Citigroup Inc. is planning to modernize its U.S. branches — after it overhauls its core processing system.

The company wants to transform its retail outlets to let customers handle much of their banking needs on their own, using self-serve processes that have been perfected online.

Observers say the 21st-century systems cannot run smoothly on Citi's existing core. But Citi, as previously reported, will become the first major U.S. bank to replace its core.

Industry watchers say that effort will eventually enable Citi to move forward with its branch revamp, and many other high-tech projects, that will appeal to modern retail banking customers.

The model is Citi's Smart Banking Branches, which are already operating in Japan and which required the company to gut its existing branches.

"We re-engineered the entire banking process," said Christopher Kay, a managing director and the head of Citi Innovation.

The mission was to "pull out every non-value-added process in banking in order to create just a really simple and easy way for customers to engage with us," he said. "Self-service, as a concept, only works when you've really done the hard work of re-engineering the experience."

To accomplish this, Citi's Japanese operation, Citibank Japan Ltd., moved some hardware out of its branches' back offices — freeing up enough space to enlarge the lobbies — and centralized those systems in a facility in China.

The first two Smart Banking Branches opened in Tokyo this month, and Citi plans to open more in Japan this year.

Citi plans to expand the model within Asia, and then "we can bring this to the United States as well," Kay said.

Kay would not say exactly what technology changes would be necessary to implement this system in the United States. Citi is known to be overhauling its core system — the project has been discussed by its vendor, Fidelity National Information Services Inc., during earnings calls this year — but Citi has not publicly acknowledged it, and Kay would not discuss it.

Fidelity said this week that the core replacement is already underway. Analysts have said that Citi has budgeted hundreds of millions of dollars; such projects can stretch on for years.

Analysts say core renewal among major banks is long overdue, and Citi is ahead of its peers.

Though some said it would be technically possible to install the new branch systems on Citi's existing core, they agreed that the effort is too ambitious to trust to the aging system.

"You can do this without changing your underlying core; you just have, at the heart of this, a very old, antiquated factory," said Robert Hunt, a senior research director at TowerGroup in Needham, Mass. "Without replacing their core, can you get everything you want? Well, no."

Nicole Sturgill, TowerGroup's research director for delivery channels, said Citi could use middleware to bridge the gap between the outdated core and the modern branch systems, but it would be difficult to attain "the level that Citi is talking about."

"I don't want to negate the importance of the core renewal. It absolutely has to happen," she said.

Many banks try to break the barriers between their product and business silos with software that can share information across channels, but in most cases each channel still operates separately.

Citi's philosophy, as implemented in Japan, is to run every channel on the same system — in effect, combining every separate channel into a single enterprise.

For example, Kay said, opening an account online is an instant, paperless process, and there is no reason it cannot work the same way at a branch. And if it is the same way at a branch, there is no longer a need to have separate systems handling new accounts.

Even though this new approach draws inspiration from the Web, it must start at the branch, Kay said.

"If you think about what we're doing … the design principles are really Legos" that can be pulled apart and reassembled in vastly different ways, Kay said. "In a branch, it just so happens that you use the majority of Legos."

Once everything was rebuilt in Japan, "the channels sort of merged together, because we really don't think about channels anymore," Kay said.

Kay's background is in retail — before joining Citi three years ago, he was an executive at Target Corp., where he handled store operations, real estate development and health-care. He said this experience has helped Citi "apply retail thinking in the context of branch banking."

By streamlining everything in Citi branches to resemble what customers have come to expect from their online interactions, "we're giving time to the customer," Kay said. Now customers spend less time on paperwork and more time engaging with branch staff.

"Customers that come into a branch either have a service issue or are looking for advisory services," Kay said. To devote more time to those things, "we need to take all of the pain away from transactions."

Sturgill said Citi's efforts could reap meaningful service benefits. Rather than try to guide customer behavior to work within existing bank methods, Citi is "trying to react to customer behavior that has already changed — and their bank hasn't."

Sturgill praised the Smart Banking Branch design's ability to free up more time for face-to-face interactions and improve the quality of self-service interactions.

"Even with the automated systems that the customer is using, what they're offered could make a whole lot more sense than what they're offered now," she said.

Kay's retail background could be essential to making this all work, Sturgill said. "We'll start to see more and more of that: bringing people into banking from outside industries. You're just transferring that knowledge from one industry to another industry, and banking could really use that right now."