Given the difficulty of converting a core banking system, it is not surprising that few U.S. bank executives are reluctant to take on the potentially career-ending risk of championing such a project.
Until recently there has been no real impetus for U.S. banks to change. Today, though, forward-thinking financial services institutions are exploring options, from rip-and-replace to service-oriented architecture and middleware, software as a service, outsourcing, and process improvement.
Many in the industry believe that even though technology has made great strides in the last few years, we have reached the point of diminishing returns. They see today's choices as allowing their institutions to compete effectively and meet strategic goals for the next 20 to 30 years. For most, it's finally worth the risk.
Core banking systems, considered the lifeblood of any banking organization, are usually decades old and of unrecognizable ancestry. In such cases, banks constantly struggle to recruit and retain people who have the computer language skills to develop and maintain programs for these aging, highly customized, and often poorly documented systems.
But dramatic changes in both the banking industry and in supporting technology over the last decade have prodded even the largest institutions into thinking seriously about sunsetting these applications.
A key reason for this is cost. Financial Insights estimates that core banking consumes more than 12% of an average bank's information technology budget; U.S. banks are projected to spend more than $6.5 billion this year on core systems. More than half that amount will be spent maintaining these aging systems and all the points of connectivity across the organization.
In a difficult revenue environment rampant with cost-cutting initiatives, banks are asking, "Is there a better way to spend this money?" Beyond the budget, traditional U.S. banks are now in direct competition with nontraditional players that are generally unencumbered by legacy core environments. Along with such well-known names as Bank of America Corp., Wells Fargo & Co., and Wachovia Corp., the list of the top 25 U.S. banks now includes the mortgage company Countrywide Financial Corp., the tax preparer H&R Block Inc., Merrill Lynch & Co. Inc., MetLife Inc., and, from abroad, ABN Amro Holding NV, Deutsche Bank AG, and HSBC Holdings PLC. Such new entrants often establish themselves by leveraging functionality that enables product and pricing flexibility and lower transaction processing costs.
More Choices
U.S. financial institutions now have options they did not have five or 10 years ago that mitigate the risks of core transformations. The biggest technological advancement to benefit core banking is service-oriented architecture. Five years ago only a handful of vendors and leading-edge institutions were using middleware to connect and open up systems. Now service-oriented architecture is an established concept and common practice in banking.Software as a service, or SaaS, is the new buzzword used to describe service bureaus, hosted solutions, and the like. It also presents opportunities, particularly for community banks and credit unions.
We see two primary drivers of conversions. The first, and the one where we are seeing the majority of activity, is the core processing system's inability to continue to support the bank, either because of scalability issues or insufficient functionality. Senior executives at the $17 billion-asset Webster Financial Corp. of Waterbury, Conn., the 64th-largest U.S. banking company, said a rapid overhaul of its core processing and channel environment has been a success. Additionally, banks that merge or make acquisitions often find themselves with multiple core systems, none of which have enough scale. The second driver is strategic. The core processing technology still works, but banks are finding it increasingly difficult, and expensive, to maintain their existing infrastructure while connecting new systems to an aging core.
The $706 billion-asset Wachovia, the fourth-largest U.S. banking company, is committed to service-oriented architecture that blends with delivery mechanisms to provide uniformity. The end result is that Wachovia continues to top customer satisfaction surveys even while the work goes on. For 2006 the No. 13 U.S. banking company by asset size, at $159 billion, Citizens Financial Group Inc. of Providence, R.I., has assimilated numerous acquisitions easily. In large part, this is because the Royal Bank of Scotland Group PLC unit outsourced all its core processing systems to Fidelity National Information Services Inc. in the late 1990s. And speaking of FIS, it made a move to shore up the largest U.S. banking core systems when it offered to provide development and maintenance for Computer Sciences Corp.'s Hogan applications in an ASP delivery model. The $39 billion-asset First Horizon National Corp. of Memphis was a first adopter.
Core vendors face many of the same obstacles as the large banks and have taken a proactive approach to modernization. Fidelity's FIS Xpress Enterprise Services, Fiserv Inc.'s CBS Communicator, and Jack Henry & Associates Inc.'s jXchange are middleware offerings that integrate client and partner systems. Harland Financial Solutions Inc., Metavante Corp., and Open Solutions Inc. take a native approach with this ability built into the core processing system. In addition, Metavante has partnered with Temenos Group to develop a component-based approach that provides another alternative to the top 25 to 50 domestic banks.
It will likely take three to five years for many banks to explore the options, formulate a road map, justify the ROI, go through the RFP process, and select a partner. We project that most will use a phased approach, given the magnitude and costs of these projects. Larger banks may wait for a proof point — an example of a peer successfully transforming its core — so their transformations may take even longer.
Learning From Experience
The earliest attempts at core transformation spawned a few high-profile failures.The lessons learned have very little to do with technology, but rather with people and processes. These lessons include engaging business lines from day one, ensuring executive championship, and planning for the long term while setting intermediary goals. The most important lesson: Document, document, document.
As long as all U.S. banks have been on a relatively level playing field with equally performing core systems, there has been little impetus to change.
However, as other banks, both in the United States and overseas, upgrade their cores, U.S. banks must keep up or risk becoming laggards in the local and global marketplace.
Ms. Pratt is a research director for the Consumer Banking and Credit practice at Financial Insights, an IDC company.
