Five steps to modernize your core banking system for rapid innovation, personalization, and operational efficiencies

Banks continue to invest heavily in digital transformation, spurred by competitive pressures, changing customer expectations, and dynamic regulations.

Integral to this transformation is the modernization of their core systems. Now banks spend a quarter of their IT budgets, equating to millions of dollars, in maintaining their core banking systems. These legacy systems inhibit banks from innovating faster. Moreover, the dwindling talent pool to support these legacy systems implies that banks are rapidly looking for alternatives.

Unsurprisingly, 37% of global banking leaders state that transition to a modern, cloud-based CBS is a top priority to achieve operational transformation. Among leaders of the largest institutions (with assets of more than $1 trillion), 48 percent of respondents made this their number one goal.

However, core modernization projects are often risky and are associated with cost overruns and unclear returns. So how can banks approach core modernization? This article introduces the concept of coreless banking, the challenge that banks face in their modernization journey and recommends a five-phased strategy to help banks better manage their modernization programs.

What is Coreless banking?
In his annual message to investors, the MD & CEO of HDFC Bank, among the top 5 most valued banks globally, outlined his bank's strategy to hollow the core by moving from legacy systems to a cloud-native system and a neo-technology stack. The bank aims to create separate core systems for each module, such as payments and customer records. This will reduce the dependence on the current monolithic core, improve data-driven personalization, spur faster product innovation, and boost operational efficiencies.

The above is the principle of coreless banking wherein banks opt for a lighter core banking system, typically covering accounts, transactions, and products. The other modules, for example, payments, KYC, regulatory reporting, ID & V, etc., are provided by best-of-breed fintechs and integrated with the core banking system through microservices and APIs. An inherent advantage of this composable approach is that banks can combine and recombine solutions from different vendors as needed. Thereby, they can stay nimble and adapt to changing market dynamics quickly without needing large-scale transformation programs after every few years.

HDFC Bank is not alone in this journey. Several global banks, including JPMorgan Chase, Lloyds Banking Group, Westpac, and Intesa Sanpaolo announced partnerships with modern cloud-native core banking players. The coreless initiative propelled by Banking Industry Architecture Network (BIAN) has many leading banks as members, including Citi, PNC Bank, and Bangkok Bank.

Senior leadership team of the bank should understand and commit to the core modernization program ambitions from the outset.

Challenges that bank face
As outlined above, moving to a coreless approach with modern cloud-native core banking systems can provide benefits around better customer experiences and operational efficiencies. However, the core modernization journey can be challenging for large banks because they have relied on these systems for several decades. And any change to the core will impact the entire banking operations and customer transactions!

If not done correctly, the downside is high - both from the perspective of customer experience and regulatory scrutiny. For example, TSB Bank in UK was fined £48.65m by UK finance regulators for failures that led to unavailability of services during the migration of millions of customer accounts between banking systems.

Cost and time overruns are also common. For example, a leading Australian bank saw its cost of modernization skyrocket to over 3x the initial estimate! A related challenge is the difficulty in ascertaining the returns on investments upfront. Too often, IT teams drive core modernization efforts, and they may not have the tools and measurement frameworks to link business benefits to modernization activity.

"Modernization programs often downplay the people and cultural nuances that ultimately contribute significantly to their success."

The five-pronged strategy
Despite the benefits, the challenges above are a reason that large banks are cautious about modernization. However, stalling modernization is not an option, given the increasing demand from customers for great experiences, pressure from competitors, and the cost involved in not only maintaining the legacy but also to add new features. Moreover, the large, monolithic systems in play today are coming to an end of life. Soon there may not be people around to manage these!

So, what can banks do to mitigate these challenges? We recommend the following 5 phased approach to transformation.

1. Start with a clear ambition, a business case, and executive leadership involvement:
Senior leadership team of the bank should understand and commit to the core modernization program ambitions from the outset. Start by creating a clear north-star vision for the modernization effort. Then build an investment case validated by the CFO and identify prioritized use cases for modernization based on the overall strategy. Following this assign accountable owners to drive the modernization program, bringing in the right combination of business, functional, and technology capabilities.

2. Choose the right partners: Since coreless modernization can be a long-drawn effort that involves multiple vendors, banks should prudently evaluate partners across four dimensions. Firstly, they should consider the functional expertise of the vendor analyzing the depth and breadth of functionalities they support. Moreover, does the vendor offer a market-demand-aligned and transparent product roadmap? Secondly, in technology maturity, banks should analyze whether the vendor supports a modular architecture, follows an API-first approach, and provides the ability to grow and nurture a healthy technology ecosystem. Thirdly, does the vendor demonstrate market readiness and provide tangible proof points of coreless implementations in the same geographical region? Does it have the necessary regulatory clearances to offer its services in the market now and in the future? Fourthly, banks need to evaluate organizational maturity. For example, does the vendor have a scalable operating model that ensures the required local and distributed service resources? Does it demonstrate financial stability, to continue to support the bank over the period of implementation and beyond?

3. Choose the right modernization strategy: Banks can choose from one of the two core modernization options depending on their business priorities and current capabilities. The first option is to pick up individual, specific processes or domains and build a replacement API-enabled architecture and migrate the data to the new system. This approach can deliver tangible results faster. However, because of incremental changes, it can take an extremely long time to complete the modernization. The second option is to build a new system alongside the legacy system. This approach works particularly well when a bank moves into a new business line unsupported by the legacy CBS. It can therefore mean building a new system afresh, unencumbered by legacy constraints. However, it also means that the bank will need to run two systems in parallel for a period, thus increasing complexity. Several factors, such as the current maturity of the bank, ambitions, risk appetite, and commercial environment, will eventually determine the appropriate approach.

4. Prove the platform early, reshape, and progressively modernize: It is vital to prove the new platform via a pathfinder that involves a customer-facing launch. Getting to market quickly builds belief in the new capabilities while enabling learning and continuous iteration. For example, HDFC bank is using the payments module modernization as its pathfinder. Customer Master and other modules will follow this. Similarly, Lloyds Banking Group is looking to progressively modernize, incrementally building confidence as it transforms individual systems.

5. Focus on people and operating model and not just technology: Modernization programs often downplay the people and cultural nuances that ultimately contribute significantly to their success. For starters, there can be reluctance on the part of some stakeholders to change. Maintaining executive buy-in to act and manage these resistances is thus vital. Additionally, new skills need to be developed or acquired. For example, the coreless approach relies on several vendors and fintech partners. Therefore, managing vendor relationships and their performance SLAs becomes extremely important. Additionally, it is vital to train existing employees on modern engineering concepts such as cloud, agile, and DevOps.

Coreless banking is a huge change for incumbent banks; however, it is a vital cog in their path to delivering superior customer experiences and driving internal efficiencies. To succeed banks must align the modernization with business priorities and maintain executive support throughout the journey. Additionally, they must choose the right set of partners, choose the appropriate modernization strategy, while continuing to invest in people and operating model transformation.