Understanding Your Digital Options
Competing in Digital Banking is becoming more important for Community and Mid-sized banks for several reasons:
COVID19 has made digital delivery of banking services a must – traditional customers need safer options than coming into a branch.
New customers are demanding the same capabilities as they see at the larger banks.
Real time information is becoming key to modern analytical and compliance models.
Digital banks are realizing higher rates of return, net promotor scores and improving access to capital.
Bankers themselves need to have digital capabilities to manage processes and have access to data outside of the bank office location.
Many bankers are frustrated with their current core banking platforms and the lack of progress in innovative digital capabilities, however:
Replacing a core banking system for many firms is the largest, most costly and risky initiative they have ever taken on.
The large banks have core banking systems with the same issues as smaller firm yet are able to implement digital banking.
Large firms use their strength in systems integration, data management, and development to implement advanced capabilities on top of their core systems.
Today’s core systems process transactions well. They take deposits, administer loans, make payments and close the books. There’s a lot not broken there – does it really need to be fixed? Yet, their pace of digital modernization is slow. There are better options to implementing digital capabilities that bankers should consider – integration is one of those.
Integrating new digital and data capabilities to an existing core banking platform is a fraction of the cost, risk and time of replacing a core system. It is an option within reach of small and midsized firms especially as advanced middleware, data management and secure cloud capabilities are affordable and available.
Yet, many firms are not aware of these options and either stay frustrated or take on projects that are much larger and riskier than their normal risk appetite would allow.
Here, we will discuss and explore these different options for digital implementation. There is not one right answer for the industry, but rather each firm should assess its situation, strategy and capabilities to determine the right options for its Digital Roadmap.
We think there are four Digital Banking implementation alternatives:
Rip & Replace – Full replacement of your existing core banking system with a modern digital core banking system.
Side by Side – Stand-up a digital core banking system side-by-side with an existing core banking platform as either a separate new bank or augmenting existing bank capabilities.
Integration – Integrate digital and data capabilities with an existing core banking platform using advanced middleware, cloud and real time capabilities.
Wait and See – Hope that your current core provider will develop the digital and data functionality you want in future releases. Also, hoping that it meets your timing and functionality requirements. This is a legitimate option and many banks opt for this.
The Pros & Cons of Each Option
None of these options is inherently right or wrong in and of themselves. Each firm should consider options in the creation of its Digital Roadmap. Similar firms may come to very different conclusions based on an assessment of the options relative to their objectives, risk appetite, organizational capability and strategy.
A brief evaluation of the options based on our experience is below:
Some firms have made the decision to “go for it” and are ripping and replacing their core systems. Firms that take this approach are to be applauded for their leadership. Careful planning is required, time and effort must be spent to understand what is truly involved in the replacement initiative.
The Side by Side approach is where a digital system is implemented side by side with the current core system. There are complexities to this approach as well, including back-office process and customer data integration. Many large firms have tried this as a Champion/Challenger approach only to back away later, yet it is an option worth considering.
Few firms are aware of the opportunity afforded to them by the systems Integration option. This is where digital and data capabilities are integrated with your existing core system. Indeed, we think this could be the “faster, better and cheaper” option that makes innovation within reach to smaller firms.
Many firms have decided to Wait and See, hoping that their current core provider will eventually come through with the capabilities they need. However, hope is not a plan. And there is no guarantee that what is delivered will suit your firms needs. While frustrating, this is a valid strategic option that must be considered.
Challenges Faced by Bankers
Community and mid-sized banks often feel that they are in a competitive corner and cannot compete with the larger banks in technology due to:
Inflexibility and Slowness of their Core System providers – there are three dominant Core Banking Systems (hereafter referred to as the Core Providers): JackHenry & Associates, FIS, and FiServ that are installed in 80%+ of community & midsized banks. Bankers are often frustrated with the inability of Core Providers to innovate quickly, provide timely service, vendor lock-in and long-term contracts that have high switching and cancellation penalties.
Lack of key skills in system architecture, development and integration Larger banks have a distinct advantage in technical talent and how systems are designed and integrated to form an end-to-end solution. There are many software components in modern systems architecture and the smaller banks just simply don’t have the skillsets to understand the options and tradeoffs of how to implement these innovative technologies.
High Cost & Risk of Implementing Digital Core System Alternatives – A viable but costly and risky alternative is to implement a new Digital Core System, such as Temenos or Finastra. These systems have solid digital capabilities but projects are often delayed when banks understand that ripping and replacing has high cost and risk implications.
Lack of familiarity with Cloud Development processes and Access to Advanced Tools – Many Banks are often unfamiliar and uncomfortable leveraging the Cloud, including the information security requirements needed to perform their own development. Key system integration tooling leveraged by larger banks is only recently available to the smaller banks.
Inability to manage and govern data effectively – Data is foundational to digital banking as well as almost all other key decisions in the bank. Having high quality data, with real time access and availability is a key aspect to controlling your banks digital future. Managing data as an asset is more than a technology problem, it is a business problem first and foremost. Yet, many banks do not have the Data Governance capabilities to get the most benefit from their data.
The Financial Brand recently conducted a survey of the digital banking challenges faced by bankers. Their findings are not a surprise:
In the pages below, we will elaborate on some of these challenges and how banks can address them. As a firm, we feel these gaps can be addressed and is one of the reasons we formed FinResults – to help small and midsized firms compete with the larger firms in technology. And while these challenges are daunting, they can be addressed successfully.
Solution Alternative #1 – Rip & Replace
“Rip and Replace” is a common phrase used in the IT industry to describe the complete replacement of an existing system with a newer alternative. In this instance it is ripping and replacing the existing core banking system with a newer digital solution.
This approach is used frequently in business. The problem with this approach is that it is often much more difficult, costly and risky than senior executives realize. Here are some factors that need to be carefully understood and considered:
Your Current Environment is More Complex than You Realize– The tight coupling of existing systems and off-line business process to the existing Core Banking system is just not well understood in the early phases of a replacement project and can represent significant cost and time overruns in a Core Replacement project.
The Degree of Customization to the current Core Banking system to accommodate unique bank processes is not well understood early in the project. The new digital system will need to be configured or modified to accommodate these unique processes. At one $4B bank recently, we uncovered over 1,000 unique stored procedures that needed to be dealt with one by one.
Immature Back-Office Process Support – The newer Digital Banking System has a great look and feel, however, it is not as mature in supporting back office operational processes as one of the existing legacy Core Banking Systems providers. So, while the bank gains in one area it may lose in another. These processes will need to be accounted for and the cost / benefits weighed against each other.
Integration with Existing Systems – Such as CRM, ALM or AML that are integrated with the existing Core will need to be re-integrated with the new Digital system. This is a time consuming and challenging effort.
Data Conversion – Conversion of data into the new system is difficult. Not all data easily maps into the new system. The new Digital Banking system requires fields that are not required in the existing system. This data must be added, cleaned or converted to accommodate the needs of the new system.
Reporting & Analytics – Reporting and analytics systems will need to be re-developed and configured. There are often custom reports that the new system will not accommodate out of the box. A survey of reporting and analytics requirements across all of the key functions will be required and a plan to replace them will need to be developed.
Legacy Data – Legacy data in the core system will need to be archived or stored in a data environment. Not all of the historical data in the Core System will need to be converted, so a plan for this data will need to be determined.
Information Security Roles & Procedures – All information security roles will need to be reconfigured for the new Digital Core Banking system. All users and their access and provisioning will need to be addressed. Integration to existing user authentication protocols will need to be determined.
Skillset Challenges and Time – Ripping and replacing requires many specialized IT skills that most banks don’t have on staff. These skills are needed for the duration of the project and less so after. Contract resources and program management talent will need to be procured to complete the implementation.
Training, Change Management and Communications – Both to employees and customers will need to be addressed. This is a significant business disruption and call centers will need to be staffed up to handle about six months of customer calls as they learn to interact with the new digital system.
Your Current Core System Provider will be both Unhappy and Unhelpful with your conversion to a new provider. There will be clauses from the existing contract that you didn’t know existed brought forward and the cost to exit will be more than you thought.
The Regulators will find “Things They Don’t Like” about the new system and there will be a new round of MRA’s to go spend money and time on. Regulators have seen the traditional core banking systems and have a degree of comfort with them. Key control factors have been built into these systems. The newer systems will not have this familiarity or input over time from the regulatory community. The new systems will catch up over time.
Vendor Lock In risk will continue as a risk as you trade one vendor for another although the new vendor could be more flexible. It’s an unknown.
In terms of cost, risk and time, the option to Rip and Replace is high in each of these categories. Each bank has its own risk appetite and Rip and Replace may not be the best option for every bank. This is why many bankers are reluctant to take on the Core Rip and Replace project and the industry surveys bear this out.
In fact, the most common conclusion arrived at by bankers is that they need to combine with other banks in order to provide competitive technologically. However, the cost of combining two separate banks is often not 2X but 3-4X the cost of the original core system replacement. It will take significant time to combine and get the desired digital capabilities up and running.
While Core System replacement is not the least risky, it needs to be evaluated against other alternatives and the implications need to be explored and understood with eyes wide open.
Solution Alternative #2 – Stand up a Digital Bank Next to an Existing Legacy Bank (Champion / Challenger)
This option is often put forward by the digital core banking software vendors. This option is less involved than Rip and Replace, but there are several important factors that must be considered.
How do You Manage Customers who want to be part of the legacy bank and the digital bank? Do they have separate accounts? How will you provide a consolidated 360-degree view of the customer? Managing customer data between the banks must be thought through in advance.
Back-office processes will need to be re-worked to accommodate the new digital banking system.
Data from both the legacy and Digital systems will need to be consolidated to create a total management and financial reporting view of the bank. Reporting and analytics processes will need to be modified.
New Staff will be required to manage the additional workload required by the new digital banking system.
Information Security provisioning will be required and security systems will need to be modified for the new systems.
Marketing spend between the legacy and digital bank needs to be allocated. Supporting the marketing requirements of both sides of the bank may be more than it’s worth in terms of return on investment.
Larger banks that have attempted this approach have created a Champion / Challenger Bank strategy. Many backed away from the approach after a period of trying it for the reasons discussed above.
The implications of running two banks, integrating the back office, training and information security are significant factors when considering this option. Yet, it remains an option and should be evaluated when considering digital strategies.
Solution Alternative #3 – Integrate with Existing Core
This is the approach typically used by the larger banks. Given their strengths in Systems Architecture, Development and Integration, large banks will add capabilities into their existing core banking systems. Large bank core systems are typically a custom build solution that has been added to over the years.
In this approach, the core banking system is left in place and digital and data capabilities are added on top of the core system. There are advantages and disadvantages to this approach:
Successful execution requires advanced skills in systems architecture, development and integration.
Specialized Middleware, such as system integration tooling, is required and the best tooling, used by the larger banks, has only recently become available to the smaller banks.
A Data Foundation is often a requirement to make this option work on a practical basis. Initially, large banks built data foundations first and they became part of the needed infrastructure to support ongoing digital banking applications.
Architectural Strategy and a Long-term Systems vision is needed or this approach can end up as spaghetti and a series of one-off integrations that is inflexible and difficult to manage over the long term.
This Approach is Within Reach – By leveraging cloud and distributed development capabilities, new digital capabilities can be brought on-line relatively quickly and less expensively than other approaches. Having the right skills and understanding of the tooling required is imperative.
A Drawback to this approach is that a non-digital core system can be a hinderance to longer term digital banking requirements.
This approach offers much from a flexibility, risk, cost and timing perspective. Compared to the two prior alternatives, it can be compelling if the right skills and tools are available to do the job.
There is also the benefit of not being reliant on one vendor. Banks who have this capability can take advantage of innovations from several vendors. They increase their flexibility with this approach. This can be an attractive option for innovative banking leaders.
Solution Alternative #4 – Wait and See
Given the challenges and risk of Ripping and Replacing, the Wait and See approach is the one often defaulted to by Community & Midsized Banks. Not that they’re necessarily happy with this option it has disadvantages as well. However, given the cost, skill and risk issues of the other approaches, many banks will simply wait to see what happens.
In other words, the Community & Midsized Banks will talk about the problem, complain about the problem, and in the end, find that they really have no other realistic alternative and will simply do nothing but wait and see how the market shakes out. You see this frustration come out in the industry surveys.
Here are the key points about this approach:
The Wait & See Approach is a Legitimate Strategic Option when you consider the other alternatives in the market today. A bank has to feel a real call to action in order to be motivated to take on options 1-3 expressed above. Perhaps the changes brought by COVID19 will provide that necessary impetus to seek real alternatives to change.
Core Vendors may not be Motivated to Provide Additional Capabilities. A Core banking system is a transactional processing engine, often based on years old technology. Making changes to these systems to accommodate new capabilities is not easy or necessarily profitable for the Core Systems Providers.
The technological differences between the legacy Core Systems and those used in the Innovative Technologies is sometimes large. There are major differences between the technology behind a transactional system vs. a data management and analytics system. It’s difficult for transactional systems people to get their minds wrapped around these technological differences. Different programming languages, design principles, tools, and approaches, etc.
With these technological enhancements comes new requirements: staffing, software acquisition and hosting of new technology platforms. If these new capabilities are not widely adopted by their customer base, it may not be a profitable move. New capabilities require investment, which may not work out for the Core Provider.
To keep customers happy, the Core Providers will provide impressive product roadmaps for great capabilities in the future. These capabilities often are delayed or don’t happen. They keep the customer happy for a time and delay decision making on seeking out other alternatives.
Is it Really Core to a Core Provider – In other words, there is good reason for a Core Provider to drag their feet on providing the innovative technologies. Is this new technology really in a Core Providers, well, core business model?
A Good Argument is to be Made that if it “Ain’t Broke Don’t Fix it”. Core Systems generally do what they’re supposed to do pretty well: Process transactions to support core banking business processes. The key question for a banker becomes how do I get innovation while not breaking something this isn’t broken?
Wait and See was probably the defining strategy for many bankers through March of 2020 in the pre-COVID19 world. Given, COVID19 and the changing nature of banking service delivery expectations by customers, we believe that banks of all sizes will be looking for better options.
So What Do We Do Next?
In our opinion, it is important for a bank to properly assess its situation and develop a roadmap for the future. The Assessment & Roadmap phase in our approach evaluates the banks current state and helps to determine which option is the right approach for the bank.
Given the stakes involved, the investment and the potential to impact a banks future direction, we recommend that this assessment process be completed.
Digital Innovation is not out of reach for the Community and Midsized firm. Each firm should become familiar with the options available to them and understand the pros / cons of each.
We welcome your comments and look forward to setting up a time to discuss these options further. We can be reached at firstname.lastname@example.org.
About the Author:
The author is Michael (Mike) Andrud, President of FinResults, Inc. Michael can be reached via email at email@example.com or at +1 (561) 288-6548. Previously Michael was a mid-sized bank Chief Information Officer (CIO), Chief Data Officer at a large bank, and Principal Banking Data consultant at a large consultancy.
FinResults is a consulting and technology professional services firm located in Boca Raton, FL, focused on helping smaller and midsized firms succeed in Digital, Data and Process Transformation.