The convergence of new legal and regulatory issues, globalization initiatives, and new enabling technology is a force for dynamic change in a marketplace, and it inevitably becomes a driver for adoption of outsourcing in new areas. That’s the situation now playing out in the area of core banking systems worldwide.
Core banking systems are the applications responsible for processing and posting transactions in payments, savings accounts, loans, and securities. They are a mission-critical element of the banking business.
But banks’ legacy systems are no longer adequate for today’s business needs. They’re focused on product-oriented back-office processes instead of customer-oriented processes; perform batch processing instead of online, real-time, STP (straight through) processing; and are IT driven and reactive instead of business driven and proactive. Legacy systems are fragmented and don’t present an integrated global view; for instance, they cater to many different European countries instead of operating on a European Union basis. They cannot conform to new payment processing technologies and regulations.
System replacement with a modern core banking solution includes such benefits as greater efficiency, easier access to information, and the ability to add new applications without fear of system crashes. Among other benefits, developments in packaged solutions include a move away from dependencies on hardware platforms and operating systems.
Despite the need for the system replacements and benefits of the enhancements and maturity of the available solutions, many banks are not yet undertaking core systems replacement.
“Because of the high risks and high costs involved, these are not projects that anyone wants to do,” states Craig Zander, principal, Core Banking Practice at Capgemini.
Capgemini’s 2008 Core Banking Systems Survey examined current core banking trends since 2006 as well as the 16 major core banking systems solutions now available.
As the survey report states, “Replacing a core banking system is often compared with replacing the engine of a Boeing 747 in mid-air. Experts consider core banking replacement to be the most complex, risky, and expensive IT project that any bank can undertake.”
Many mid-tier and top-tier European banks are early adopters of the new solutions and are replacing their core banking systems — replacing their legacy systems with a single global system in each business line.
However, many large European institutions are still battling outmoded, inadequate core systems that no longer meet their needs. In the United States, most banks are not yet replacing their systems and plan to do so by first implementing new systems only in global divisions before tackling domestic systems.
Zander ties the adoption rate for replacement projects to specific regulatory or competitive pressures. Europe is further along the curve in adoption of core banking system replacements. These banks, for instance, need to transform their technology to accommodate the SEPA initiative on payments transactions in Europe. The European financial services industry is also dealing with cross-border mergers and acquisitions. And larger global institutions want to adopt a standardized global core processing platform, which requires systems with multi-currency, multi-language functionality.
Zander says Capgemini is beginning to see similar types of things happening in North America, which will start to drive the need for system changes more quickly. In emerging markets, he says it’s easier for banks to adopt the core banking technologies because older technologies are not as entrenched as they are in developed markets.
He cites an example of a North American bank he encountered this spring. “They haven’t accepted a new release for a deposit system from their current vendor since 1994. As a consequence, they’ve invested an enormous amount of money in customization — which makes the change to a new system even more complicated. In some of the lesser-developed countries, they can actually skip an entire generation of systems because they’re not as entrenched.”
Similarly, it’s easier for a tier-three or tier-four bank to replace its core system because it doesn’t operate in as many markets as a tier-one or tier-two bank. The number of third-party applications that need to be integrated into the new core system is another factor impacting the adoption rate. Most tier-one banks have more of these applications, and they replace the apps or integrate them into the new system.
“We’re seeing indications from a number of banks in North America that there are going to be RFPs coming out this year for core system replacements,” says Zander. “The need to adopt a new core processing system wasn’t as compelling in the past; there needs to be a strong business driver.”
He mentions three drivers that now make it easier for a North American bank to create a business case for going through a core systems replacement.
- Over the last several years, the cost of support and maintenance of legacy systems occupies 50 percent or more of the banks’ IT development budget. Consequently, the banks have fewer funds for innovation to meet customer demand and regulatory compliance.
- Real-time processing is more critical in a global marketplace, but legacy systems are doing batch processing. “If your batch system is down for overnight processing, that doesn’t allow you to offer global treasury management services that the market demands,” explains Zander.
- A bank cannot realize the full value and advantage of image capture and image exchange rather than paper checks if it still needs to process the images overnight.
- When there is a convergence of new legal and regulatory issues, globalization initiatives, and new enabling technology, it inevitably becomes a driver for adoption of outsourcing in new areas.
- In IT implementation projects, outsourcing eliminates much of the risk and also reduces the cost significantly and ensures the necessary resources to achieve the project successfully.
- When outsourcing a mission-critical process, companies often retain the project-management functions in house.
- In geographies that are new to outsourcing a particular process, the service provider needs to be a global company with a proven track record of having successfully assisted clients in successfully completing the same type of work in other countries. The provider should have a set of proven, refined processes and best practices that it can import into different markets around the world and can follow again and again.
- When selecting a new IT solution, it is best to drive the selection process from a business perspective, rather than a technical perspective, to ensure it can achieve the vision and objectives over the long term.
In addition to these different drivers, Zander says that in large institutions, certain business lines will drive the system replacement because they will see more quickly how their segment of the business can benefit from it.
“In North America, I think we’re going to see core systems replacement happen on sort of a modular basis,” says Zander. “I think banks will decide to replace the deposit and loan systems and the general ledger in the order that they consider to be most important to run their businesses. A bank might decide to replace its general ledger system first, for instance, to help it comply with governance requirements imposed by Sarbanes-Oxley.
Replacing the systems in a modular approach also reduces some of the high risk associated with these system replacement projects.
The outsourcing options
Outsourcing also eliminates much of the project risk and also reduces the cost significantly.
“This is a project that they hope they only have go through once in a lifetime,” Zander comments. “That being the case, banks don’t staff up either with the resources in terms of number or in terms of people who have been through this before to manage the project successfully completely on their own.
The portion of a replacement project that banks outsource varies per institution and can vary from handling the entire project to taking a system integrator role.
Project management usually stays in house. “Certainly some financial institutions regard this as being so absolutely critical to their current and long-term success that the project management aspect of it isn’t something that they will turn over to somebody else,” says Zander.
The benefit of utilizing an outsourcing service provider with experience and expertise in this work is that it brings all the required resources as well as established processes, methodologies, test scripts, and other artifacts from having done other replacement projects. Another valuable benefit: the bank still has to conduct business (providing quality customer services and also bringing new products to market) while the replacement project occurs over a lengthy period of time.
Zander cautions banks on doing their due diligence on the experience factor of outsourcing service providers for these projects. “Here in North America, none of the large tier-one or tier-two banks have done a core systems change in the last five years. So there isn’t a company in the market that can say: “We’ve done five of these projects already.”
Thus, the outsourcing service provider needs to be a global company with a proven track record of having either managed or assisted clients in successfully completing these kinds of core system changes in other countries. The provider should have a set of proven, refined processes and best practices that it can import into different markets around the world and can follow again and again.
From a cost standpoint, it’s an advantage to choose a service provider with offshore resources to get things done on time and manage costs at the same time. “The number of trained, domain-experienced resources that can be placed on a systems replacement project on a global basis is a big advantage,” says Zander.
Choosing the replacement core systems solution
Another important service provider selection criterion: choose a provider with strategic alliances and experience in working with all the major core processing vendors.
Selection of a packaged-based solution for a core banking system is a complex process. It’s also a strategic decision with long-term implications. To ensure the system will achieve the vision and objectives, banks must drive the selection process from a business perspective, rather than a technical perspective.
How the study was done: Capgemini compiled its 2008 Core Banking Systems Survey from September to December 2007. It was based, in part, on a survey sent to the 16 major vendors of core banking solutions. The survey report includes a discussion on solution selection criteria as well as a discussion on a structured approach for implementation based on best practices.