Dollars and sense

US banks are waking up to the importance of infrastructure improvements as their aging core banking systems are taking their toll on competitiveness. By Neil Davey

The banking industry has gained a certain notoriety over time for operating in the technology slow lane for its heavy reliance on legacy systems in recent years. But the latest findings suggest that the financial sector may finally be shaking off its reputation and shaking up its core banking systems. A new global survey of senior bank executives and bank branch staff by global management consulting, technology services and outsourcing firm Accenture and business software solution giant SAP AG indicates that institutions are finally acknowledging the impact that aging core systems are having on their competitiveness – with a growing number now looking to update their systems to ensure future success.

“Like any other corporation, banks have got to grow to survive,” says Thomas F. McAllister, Senior Industry Principal, Banking Solutions and Field Services Hub at SAP America, Inc. “However, everybody can now offer pretty much everything and deposits – and, to a large degree, mortgages and loans – are becoming a commodity in the US. Therefore, banks have to be able to differentiate by pricing and by customer relationship management rather than by the actual products. However, aging core banking systems mean that bankers are experiencing difficulties in changing quickly, reacting and offering new services to their customers and, at the same time, building a good relationship with their customers.”

“The good news of this survey is that core banking is pretty strongly on the agenda,” adds Jean-Marc Ollagnier, Global Managing Partner of the Accenture Financial Services Solution Group. “We were pleased to see that the survey really confirmed the fact that a lot of banks have come to the conclusion that it is probably time for them to seriously consider some transformation of their core system in some specific space to continue to be successful and more industrialised.”

One of the first studies to gather the views of high-level bank business and IT executives, as well as the branch-level employees who are the primary users of core banking systems, nearly 1500 bankers around the world participated in the report, with 43 of the top 100 banks represented. The findings depict an industry that is in technological transition as it looks to leave its legacy of limitation behind.

“When we asked banks what the biggest problem hindering the success of their core banking systems was, flexibility was quoted by over 70 percent,” says Christian Göckenjan, Vice President of Financial Services at SAP AG. “Flexibility impacts issuing new products, issuing new channels, merging and acquiring new companies, ‘flexibilizing’ pricing and relationship pricing, adapting to any other market dynamics in terms of product offerings…the list goes on and on. They can’t change and react to the market pressures that we have today: whether these are regulatory pressures, pricing pressures or migration and merger pressures, where they can’t bring systems together.”

“Banks understand that they not only need to simplify their infrastructure in order to be more efficient but also to continue to differentiate on the market side – through relationship pricing, new products, new distribution channels and so on – if they are to continue to grow,” continues Ollagnier. “And they are now seeing that they need to move because their current system is creating some constraints.”

Flexibility limitations
Executives surveyed indicated two major reasons their systems are so inflexible: old systems built on what they considered to be the wrong technology for future growth and systems that have been customized over time, resulting in complex systems resistant to change and expensive to maintain.

“Everything was built around single products but what has now become imperative is product combination,” continues Göckenjan. “So a customer wants a current account with an overdraft facility and he wants his loan debit to be offset with the credit on his current account. He wants all of that to be bundled. And then he wants that to be taken into account when negotiating his charges for securities trading. You can’t do that possibly if you have single isolated product silos that sit next to each other but don’t talk to each other and have no connection.”

“In North America, historically we have used standard software and packaged systems for the last 25 to 30 years,” explains McAllister. “There is a lot of old legacy hardware and software. Banks are hiring folks that are used to working in COBOL and even assembly language systems that are old and not as flexible and valuable as the new logic-oriented systems. But bankers are faced with the need to be agile. There’s one large bank here in the United States, recognized for being customer-centric, that is still not able to merge one of its largest banks. It can’t offer the same product set in one geographic location that it does in the other because it can’t bring the systems together!”

Not surprisingly with such complex systems, virtually half of the executive respondents cited cost as a major issue with their core banking systems. What did come as a shock, however, were the extent of the costs relating to these systems.

“If you look at the way banks spend their money, about 50 percent is spent on maintenance,” highlights Ollagnier. “But when you look at development, which is the remaining 50 percent, they spend more than 25 percent building interfaces between systems. Therefore, the innovation development part of their IT budget is only in the 20-25 percent range. They are spending huge amounts of money to maintain what they have. When they build a project a huge amount of interfacing and technological work needs to be done because of the aging system. This means that their legacy is limiting their ability to innovate. That is a wrong dynamic because innovation remains important to the business.

“Also, because they are working on old technology, they will face problems attracting the best talent to maintain their system because it is more and more difficult to find engineers that are willing to work on old technology. So they will have an issue where some of their workforce will retire in the coming years and they will have difficulty attracting new talent to work on those technologies.”

Competitive risks
Overall, the study’s results underline the fact that the sector’s inability to maintain flexible operations and innovate and the inability to attract the best workforce threatens to have a significant impact on many banks – and this is expected to force their hands, encouraging them to look at migrating or replacing their legacy systems. Certainly there is new technology emerging that could provide a solution to their problems, offering a flexibility to introduce new products and offer an attractive proposition for customers.

“The new software will be component-based, it will be quite changeable and will be able to offer new products in weeks instead of six months to a year,” says McAllister. “The new products will be real-time, and real-time positioning is a huge advantage. Think in terms of the corporate or the retail customer – if they are able to have access to all of their accounts then the banks can do the relationship right there in real-time. The constraint is not the bank’s deposit system but whatever the feed is, and as soon as firms are on a high-speed link, they can move money among their subsidiaries, they can know what their position is, they can invest any overs that they don’t need for the day and intra-day investments and earnings could become a reality.”

But with customers sure to clamour for such services, there are serious competitive risks for those that continue to turn a blind eye to their core banking system shortcomings. “There is a danger that there will be a fast mover in the market, an early adopter,” suggests Göckenjan. “Right now, part of the reason why US banks can afford not to move is because most or all of them don’t move. But as soon as somebody breaks the ice, that will release a new force.”

Despite these warnings – and despite the study clearly demonstrating that most banks are now well aware of the impact that their aging core banking systems are having on their competitive edge – under a quarter of US banks are moving to overhaul their core technology. Only 20 percent of North American banks are planning core banking system replacements within the next five years, according to the report, compared to 30 percent in Europe and over 35 percent in Asia Pacific.

Figuring out transition
While this has been a cause for consternation for some, McAllister insists there is no reason for concern. “That 20 percent probably have an activity in place, are looking at what they have got and are already figuring out changes,” he explains. “If we had asked the question “who is talking about their core legacy systems?” the number would have been much higher – and 20 percent is a great figure already. But the North American banks are looking at their infrastructure and they know they have to be flexible, they know they have to be able to change, they know they have to be able to offer more products and have to be able to understand the customer. However, core banking, especially deposit transformation, is expensive and timely, so needless to say they are very cautious. So they are talking about changing their systems and they certainly know there is competition coming in. The American banks are simply trying to figure out how to transition at the moment.”

Ultimately, Ollagnier and Göckenjan are also optimistic about the study’s findings – and foresee that the sector’s acknowledgement of its infrastructure limitations will be the thin end of the wedge. “It is fair to say that they need to engage some re-platforming in some way, because it is the only industry now that remains with these kind of processes,” he concludes. “This industry is generally much more profitable than other industries, and it globally manages a lot of very difficult processes which is impressive. But if you look at its basic infrastructure you see a problem. It has this legacy that is preventing it from really streamlining their operations and taking it to the next level. The fact hat we are already seeing 20 percent of the US market ready to move ahead is good progress, as 20 percent of all the banks in the US is a large number. We are convinced that more is to come because the need is there – when you have 70 percent saying that they have flexibility issues and that they are unable to cope with new challenges then you know there is more to come.”

“It is encouraging and it is a large enough part of the market for us and others to see the value and importance of the industry moving,” concludes Göckenjan. “Core banking system replacement may mean different things for different institutions. It may not always mean replacing and renewing the whole system. It may mean smaller parts of it. But even that will lead to a greater openness in discussing changes of core banking systems because nothing convinces banks more than some of their peers having done it. And with the willingness of the first 20 percent to consider that over the next five years, there will inevitably be successes and references for others to look at, and as soon as that is there, there are fewer and fewer reasons for other banks to ignore that path.”