Pressures to upgrade ageing systems come from both business and IT, but banks are reluctant to go for wholesale replacement of core systems. Joy Macknight looks for the reasons for this
Core banking systems are the lifeline of any financial institution. In wholesale and retail banking, they are the ledger and transaction records; but it goes much deeper than that.
Virginia Garcia, senior analyst, financial services strategies and IT investments, TowerGroup, defines them as the engines of the financial services technology that drive the core processes for banks, insurance and capital market firms. “Origination and servicing solutions in the lending industry and trade processing would also be included. So these are the systems that drive the core functions,” she says.
Some in the industry liken core systems to vital organs, so it is no wonder that there is some hesitancy when talking of replacement. “To buy a new core banking system is a major project — it is a heart and lungs transplant for a bank. In the past, banks have been reticent about making the move and tended to look at other ways of improving productivity. The trend has been to ignore that piece by buying new branch delivery solutions or new channel solutions, and surrounding the core systems,” says Mike Davey, senior vice president, business development, at core banking systems vendor Fidelity. “But many banks have done that and now to keep driving the cost base down, they are finally taking a look at the core systems and what they can do to move these things forward.”
Clearly, many IT directors find themselves with a yoke around their neck with respect to being able to free up funds for new technology investments because their core systems are consuming an ever larger portion of their time and budget. “Financial institutions are competing on costs like they never have before, operational efficiency is becoming front and centre in the boardroom, and core systems are a very big part in the tool kit to drive down those operational efficiency ratios. It’s all about streamlining business processes by eliminating redundant processes and custom steps that require a lot of manual human intervention because that opens up room for error,” says Garcia.
But making the business case still remains the biggest challenge.
“Intuitively, managerially they know it’s a good idea, but then they look at the finances. If it does stack up, they then compare it to the risk of implementing the product, because this is the ultimate ‘betting the bank’ project — they have to get it right, there are no compromises. If you don’t get your internet site up and running, it’s mildly inconvenient and embarrassing, but the world still revolves. But it doesn’t if you have screwed up your core banking system. So it’s quite often a distressed sale,” says Jeremy Bryson, director financial services global markets, Atos Origin, an IT services provider.
The market pressures for core system replacement are: the drive for agility and flexibility to be able to cope with ever more challenging business requirements; cost and operational efficiencies; compliance with regulatory requirements; and reducing operational risk. Many banks are discovering that their banking platforms are simply beyond their best age; it has become too costly, both in terms of money and time, to create new products or adopt new processes. “The changes needed are too costly, too risky or they cannot deliver significant quality,” says Jost Hoppermann, vice president, research, financial services Europe at Forrester Research. “We are also seeing projects being delayed by years, instead of months, and the quality going down. Some banks are in a position where any change is a major initiative because their banking platform is still based on an old, proprietary core system.”
“In essence, what is happening is that the visibility of core systems deficiencies are being elevated,” says Garcia. “Where once they were the source of many a headache for IT directors and employees within the IT department, now the business managers, chief financial officers, chief executive officers, are understanding the source of their headaches. Core systems are the root of many problems and they are exacerbating an exceedingly difficult mission that these business managers are on.”
“So today we are working in the arena where money counts and if you can deliver economic growth out of the core system replacement, then you will get the project approved; if you can’t, you probably don’t. What’s on the agendas and in the minds of chief executives in the big banks is the ability of technology to drive organic growth. The need to understand the client and do what the client wants — that’s in the minds of chief executives today,” says Andreas Andreades, chief executive of Temenos, a core banking systems specialist.
This is certainly the case with the National Savings and Investment Bank, a UK government-backed savings provider, which in 1999 partnered with Siemens to replace its banking system. In a deal which included outsourcing 95 per cent of its business processes, NS&I streamlined its business to make it customer focused.
“We had 13 separate systems, yet only 12 products, each having a separate administration process. Staff were trained in their particular jobs and couldn’t move within the company,” says Steve Owen, partnerships and operations director, NS&I. “The whole business was based on a 1960/70s IT system, mostly in-house developed. With retiring programmers and hardware that was no longer supported by the manufacturers, we knew we had to make a change. The competition in the market was forcing us to re-evaluate our business strategy. Our goal was to try to make the customers happy.”
“One of the burning problems NS&I had was the type of organisation it was and when the scale of the outsourcing came into play, it saw some significant threats in the way it was working and it couldn’t get investments going into the business. The feeling was that it needed new drive and energy to get it back on the growth path,” says Sukand Ramachandran, financial services BPO strategic initiative leader at Siemens. “To bring in some more operational flexibility, we needed to get some sort of homogeneity of the operating platform so that once it had that and a unity of the way we process things, it could start moving things around and looking for efficiency value.”
In a recent survey, Forrester Research found that more than three quarters of the financial institutions surveyed have either already started renewing their banking platform or plan to do so by 2010. Most analysts and vendors agree that the core systems market is more dynamic in the Asia Pacific region, and to a lesser degree in Eastern Europe and the Middle East. The US is seen as the slowest uptake in the replacement cycle.
“Eastern Europe has been very buoyant in terms of replacing their core banking systems for several reasons: they don’t have the problem of legacy systems and they have investment from Western European banks acquiring them. Instead of trying to build something in-house, they went straight to a third party vendor and the volumes are very different so there are no real issues in terms of scalability. They have become a test base for implementing a third party vendor and it might mean that it will start migrating back towards the west again if those are successful. Asia Pacific is the market for core banking, the most explosive one and driven by the need for greater efficiency,” says Rachel Hunt, manager, European Banking Research, Financial Insights.
“Historically it has been the emerging economies that were the earliest adopters of technology because they had a clean sheet. We are starting to see economies like India and China burgeoning, and they aren’t weighed down by 50 years of legacy technology that some of the Western banks are. They are starting to grow rapidly. I have the view that one of those guys is going to give the Western banks a run for their money in years to come,” says Ian Benn, marketing director of retail banking at Misys.
Many of the smaller financial institutions, Tier 2 and Tier 3 banks, have been engaged in core system replacement for a few years and have looked to packaged solutions from different software vendors. But for the first time, Tier 1 banks are looking to move away from in-house developed technology to a packaged solution. One of the things that is helping to drive that tipping point is the technological advances made by the vendors.
“Quite a few Tier 1 banks are looking at a replacement now because the costs of maintenance are just too high — 40 to 50 per cent of their total IT budget is just the maintenance of legacy and core systems. Also they are finding that they cannot tap new revenue streams because their core systems are inflexible and they are struggling to go real-time. At the same time, the offerings of the vendors out there are proving to be more viable solutions; they are proving to have more scalability and they have done a lot of investment in new technologies,” says Hunt.
“Rather than having a big bang approach, the fact that now some of the vendors are offering a product that is very componentised and based on service-oriented architecture means that the bank can have a piecemeal approach to the implementation. So it can start with one functionality and implement that, see how it’s running and then move on to the next functionality. Maybe it’s a project that is rolled out over a longer period of time, but it enables them to see if they are happy with the technology and reduce the risk. And I think that is what is most attractive at the moment,” continues Hunt.
“Small bangs composing step-by-step migration is what the bigger banks are interested in. If we are looking at a complete renewal initiative — consisting of many small bangs — we are looking at a single digit million euros project for smaller banks, but a three digit million euros project for larger banks. This is quite an interesting sum of money even for a large bank. Therefore, it’s easier to spend that over a period of time; and if you are going gradually, it is much easier to prioritise the new application based on business value. You will try to leverage this huge investment, to make the business case for the migration real, within the step-by-step gradual migration by delivering those applications with the most value first,” says Hoppermann.
“Most important is that the system has to be very robust. The system must be behind the common campaigning vision and sound financials and a clear understanding of what the bank wants to do. If you don’t have the company vision and the alignment within the organisation, a project of this complexity and length will not succeed. It will be derailed, changed, doubted, and ultimately it will fail,” says Andreades.