(Re)-Considering Core Banking Replacement

One of the most difficult challenges in considering banking channel renewal and growth is how to integrate these changes with the core systems that support them. In this article, Financial Insights reviews a new paradigm in core banking that business and technology leaders may want to consider.

Core banking vendor selections have traditionally focused on evaluating application features, functions and benefits to find the best alternative for each institution. Since Y2K, many banks have postponed making a core banking selection for a variety of reasons. Bank CIOs and executive managers have to make IT investment decisions that produce a positive, long-term impact with minimal downside risk. In core banking replacement, especially for large institutions, the downside risk of a failed deployment could be catastrophic. However, the need to remain competitive and gain ground in the marketplace is forcing Canadian bankers to focus on achieving integrated banking in a cost-efficient way. Is there an alternative framework for evaluating core banking solutions that could change market dynamics and address the downside risk?

For the purpose of this analysis, "banking" refers to the deposit, lending and payment business requirements provided by a wide range of institutions (e.g., banks, trusts, and credit unions). Core banking applications have been at the centre of banking IT application architecture since the 1960s. Financial Insights' analysts have been covering the core banking solution space in all major regions. Technology system vendors and banks have either expected or questioned the prospect of an increased volume of core banking deals. In spite of continuous improvements in IT infrastructure, the core banking business requirements have not changed dramatically over the past 25 years.

Since Y2K much of the new application spending in the core banking area has focused on areas such as channel distribution and renewal (e.g., Internet, mobile, branch, and call centre), regulatory initiatives (e.g., Basel II), or improving a bank's decision-making analytics (e.g., risk management, profitability, and customer segmentation), but not necessarily on creating new banking products.

Several issues surface when the question of a core banking replacement is raised. Cost is one concern. Most banks view operating cost efficiencies as a differentiating factor in maximizing their profitability. A cost-effective core banking solution can have a significant impact on a bank's IT and operational cost structures, particularly for small and medium-sized banks.

Another issue is integration. Tying together a bank's lines of business and various products can enable better customer service, enhanced revenue opportunities, and more operating benefits. This issue affects banks of all sizes. However, the larger the bank, the more difficult the integration, and again, the greater the downside risk. However, a large bank that creates its own successful "core banking platform" can generate a continuous flow of benefits that makes technology a sustainable differentiator. Alternatively, banks have adopted a “rip and replace” approach in moving their core systems to a single vendor.

Now, a third approach to the core banking replacement decision is available. This method is predicated on establishing a "platform" on which separate modules can be used to build an optimal solution while mitigating much of the downside risk. The complexity of banking has made it impossible for a single vendor to develop and deliver all of the features and functions the industry requires. In this new platform approach, Service-Oriented Architecture (SOA) is the basic building block. The platform approach allows a bank to build a new core-banking solution using applications from multiple vendors.

A significant part of the challenge in implementing this new platform approach is the need for SOA standards in defining what the basic building blocks should look like. A number of initiatives are already underway to do this. One of the most important is the Banking Industry Architecture Network (BIAN), which seeks to “enable faster strategic and operational changes of the banking business by providing systematically defined banking functional IT services based on a broad consensus in the banking industry,” according to the BIAN Web site (www.bian.org) Microsoft is one of the leading vendors in the BIAN working group, which also includes global banks.

Banks have three major dimensions to their application architecture: line-of-business applications, enterprise applications (e.g., general ledger and HR), and infrastructure. If the core banking framework operates on and/or interacts across all dimensions with plug-and-play integration through the platform approach, then the process for evaluating a core banking vendor shifts away from the traditional focus of evaluating a line-of-business application (e.g., retail banking). Reframing the evaluation process changes the entire dialogue between a bank and vendors, since multiple vendors can be involved. It can also affect the criteria for making a decision and the structure of the contract (e.g., pricing variables, aligning deliverables, and supplier performance metrics) awarded to key core banking platform vendors.

Banks that are the most successful in defining and implementing core banking platforms will achieve benefits above and beyond traditional approaches. The benefits include a faster path to building the initial system, flexibility to quickly adapt to changing needs, and the ability to choose and integrate new best-in-class components. This in turn leads to downside risk being minimized for the organization.

Size and scale should not prevent an institution from pursuing a core banking platform analysis, and in Canada we have seen small and medium-sized institutions leading the way in core system replacement. However, it is the largest institutions that have the highest risk/reward potential. The core banking platform approach may enable CIOs who have synchronized the framework with top management and line-of-business executives to cover line-of-business, infrastructure, and enterprise solution requirements to focus instead on execution. Large banks that successfully adopt the platform approach stand to gain long-term competitive advantages and better control over IT costs. CIOs who have not engaged in a platform dialogue with top management may have to make do with their existing vendor community and focus on leveraging the strategic direction of the bank's primary core banking vendor. Finally, senior leadership and line-of-business executives may want to consider how a comprehensive platform approach could improve their bank's ability to achieve its growth and profit objectives while minimizing risk.

About the Author

Rob Burbach is Senior Analyst for Financial Insights' Canadian Financial Advisory Service, which covers the banking, brokerage, investments and insurance industry and its underlying technology solutions in Canada.

About Financial Insights

Financial Insights, an IDC Company, was formed in November, 2002. Its focus is to provide strategic business technology and application advice for the financial services industry. IDC is the premier global provider of market intelligence, advisory services, and events for the information technology and telecommunications industries. IDC helps IT professionals, business executives, and the investment community make fact-based decisions on technology purchases and business strategy.