avoid suffering from punitive penalties, banks must confirm that their systems are properly integrated potentially demanding for an overhaul of the existing core system. 10 Banks have to be able to create reports on short notice concerning their capital positions and risk exposures. Thus, data need to be collected in an efficient manner, reports generated on time and accurately, and the difficulties due to heavily customized and inflexible legacy systems have to be overcome. Increased competition
Significant changes in the banking market can be observed looking at the two market participants: financial service provider and customer. Financial institutions plan to use innovative products and services to differentiate from competitors and attract customers. This causes decision makers to consider core banking renewal to gain a competitive advantage. Understanding the customer In order to remain competitive many banks have recognized the need to put more focus on their customers in their strategic and tactical decision-making process.
In large part to the Internet banking customers are better informed about products and services they purchase and increasingly ask for more individual solutions. Furthermore, banks have suffered from loss of trust due to the financial crisis and current market events, resulting in customers demanding for more control in their banking relationships. 12 Customers wish for more personalized services and products and expect to be able to purchase products and view their accounts whenever, wherever and however with consistent and up-to-date information. To uccessfully meet customer’s needs, banks have to be capable of identifying those, which branch staff worldwide has had problems with. Branch employees complain that in terms of identifying possible business opportunities their systems are failing them, as was conducted in the worldwide core banking survey by Accenture and SAP. 13 The power of clients may be a threat for some banks, but also an opportunity for those who acknowledge their importance and thus take action to bring new functionality, products and services to market quickly and optimize the potential of each customer relationship.
New competitive landscape Important changes in the business environment are challenging banks in maintaining their market share. Community banks, industry specialists and non-banks are now competing to increase their customer base by offering specialized services to targeted groups of customers. 14 Not having to deal with the weight and cost of legacy systems and processes, such nimble players have a significant advantage being able to use their resources for innovation. Banks face the risk of losing clients to those innovators that are continuously improving collaboration and segment capabilities.
Given that 50% of customers would only give their bank two chances to fail in meeting their requests before considering a new financial provider, banks need to prepare. Limitation due to legacy systems Trying to cope with the demands of today’s banking environment financial institutions have encountered major problems with the functionality of their existing core banking systems to support changes due to regulatory requirements or competitive reasons. The term legacy is in this context defined as “of, relating to, or being a previous or outdated computer system”. 6 Need for greater flexibility A survey conducted by Accenture and SAP in 2005 showed that lack of flexibility, mentioned by 70%, is one of the key problems with current Core banking systems. 17 The source of the problem are legacy applications that limit the bank in developing and introducing new products and services needed to increase customer satisfaction. Banks want to expand into new geographies and new product lines and therefore need a flexible and scalable system.
Legacy systems are usually highly customized, if not too customized, and highly resistant to change, hindering banks in launching new business models and implementing regulatory changes. Also an obstacle is that most legacy systems are product-centric, rather than customer-centric, which is also reflected in their IT architecture. However, banking strategies change to a more client-focused approach, where the core banking system holds a single instance of a customer’s record and then relates it to all of the customer’s accounts. 8 Furthermore, the majority of legacy systems are neither multi-channel nor multi-currency capable. Outdated and costly systems and processes Existing core banking systems date back to the 1970s/1980s and were designed to provide foundational capabilities. These legacy systems are predominantly in-house developments, which typically run on Assembler or COBOL code and were built around products, not customers. Within the past 20 to 30 years new delivery channels, products and market segments have extended the banking business.
Banks have used middleware to deal with the shortcomings of the system and to add functionalities layer upon layer on the outdated systems. 19 Up to the present banks have spent a great amount of money on maintaining their systems, easily 70% of their entire IT budget, where less than 30% were spent on new capabilities. 20 A major portion of this spending was used for the development work to write a new product functionality or system feature into the core system. For some banks lowering total cost of wnership may be reason enough to pursue core system replacement, as more than 47% of the interviewees of Accenture’s & SAP’s Core Banking survey identified cost as top issue. 21 Need for improved system integration and stability The Core Banking Survey by Accenture & SAP Core Banking Survey also identified a variety of issues at the branch level, which are closely related or are in fact the result of core system issues. Frequent or unnecessary delays were cited by 50% of the branch staff interviewees as main processing issue, along with inconsistent customer data, incorrect understanding of customer needs and incorrect data.
Another major issue is the result of product-centric legacy systems with siloed lines of business. Information on one customer needs to be rekeyed multiple times, causing redundancy of information and inconsistent customer data. 22 Diminishing legacy technology skills The technology of the proprietary legacy systems is often poorly documented and only known by employees that were part of the development of the legacy systems. Banks rely on the knowledge and experience of a generation of workers that nears retirement or already has retired.
New employees with the needed knowledge are difficult to find. For those banks who collaborated with vendors, the challenge might be that some vendors that installed the system went out of business or do not support the system anymore. 23 Being able to respond to demands from an ever mobile and tech-savvy populace is vital. Traditional core banking systems make catering to the customer difficult. Banks need to be able to go wherever their customers are going and their core platforms are a big anchor dragging them back. . 2. 4. Mergers and Acquisitions M&A activities were the growth engine for a lot of banks in response to the financial crisis and also continued throughout the year 2010 and first half of 2011 even though the number of M&As has decreased significantly. Sometimes overlooked or underestimated is the role of information technology. The rationale for banks to merge with another bank is the expectation to achieve business benefits like increased market share, reduced joint operating costs and a more integrated value chain.
IT integration is of crucial importance to leverage anticipated synergy effects. Usually there are different core banking systems in use and an important decision to be made is the choice of the target core banking system. The options are choosing either the core banking system of the acquired or acquiring bank, consolidating the two, or completely redeveloping. In the post-crisis environment no institution is likely to choose running two core systems simultaneously and thus most banks decide in favor of migrating the acquired bank to its core banking system.
In the past, however, a lot of banks avoided the time and expense of consolidating their inflexible legacy systems, and therefore had to manage multiple banking platforms forcing them to maintain and support a mix of systems. This often exceeded the amount of time and money planned to save. Those banks pursuing consolidation often utilized middleware to deal with the shortcomings of their not scalable legacy infrastructures. Failed post-merger integration stands out as root cause for the low rate of success of 50 to 70% of all M&A transactions where banks were not able to leverage the anticipated synergies. 4 Banks today still continue to manage a very complex IT environment consisting of multiple core banking systems, that continue to age and make their support challenging. A wide mix of hardware platforms, operating systems, messaging formats, database standards and business rules require banks to implement a core banking system that is not only standardized but also scalable and flexible to facilitate future M&As and realize their full business potential.