A breed of emergent vendors is aiming to break apart the oligarchy ruling the core banking space and disrupt a market which has been experiencing consolidation for a decade. Those in the market suggest that cloud-based platforms could see the pureplay core system business model “come to an end”.
In 2014, Gartner listed 19 core banking vendors in its Magic Quadrant rankings. In 2018, it listed just eight. The market has experienced a series of mergers and acquisitions, including the creation of Finastra in 2017, and the takeover of First Data by Fiserv – a deal which combined the former’s 12,000 banking clients with the latter’s 4,000 enterprise payments customers.
“The core banking [vendor] space is a shrinking one,” says Avaloq CEO Juerg Hunziker. “Consolidation will continue for the foreseeable future and just being a core systems provider, without the ability to provide extended services, like software-as-a-service (SaaS) or business process outsourcing (BPO), will be a business model that will come to an end.”
“Choice is always welcome and consolidation limits choice,” says Anton Rutten, head of IT systems at Rabobank. “However, there are two positive side-effects. First, you start looking for alternatives with smaller start-ups instead of the same short-list. Second, it also brings some standardization. We want to focus our creativity on what kind of value we bring to the customer rather than focusing on which core banking applications we are building it on.”
In the United States, community banks are often forced to choose between a handful of providers, usually comprising of Fiserv, FIS, Jack Henry & Associates, and Finastra (from its old days as D+H). David Mitchell, president of Nymbus, says that mid-sized institutions across the US “are often locked into long-term contracts” with major providers, and as a result can be left “frustrated by the amount of time it can take to update or do a full core conversion” on crucial systems.
The market saturation of vendors in the US prompted the CEO of the American Bankers Association (ABA), Rob Nichols, to invite the major providers to join a specially-created committee. In a letter, seen by American Banker, Nichols asked the CEOs of Fiserv, FIS and Jack Henry to provide more lenient contract terms and upgrade their technology to match their customers’ needs.
Going further, the ABA made a direct investment in cloud core banking firm Finxact in January. “ABA is pleased to take part in this historic opportunity to chart a new path for core banking services,” said Nichols, in a statement accompanying the news. He added that the association would look “at every avenue — whether it’s investments in companies like Finxact, working with other core providers or endorsements of new products and services — to help all banks keep pace with the digital revolution underway.”
Finxact co-founder and chief marketing officer, Dan McKinney, believes that for banks to have proper choice, new vendors “must provide banks with solutions that materially move the dial”. “This cannot be achieved by relying solely on incremental improvements to existing solutions. It can only be achieved through a new category of core banking solution that is cloud-native, API-first, extensible, and elastically scalable from the smallest digital-only bank to the largest top tier bank.”
“If a financial institution wants a sustainable platform that will see them into the future, then it cannot be the one-size-fits-all option - traditional core systems and products delivered by a single vendor are not agile enough to compete in the digital age,” says Ben Goldin, chief technology officer at cloud core banking firm Mambu. “Digital technology moves so swiftly and there are so many dynamic new products and services in the market, financial institutions have the options to accessing the solution that best suits them.”
A snail’s pace
Core banking systems sit at the heart of every bank. They process all deposits, payments, loans, bank transactions and customer data, as well as interface with general ledger systems and reporting tools. Core systems are notoriously costly and difficult to replace efficiently. The process has earned its fair share of monikers: untangling spaghetti, open heart surgery, replacing the engine at 80mph.
In 2017, Rabobank created a 3D model of its existing IT environment, including all the systems and dependencies involved, and put it in the hallway of its head office, just to show the complexities of such interconnected core systems. Plenty of historical examples exist to underline the risk a replacement of these platforms entails.
In 2011, it was reported that Allied Irish Bank, in a lawsuit brought against technology vendor Oracle, claimed to have spent $84m on a 2007 core transformation which ground to a halt after just three years. UK challenger bank TSB’s failed 2018 implementation of Proteo4UK – a core banking system provided by its parent firm Sabadell – cost the bank an estimated £176m in customer redress, advisory, and disruption fixes. Sabadell has claimed that the integration was the largest “successful” undertaking of its kind in Europe. It resulted in the resignation of the bank’s CEO, Paul Pester.
Internally, the need for a new core banking system is often recognised. A number of surveys (KPMG, BI Intelligence, Infosys) conducted over the past few years have indicated that core replacement holds ample real estate amongst the major concerns of c-level executives. A 2018 Financial Conduct Authority (FCA) report into the UK retail banking sector found that the maintenance of legacy IT systems costs banks 18-26% of total operating costs. There was also a marked difference in the FCA data between banks incorporated before 1993 and those after: the UK’s older banks spent 0.5% of their total lending assets on maintenance, the newer ones 0.2%.
But core banking projects are multi-year undertakings worth millions, and in many cases can make or break the careers of those involved. The FCA report shows that since 2015, four major banks have spent at least £680m on “reconfiguring and rationalising” IT systems. Commonwealth Bank of Australia completed its core systems revamp in 2013, two years behind schedule at a cost of more than AU$1bn. This kind of large outlay, as well as the threat of failure, has led a culture of risk avoidance, where a bank will extend its contract on a system for many years to avoid facing up to change. Alternatively, they might swap between one of two dominant vendors in the marketplace.
“Many of the banks will say now, ‘how about we kick the can down the road another two or three years?’ that’s all the time and it’s still what we see now, despite the industry’s urgency to replace systems increasing,” says Hunziker. “We see a lot of banks which realize that despite the fact they might run, host or own their own banking system effectively and cheaply, they have huge difficulties in terms of digitalization. It’s no use building products for the front if you’re not properly supported in the back.”
Replacing a core system is a strategic decision which requires “courage, persistence, and a certain amount of money,” adds Hunziker. Yet, when core replacements can take multiple years, not many c-level executives are willing to pull the trigger. “CEOs, CTOs and the heads of retail banking are often measured on 12 to 24 months cycles,” he adds. “Transforming a bank takes two to three years. When you’re changing your direction almost on a yearly basis, it becomes a lot more difficult.
“Technology is the future of running a bank, but when I look at the bankers today who are in charge I can’t remember anyone who has actually been a CTO. The closer a relationship the board and CEO have to technology, the higher probability there is of success.”
Rutten adds that “a culture in which people are aware of the importance in availability of systems for our customers, combined with a focus towards rewarding learning and not guilt,” are essential to identifying issues before they occur. “Making the changes ever smaller in sequence” will also go some way to reducing impact, he adds.
“Today CEOs and CTOs have alternatives to the high risk, high cost conversions of the past,” says McKinney. “Modern cloud-native, API-first core systems are architected to be open and secure. Modern cores should be technically and commercially a SaaS service. A new bank instance can be stood up in minutes with banks only paying for what they consume. Modern cores with a component-based design can be configured for new products or to adapt to legacy banking products. The configuration can be done in weeks, instead of months.”
An alternative to full core replacement is the launching of subsidiary digital banks. JP Morgan Chase released Finn by Chase in June 2018, while north of the border, Canadian firm ATB Financial plans to launch Brightside later in 2019. In the UK, Santander is planning a digital financing platform for SMEs. Goldman Sachs debuted Marcus, its retail banking arm, in the US in 2016. The platform has written $2bn in loans in its home country, and has broken into the UK space, with 50,000 customers signed up in the two weeks following launch.
A January Oliver Wyman report states that banks starting from a technological “clean slate” are able to release new products in two weeks. The average for a major legacy bank, it adds, is three to six months. The report also found that cost per acquisition stands at $30 for digital institutions, and $150 for incumbents.
According to Mitchell, these new digital-only brands can be launched quickly with the aid of a banking-as-a-service partnership between the parent bank and a vendor they deem to be agile. “From the selection process to the full deployment of a subsidiary digital brand, the initiative can move forward unencumbered by the needs of the traditional operation,” he adds.
“For banks and credit unions looking to quickly acquire new deposits and revenue through a digital-only brand, outsourcing the tools and broader operations is now a viable option. Creating a niche, digital-only brand offers many benefits, including reaching new consumers, less overhead costs and generating additional deposits revenue. These advantages will appeal to any financial institution.”
Of these digital descendants, and the challenger banks they aim to supplant, a majority are using cloud-based core banking technology. Goldman’s Marcus uses a SaaS version of Infosys Finacle’s core platform. ABN Amro’s New10 SME lending venture is powered by Mambu’s cloud offering, which also underpins German challenger N26, a challenger which claims more than one million customers.
“It is a trend we saw over the past 18 months and is just getting started,” says Goldin. “[Banks] are launching greenfield tech-enabled businesses to tap market opportunities and embark on a lower-risk technological evolution.” Spinoffs can draw on the resources and experience of the parent institution “while operating independently, embracing the technology and culture of fintechs”.
Goldin believes new vendors have been on the radar of traditional banks for some time, and that now they are being taken “very seriously”. “It is no longer the case that ‘the cloud is insecure, the technology is untested, or we only trust traditional vendors’. The market is changing.”