The New Future for Core Banking: A Short-, Medium- and Long-term View

Some predict that banks that fail to evolve their internal systems to support remote customer interaction will fail to survive the COVID-19 crisis. Is this naysayer speak or a prediction worth heeding?

Many of us have used the current lockdown as a time for spring cleaning. Banks need to do the same. Core banking systems often end up in a state of “legacy spaghetti.” When banks reduce the volume of large core processing platforms, this is a prime opportunity to upgrade servers, clean the sprawl or decommission systems and streamline the business processes supported by the legacy technology. And though this is a powerful exercise, it is not always sufficient to ensure the core banking system has completely new plumbing – cleaning is not always thorough enough or deep enough to extend into the core banking sprawl supported by substantial technical debt.

Pre-COVID-19 lockdown we saw a number of notable challengers exploring “phigital” (physical + digital) operations with traditional banks like JP Morgan Chase launching an entirely new digital bank in the U.K. This was done on a greenfield basis, bypassing the traditional legacy spaghetti to target a new segment of customers. ISG knows of more than 40 examples of banks buying or developing new platforms in this way or via phased migration.

Yes, banks are more capitalized than before, but ISG research indicates that most are some distance away from fully digitizing the customer interface and the competing internal priorities typically lead to a model built on incremental change.

Today’s public health crisis proves the shortcomings of the legacy spaghetti model, and banks are quickly reassessing the need for sprawl. They must create strategies for both the short- and medium-term. In the short-term, all banks have initiated business continuity planning and will come out of this process facing a new reality. In the medium-term, the key to sustainable banking will be the ability to flex up and down with demand. It will be much easier to swap in and out core banking modules assuming the bank can modularize. After internet banking, this is the next step to ensure digitalization. But modularizing core banking with an in-house system is proving to be difficult in the current crisis.

ISG has observed that many core banking and financial module vendors are ramping up their social media messaging on this topic, encouraging banks to replace their core banking systems. There are several things to evaluate here. We have found a big-bang approach works only in a limited number of cases, e.g., when there is a greenfield site.

Banks need to consider whether an upgrade or replacement of the core banking platform offers the better value-to-risk ratio. In most cases, replacement is too risky, too time-consuming and too costly. A phased migration to the new core banking module is the more logical choice driving the need for modularity of the core banking platform to the forefront. Several vendors are pushing white-label “bank in a box” and “bank as a service” offerings, leveraging big data to deliver on the much-touted next gen-banking experience. An example is the new T24 core banking system from banking software maker Temenos.

How to Talk with Core Banking Vendors

Core banking vendors set a revenue target for each bank that implements their products. This requires banks to take a calculated approach that includes consideration of the following:

  • The commercial model, including:
    • Price and degree of incentive alignment between the vendor and the bank. For example, will the vendor give the bank a license maintenance holiday should the usage of a module go down?
    • Futureproofing for scalability. Will the license cost remain the same even when the usage of the module increases?
    • Alignment with outcomes wherever possible. Are banks able to return the licenses they do not want to use?
  • The ability to integrate with existing or future systems/platforms.
  • The use of artificial intelligence (AI), machine learning (ML) and other technology to drive measurable outcomes (specifically relating to customers) and build on the bank’s data and market insights. This is particularly important since it enhances correlation between back-office technology transformation and increasing revenues through more productive customer engagement.
  • Relative level of difficulty/risk to implement.

An effective way to deal with vendors is to embed a specialist with your team who can bring a multiplying effect.  

One way or another, a transformation from legacy to modular is necessary as banks come out of the pandemic-induced lockdown and begin to cater to corporate customers that need to rethink their current way of working. The cost of operating technology to support such customers must not exceed the revenue from such customers. To overcome the inevitable budgetary obstacles, modular transformation must be self-funded.

The next generation of core banking product vendors are creating ecosystems from which banks can pick and choose best-of-breed modules. An example of this can be seen in the Mambu marketplace, which is assembling a growing collection of partners that offer cloud-enabled best-of-breed apps, products and tools to help financial institutions build new architectures.

This goes well beyond the user experience to encompass systems that can patch and use AI/ML to rectify errors and identify patterns in data.

Planning for the New Future

Recovery will be patchy. Banks will emerge from this crisis one way or another. The banking platforms that will support them going forward will need to serve the customer in an easy, smooth and remote way without the internal overhead so common when managing “legacy spaghetti.”

In the medium term, a cold, hard look at the sprawl and a commitment to modularization will help mitigate current maintenance expenses, avoid future costs and control the license challenges that come with deploying off-the-shelf core banking platforms.

In the long term, this pandemic proves one thing: existing strategic investments cannot be taken for granted and can become redundant. If your workforce can’t access or service your banking systems remotely during a pandemic crisis, then you’ve become obsolete. The traditional mainframe-based systems have not kept up with the demands for remote work. To compartmentalize or decommission these systems, the core banking software modules will need to be ready and available to plug in either via a cloud or other secure on-premise interface.

A fully digital core banking module with robust underlying infrastructure will go a long way toward supporting banks in the “New Future.” This also will have implications for disaster recovery and business continuity planning.

As we know, it’s unhelpful to act without facts at hand. In today’s climate, we must look at the facts and attach the correct level of probability. ISG is here to help you dissect the facts and attach the correct level of probability. Contact us to discuss how we can help your organization prepare for the “New Future.”

About the authors

Yadu Singh is a member of the ISG CXO Services team and an experienced business transformation and collaborative sourcing professional with over 20 years of consulting and management experience.

Bill Huber is Global Partner – Digital Platforms & Solutions and a well-known thought leader in the field of technology, sourcing and transformation.  In his current role, Bill is the global leader for ISG’s Software Advisory practice, which assists clients in delivering savings, de-risking their software environment, maximizing the business value of their third-party technology investments and accelerating their digital transformations.

Owen Wheatley is Lead Partner for the Banking & Financial Services (BFS) Practice with responsibility for senior client relationships, business growth, go to market strategy and delivery excellence through the management of high-performance advisory teams across multiple regions. He sits on the Executive Committees in both the USA and Europe, has served major banking & financial services clients around the world and continues to be a widely published thought leader in the industry.

Colas Truong is a knowledgeable IT Infrastructure professional that brings considerable experience in information technology (IT) to ISG’s clients in his role as Partner. Colas is among ISG's most accomplished consultants in the assessment of IT performance in particular for Corporate, Investment & Retail Banking sector.

Frank Bastian, with his broad and sound expertise, is the main contact for the top managers of our customers and their partner Ecosystem. With his strategic and practical knowledge, especially in the areas of software engineering, development and operation, he addresses the current digital challenges (Automation, Cloud, Agile Enterprise). With his self-conception as an entrepreneur and digital leader, he generates significant business benefits for customers.