The time is finally at hand for sweeping change in the core deposit processing systems that are the heart of banking, maintaining the flow of debits and credits to and from the entire enterprise.

Critical functions include tracking balances, posting interest and fees, and issuing statements. Big-bank deposit systems typically have dozens of major interfaces with other loan, accounting, payment, reporting, and check control applications.

Virtually all deposit systems are legacy systems, with roots dating from 1950s-era workflows, preceding computerization. They are like arteries with high levels of cholesterol that still function but are gradually getting weaker. Banks recognize the weaknesses in these systems and also see the constraints they put on systems elsewhere in the bank.

The Tower Group has identified two distinct approaches to core deposit systems, which we call the U.S. model and the European model. An institution need not be based in the United States for the U.S. model to apply to it, or vice versa. U.S. thrifts in particular often fit the European model.

A typical U.S. commercial bank accepts transactions throughout the day, either at branches or through electronic channels such as automated teller machines or point of sale terminals.

A second set of check transactions is received via "inclearings" from the Federal Reserve, local clearing houses, or other banks. These items are not posted immediately to the customer's account balance file but may be posted to a memo file, which monitors funds available for customer withdrawal.

Posting to a memo file dates from the 1950s (or earlier) when branch employees would call a central bookkeeping area to see whether funds were available to cash a check. "Floor limits" allowed small checks to be cashed without a phone call. The bookkeeper kept track of these intraday items by writing the amount on a memo note and posting the memo to the account's ledger card, a 16-inch-wide, heavy-paper form maintained in account number sequence.

Actual deposits and checks accumulated in the branch and, at closing time, were batched together and forwarded to the proof department for filming, reconcilement, and separation of transit from on-us items. On-us items were manually sorted around midnight and forwarded with the inclearing checks to the bookkeeping department in account-sequenced batches. A third-shift operation would then post the transactions to the ledger cards using an electromechanical apparatus.

The introduction of mainframe computers in the 1960s let banks automate the filming, sorting, and third-shift posting functions. Though this automation was beneficial, little changed in the branches because this generation of computers lacked remote terminal capability. Thus, the calls continued to the bookkeeping department for teller holds.

The second generation of mainframe computers (introduced in the late 1960s) allowed for remote access devices, and banks moved quickly to adopt teller and platform automation. Though banks could have chosen to reengineer the deposit system to on-line posting, they elected instead to create a special "strip" or memo post version of the master file, which would be used only to record teller cash transactions.

In effect, banks replaced the bookkeeping department's process and trial balances with a computer-based memo post function. This let banks avoid teller data entry of noncash check transactions and minimize customer waiting times in teller lines. As electronic delivery channels such as ATMs emerged, banks added these transactions to their memo post processing, creating a pending file of electronic transactions that would later be posted to the master file.

The European model of bank deposit systems is based on bill presentment rather than check payment. Historically, European customers brought their bills to their bank and initialed them for payment. The teller would then debit the total of the bills to the customer's account, which was usually represented by ledger cards maintained in the branch. The bills would later be sent to a central site to be sorted by biller, totaled, and credited as a single entry to the biller's account.

Finally the bills would be sent to the billers for input to their accounts receivable systems, thereby completing the payment process. Presenting multiple bills at the teller window fostered a notion of high- service tellers rather than the high-speed teller service expected at U.S. branches.

Unlike the sprawling suburban economy of the United States, European jobs and residences were more concentrated in the years after World War II. Because Europeans both lived and worked in a neighborhood, transacting their business at a single branch, the model of maintaining ledgers in the branch instead of a centralized office was reinforced.

Cashed checks were usually presented at the branch of account and posted to the account's ledger immediately, while the customer was literally waiting on line. Interbranch cashed check transactions were handled by batching these checks at the end of the day and forwarding a cash letter to the branch of account, where they would be posted to the customer's account ledger.

As European banks adopted computers for deposit account processing, many continued the on-line posting concept. Thus, tellers could post transactions directly to customer accounts, much as they had done with the branch-based ledger cards. This made interbranch transactions possible because tellers could now gain access to and update all accounts.

Customers had been conditioned by the bill presentment process to expect a teller transaction to take minutes, not seconds. Thus, waiting for the teller to key in multiple item transactions was acceptable.

In the last 10 years, banks have been under pressure to increase the amount of memo posting they do. Pressures include regulatory efforts to reduce systemic risk, corporate treasurers wanting to view items in process, and increased check fraud. As a result, banks are now memo posting automated clearing house items and, periodically throughout the day, checks in process.

The additional memo postings have, in effect, caused banks to post virtually all items twice, bringing into question the wisdom and efficiency of the entire memo posting, batch updating methodology.

A second factor driving memo posting is the 12% annual growth of electronic transactions. This reduces the time available for the nightly batch cycle. Previously, the cycle could extend until branch opening time, usually 9 a.m. However, with customers now able to gain access to the bank from home around the clock, the deadline to complete the memo-refreshing process is moving to about 7 a.m., when call center and home banking volumes take off.

A third complicating issue is the emergence of nationwide banks. The largest banking companies now face daily transaction volumes in the tens of millions, requiring batch processing to be split into geographic regions in order to let the daily memo balance refreshing be completed on time.

The inherent weakness in this approach is the inability to process cross-region transactions efficiently. A North Carolina customer of BankAmerica Corp., for instance, could deposit an on-us check at a California branch of the bank. Though the check would be posted the same day, the deposit might be delayed one business day because the off-line process at the California operation would not be completed before the North Carolina batch update had begun.

The European model avoids the cross-region transaction problem. On-line posting also reduces the time required for the nightly updating. However, the inability of these systems to support on-line posting while the nightly updating is being done prevents banks from providing full customer service 24 hours a day, seven days a week.

Banks are beginning to realize the need to move to on-line, real-time posting. For example, both Citigroup and ING Group have recently built "direct bank" systems using an on-line, real-time system from Sanchez Computer Associates. Major U.S. vendors such as Alltel, M&I Data Systems, and Fiserv are being pressured by their largest customers to move to on- line, real-time systems with 24-hour availability.

We expect banks on the European model to modify their systems more quickly than those using the U.S. model. Therefore, European model systems can be expected to move to 24-hour, seven-day availability in 2001-2002, and U.S. model systems in 2003-2004.

Elimination of dual memo posting and the nightly batch cycle would save the industry hundreds of millions of dollars per year. Also, applications that depend on balance and customer data will benefit. They can be changed more rapidly, and the overall management of today's multichannel world can be made considerably easier. Because new core deposit systems may be client-server based, they will help speed the overall transition away from legacy systems.

Customer service will be improved by making all data always correct and always accessible. Particularly as the Internet gains force and creates new transaction volumes, this feature will eventually become standard. The bank customer will gain tremendously.

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