The heart of the bank

As a system, core banking is undoubtedly the single most important element in the bank’s IT environment. While core banking systems have been in place for around 30 or 40 years, the technology evolution hasn’t changed much since this time and the systems are pretty much what they were when they were first implemented. These systems continue to work well, however core systems invariably come back into discussion because they are costly to maintain and improve upon. On average a bank will spend between 40 to 70 percent of its IT budget on core system maintenance each and every year, which leaves very little for the bank itself to innovate or to respond to the increasing regulatory burden.

IDC's 2009 EMEA Core Banking Deal Part 1 report makes a number of predictions for the future of the core banking market by looking at the market trends for the previous year. Rachel Hunt, EMEA Research Director for IDC, explains that what was quite interesting from the report's point of view is that while 2009 was a difficult year for many IT vendors, the number of deals was fairly level with regards to the previous year.

One of the key reasons for this has been the number of mergers and acquisitions within the banking system, which has meant that many organisations have been required to replace or redesign their core systems. "If we look at the banking sector in general," says Hunt, "service-orientated architecture is gaining in maturity, and the vendors are following suit and offering solutions, which are much more componentised and can scale up much quicker.

"The analogy is that when you're replacing a core system it's like doing heart surgery whilst running a marathon; it's very risky for banks to do rip and replace. It's a complex and usually very long project," she adds. What banks are currently looking for instead are the much smaller projects, which are a lot less resource and dollar hungry. Hunt says the report has thrown up the organisations that are focusing on their pain points and then rolling it out so they replace or transform their whole core system at the end of the project.

Another interesting trend, says Hunt, is that new banks - in both the Middle East and Western Europe - are inputting brand new systems, leading to a lot of product innovation in the sector. "The majority of deals are being driven from emerging areas like the Middle East and Africa, but Metro Bank and Tesco Bank are also building brand new core systems."

So what is driving this change in core banking systems? Hunt believes that it is down to the customer. She sees that customer requirements have changed in a power shift that favours the customer as the decision maker. "In the olden days, you went to see your bank account manager and he told you about the products available and how to access them. Today, you go to the bank and tell them how you want to do your banking," explains Hunt. "Increasingly that pressure is difficult for banks to deal with because the customer wants more and more channels. Plus they want a personalised banking experience, they want to be able to see their data, they want to be able to personalise it."

Flexibility is certainly a key challenge for the future of the banking industry. Indeed, one element of introducing new channels or new products is that those products need to be introduced in a very flexible manner, particularly in the retail banking side. Dealing with the mass market, who increasingly want a personalised approach doesn't really go hand in hand.

"Banks are having to deal with a competitive environment where keeping profitable customers is becoming more and more difficult, where the differentiator is not going to be the product pricing," explains Hunt. "It's all about the level of satisfaction and the quality of service that's given." She goes on to explain that the FSA did a survey recently that found that 95 percent of consumers said they choose their banks based on the quality of the service rather than on the pricing. 

Pricing will remain important. "Very dissatisfied customers are changing their banks. The rate is currently around eight percent across Europe, but that's on the rise. Basically the customer is less and less loyal and similarly in a corporate banking world, the level of sophistication that corporates and treasurers want is much more granular, they want more control and more self-service. All these things are of course limited by your core system and how flexible it is and how cheap it is for you to introduce new products or services."

Even the quality of the service that is being offered goes back to the back-office core system. If it takes two weeks to approve a loan origination over the internet, you will not be looking at a very happy customer - if customers go on the internet, they don't want to have to wait two weeks for a decision. All these sorts of competitive issues are linked back to some of the restrictions caused by the legacy systems.

Indeed, Hunt believes that looking at the future of the banking space there will be a real shift in how banks are going to compete, particularly on the quality of service. Core system vendors need to be able to provide the tools for those banks to compete on that sort of quality and satisfaction level.

Hunt explains that she is excited about the entrance of new banking competitors that are not banks. "Peer-to-peer lending, with organisations like Zopa or Funding Circles, who are not banking institutions, but who are providing loans to consumers and small and medium businesses are really changing the way that they interact and relate to their customers," she says. "Now, the difficulty is that because they're not banks, they're not regulated so they don't have to have such complicated reporting and infrastructures as the banks. But the banks do need to learn about the ways that these people are changing and the way they're communicating and interacting with their customers."

Upgrading your system

Looking at what financial institutions can do to implement or replace a core banking system, Hunt advises that a small institution should look to integrated core systems that are provided by whole host of vendors and that cover universal banking requirements. "I would say that smaller institutions need to investigate software-as-a-service model in terms of reducing CapEx and look towards an operational expenditure model. Certainly the pay-on-demand or pay-as-you-go model's are interesting," says Hunt.

Larger institutions need to look at evolving towards a service-orientated framework and follow standardised definitions of what services should be. Looking at component solutions it is possible to find out where the main business pain points are. "One of the issues for larger institutions is that core systems replacement is seen very much as an IT issue with little involvement from the business," says Hunt.

"Increasingly this is changing to see decisions made by the business. The end user of the core system needs to be involved right at the beginning of the selection - they're the ones who should be driving the core system transformation, not the IT department, because they're the ones who have a vision of what the bank is doing, what it needs to be doing and where the real bottlenecks and pain points are."