Rotten to the core?

The banking industry has attained a certain notoriety over time for its heavy reliance on legacy applications. However, new evidence suggests that the global financial sector may now be on the cusp of an IT revolution. A 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 – and a growing number from all around the world are now looking to update their systems to ensure future success.

“The good news of this survey is that core banking is strong on banks’ agendas,” stresses Jean-Marc Ollagnier, Global Managing Partner of the Accenture Financial Services Solution Group. “We were pleased to see that the Accenture and SAP Core Banking survey confirmed the fact that a lot of banks have come to the conclusion that it is time for them to seriously consider the transformation of their core system in some specific space to continue to be successful and to be 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. And the present climate in the European banking sector has made regional participants particularly keen to make this transition – with 30 percent planning core banking system replacements compared to 20 percent in North America.

“European banks have always had to cope with diversity more than North American banks which are in a relatively homogenous market: one language, one set of behaviours and so on,” explains Christian Göckenjan, Vice President of Financial Services at SAP AG. “In Europe, everything you do is diverse, which is making the playing field more competitive. That has forced European banks to be more competitive in terms of cost and also the way that they try to differentiate themselves in the market.”

Differentiation, however, is not so easy in a market where everybody can offer everything. ATM withdrawals are frequently free of charge, current accounts are free of charge and many banks offer credit cards free of charge. So many services are simply given away because everybody provides it that there is very little commission to earn on services. And for those that have an aging core infrastructure, the problem is compounded.

“To grow, banks understand that they not only need to simplify their infrastructure to be more efficient, but they also need to continue to differentiate in the market through relationship pricing, new products and new distribution channels,” says Ollagnier. “As we witnessed in the survey, they are now seeing that they need to move because their current system is creating some constraints.”

Flexibility issues

In one of the most significant findings of the study, 70 percent of respondents nominated the biggest hindrance of their existing core banking system to be its lack of flexibility. And flexibility constraints at core system level will naturally have implications not only for market differentiation, but also for a whole host of areas.

“The lack of flexible core systems impacts a banks ability to issue new products and distribution channels, create opportunities to merge and acquire new companies, provide flexible pricing, adapt to market dynamics in terms of product offerings...the list goes on and on,” emphasises Göckenjan. “Without a consolidation of systems and processes, banks can’t change and react to today’s market pressures: whether these are regulatory pressures, pricing pressures or migration and merger pressures.”

Executives highlighted two major reasons for their systems lack of flexibility: old systems built on what they considered to be the wrong technology for future growth and systems that have been customised over time, resulting in complex systems that are resistant to change and expensive to maintain.

“In the past everything was built around single products but what has now become imperative is customer centricity as opposed to product centricity,” continues Göckenjan. “Today, customers want and expect their entire relationship with the bank to be valued, For example: a customer wants to offset a loan with a credit from his checking account. The same customer also wants this activity to be taken into account when negotiating his charges for securities trading. Such activities are not possible if a bank has single isolated product silos that sit next to each other but don’t talk to each other and have no connection. It is also not possible to resolve some of the issues with skin deep middleware or wrapping techniques alone. The backend systems themselves have to change”

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.”

Thin end of the wedge

Overall, the study’s results underline the fact that the banking sector is nearing a watershed moment in its IT mindset and development. The inability to maintain flexible operations, the inability to 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 Thomas F. McAllister, Senior Industry Principal, Banking Solutions and Field Services Hub at SAP America, Inc. “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.”

Ultimately, despite the problems that the study has highlighted, Göckenjan and Ollagnier are optimistic about its conclusions – and foresee that the sector’s acknowledgement of its infrastructure limitations will prove to be the thin end of the wedge.

“From the survey it is clear that core banking system transformation is becoming high on the CEO agenda of every large organisations across Europe,” says Ollagnier. “There are numerous reasons for this: some want to create pan-European business, for some it is more about their consolidation approach, whilst others want to move into new space. It is a big, difficult , decision for any CEO. But it will have some high rewards. Accenture and SAP strongly believe that the first bank to move in this direction will create sustainable competitive advantage because they will be able to manage more mergers and acquisitions, reduce operating costs be able to develop new products and bring them quicker to market, as well as many other advantages.”

“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 transforming,” concludes Göckenjan. “Core banking system transformation means different things for different institutions. It may not always mean replacing and renewing the whole system landscape. It may mean smaller parts of it. The transformation 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. The survey showed the willingness of 30 percent of banks in the next five years to transform their core banking systems. We are beginning to experience this move to transformation and with this there will inevitably be successes and references, which will provide fewer and fewer reasons for other banks to ignore this path.”