Core Banking Modernization: The Time Is Now

For the average banking customer, technology is simply a facet of everyday life. From the high-powered supercomputers they carry in their pockets to the global network that enables them to connect with people on the other side of the planet in seconds, customers are so accustomed to the ease and convenience digitalization has to offer that it has become almost unremarkable.

It’s little wonder, then, that digital banking has become table stakes. Where once the ability to access an account online to make deposits and transfers was seen as novel, it’s now a baseline expectation. Customers want more from their banks in terms of service and capabilities, and fintechs are all too happy to oblige. To keep pace with rapid innovations in the banking sector, deliver on these expectations, and maintain competitive standing in an increasingly crowded market, financial institutions must first modernize the core banking systems they rely on for day-to-day operations.

In this article, we’ll explore the topic of banking modernization in-depth, and help banks create a roadmap for their own data estate modernization journey.  

What Are Core Banking Systems?

As you’re likely well aware, a core banking system refers to any back-end system responsible for processing daily banking transactions across branch locations, such as opening a new account, onboarding a new customer, making a deposit, and so on. Core banking systems are the foundation of any banking institution and play a key role in most interactions between the customer and the bank — either in the form of an actual teller or a web portal — itself.

All core banking systems fall into one of two categories:

• On-premise Systems: Systems that fall into this category live on a bank’s infrastructure — that is, they’re hosted on a bank’s own in-house servers. On-premise systems are typically expensive to run, difficult to upgrade, and challenging to maintain if a bank lacks the appropriate internal IT resources to do so.
  
  An added challenge is that many on-premise core banking systems are considered legacy platforms, which means they’re outdated and, as is often the case, no longer supported. As a result, legacy platforms are incompatible and cannot integrate with new programs or applications, and cannot be easily updated.
  
• Cloud-based Systems: As its name would imply, a cloud-based core banking system is hosted entirely in the cloud. Rather than maintain hundreds of servers across branch locations, a bank retains the services of a third-party cloud provider that can host its core banking systems on its behalf. In this arrangement, the third-party provider is solely responsible for updating and maintaining the system.
  
  The end-user experience for a cloud-based core banking experience is virtually the same as it is for an on-premise system — and may, in fact, be even faster. Given the ease of use and convenience cloud-based systems offer, many banks choose to migrate from on-premise to the cloud — which is a key component of core banking modernization.

What Is Core Banking Modernization?

Core banking modernization refers to the process of upgrading, rewriting, or replacing legacy systems in a financial institution’s IT environment. Banking modernization can take a few different forms — which we’ll discuss later in this article — but ultimately serves the purpose of enabling banks to enhance operational efficiency, improve agility and scalability, access new technical capabilities, and deliver better banking experiences to customers.

4 Factors Driving the Need for Banking Modernization

As noted earlier, digital and virtual banking has become a baseline expectation for financial institutions, one they must exceed to remain relevant in an industry increasingly defined by innovative technology. But this is just one reason why banks must embrace modernization — in truth, data estate modernization is a multi-faceted issue with many compounding factors.

These factors include:

• Demand for seamless, connected digital experiences. Because they are built on antiquated technology and use outdated programming languages, legacy core banking systems are incompatible with newer systems. This incompatibility prevents legacy platforms from integrating with modern systems, which can create disjointed and disruptive digital experiences for bank employees and customers alike.
  
• Inherent issues with legacy platforms. Many legacy core banking systems are heavily customized and rely on hard-coded business rules, which — when paired with their inherent incompatibility with new operating systems and programming languages — makes them difficult, if not impossible, to update. Add to that the fact that many of these systems are 10, 20, or even 30 years old and poorly documented, and it’s easy to see why legacy platforms are challenging for employees and customers to use and are antithetical to digital transformation and innovation.
  
• Increased market competition. The banking industry has become one of the most competitive markets, with established institutions, neobanks, and other new market entrants — including tech giants — all jockeying for position. Fintech startups and the likes of Amazon, Google, Meta, and Apple have the advantage in that tech is coded into their DNA, and their offerings are not only cloud-based but cloud-native. Given these conditions, traditional banks can no longer afford to operate on decades-old legacy systems.
  
• Rapidly changing regulations. The regulatory landscape within the financial services sector is complex and constantly evolving. If early predictions for 2023 are accurate, concerns about consumer protections, conversations around digital assets, and the issue of climate change are all expected to shake things up in the coming year. To keep pace with these changes and remain compliant, banks need the agility and flexibility to adapt to new inputs and requirements — something legacy core banking systems cannot deliver.

7 Benefits to Core Banking Modernization

Banking modernization is not only a solution to some banks’ most pressing challenges — it’s also an opportunity to streamline operations, enhance efficiency, and better serve customers.

Banks that choose to modernize their core systems typically experience:

• Lower operating costs. Without the need for physical infrastructure in the form of servers and on-premise databases, banks can save big on management and maintenance costs. Modernizing legacy systems also enables banks to consolidate applications, further reducing their IT overhead.
  
• Real-time processing. Legacy core banking systems are notoriously slow at processing transactions, which translates to long wait times, frustrated employees, and dissatisfied customers. By comparison, modernized systems utilize cloud platforms, which are capable of processing large quantities in minimal time. This enhanced capability eliminates latency problems and enables banks to process transactions in real-time, allowing for a more streamlined customer experience and increased employee productivity.

• Enhanced agility. Modern banking systems use microservices — that is, a collection of smaller, loosely coupled services that can be deployed independently. Microservices are inherently more agile than monoliths; therefore, core banking systems built on a microservices architecture are more agile than legacy platforms built on a monolithic architecture.
  
  This agility enables banks to quickly update their core systems to take advantage of the latest innovations, adapt to changes in the marketplace and disruptive events, and rapidly develop and deploy new products and service offerings.
  
• Increased scalability. Cloud-based core banking systems can be easily scaled up or down as needed to accommodate demand. For example, if a bank were to receive a high volume of transaction requests in a short window of time, cloud computing would enable that bank to access the IT resources it needed to accommodate those requests without compromising processing speeds.
  
  Another example: If a retail bank were expanding its services into a new territory, it could quickly add seats to its existing software license to accommodate new employees hired to cover that territory. 

• Greater resiliency. Aging physical infrastructure translates to an increased risk of downtime as hardware degrades over time, as well as increasingly expensive fixes to bring systems back online. Since cloud providers have substantial resources to dedicate to security and redundancy, banks that utilize modernized core systems are less likely to experience service interruptions and enjoy greater resiliency and business continuity.

• Advanced security. As noted in the previous bullet point, cloud providers have substantial resources to dedicate to security, meaning they typically have access to the latest-and-greatest cybersecurity solutions, such as machine learning, artificial intelligence, biometrics, and more. Furthermore, by hosting all company and customer data in the cloud rather than on-premise, banks can reduce their exposure to data breaches and other cyberattacks.  

• Open banking opportunities. A growing trend in the financial services sector, open banking refers to:
  
  “…a banking practice that provides third-party financial service providers open access to consumer banking, transaction, and other financial data from banks and non-bank financial institutions through the use of application programming interfaces.”
  
  Open banking boasts numerous benefits, including collaboration between established institutions and fintechs, access to innovative technologies, optimized service offerings, and increased customer engagement.

However, to take advantage of these benefits, banks require the interoperability to exchange information and the compatibility to integrate with new technologies — something that simply isn’t possible with legacy systems. To capitalize on the potential of open banking, as well as other emerging trends within the banking industry, institutions will need to embrace core banking modernization.

Paths to Banking Modernization

Though there are many paths to data estate modernization, the three most common are:

• Rehosting: Sometimes referred to as the “lift and shift” method, rehosting “lifts” an entire legacy system and all of its data out of an on-premise environment and “shifts” it into the cloud. Rehosting is a fairly straightforward approach, one that simply moves a legacy system from one location to another without altering any of its core functionality. This reduces the risk of disruption and gives banks the opportunity to prove systems out before going live.
  
  Though banks might find this low-risk approach to core banking modernization appealing, it’s less impactful than other methods because it does not improve upon existing systems.

• Replatforming: The general concept behind replatforming — also known as “lift and reshape” — is essentially the same as rehosting, with one key distinction: Once a legacy system and all of its data are in the cloud, small adjustments are made to its programming to enhance its functionality.
  
  Replatforming is the happy medium between rehosting and refactoring — which we’ll discuss in the next bullet — and offers some of the benefits of both: Banks enjoy enhanced functionality with minimal risk of disruption. 

• Refactoring: The most transformative of banking modernization methods, refactoring rewrites or restructures a legacy system’s entire underlying code to make it suitable for cloud infrastructure. Banks that want to take full advantage of the benefits of a microservices architecture will need to utilize this approach.
  
  Although refactoring poses more risk than other data estate modernization methods, it also offers greater rewards. Banks that choose to take this path gain access to new and innovative functionality, deliver new benefits to end users, and capture additional business value. 

Which path to core banking modernization an institution takes depends entirely on its needs, goals, and priorities. Although some banks may favor a low-risk approach — and understandably so — refactoring does offer the greatest transformational value.

Once a bank determines which path to follow, the next step is to determine the appropriate cadence. Some institutions may choose to take a “big bang” approach, which involves a total overhaul replacement of core banking systems, whereas others might take a more progressive approach to transformation, in which incremental changes are made over time. Big bang modernization can be appealing because it only involves a single delivery, and it’s more prone to risk than progressive transformation, which is highly iterative in nature. 

Creating a Banking Modernization Strategy

Though banking modernization — and digital transformation as a whole — might seem overwhelming, it is a bank’s best chance at achieving its strategic goals. Other than working with a qualified consultative partner, developing a modernization roadmap can help make the transition a little easier.

Here are a few recommendations to get started:

• Determine your motivations. Work with key stakeholders, including executives and business leaders, to determine your underlying motivations for core banking modernization, as these will help shape the project.
  
  It’s also important to communicate these motivations throughout the company. Even the most promising project can fail when motivations are misaligned, so communication is key.

• Identify desired business outcomes. Banking modernizations can be costly and time-consuming, with wide-ranging effects, so it’s essential to garner support across the business before getting started. To secure support, clearly identify desired outcomes across all business units. Once this step is complete, break those outcomes down into measurable results that you can monitor and communicate throughout the project.

• Consider the financial implications. Identifying your institution’s motivations and target outcomes will inform financial considerations, including how the project will impact your bank’s financial position, what accounting key performance indicators (KPIs) to track, and what processes your chief financial officer and finance team need to understand.
  
  Other financial implications to consider include moving from a capital expenditure to an operating expenditure model, reducing your bank’s data center footprint, enhancing productivity and service delivery, and increasing sustainability.

• Factor in technical considerations. Before starting any modernization project, you’ll want to consider the possibilities — that is, what your institution stands to gain in terms of technical flexibility, efficiencies, and capabilities by modernizing core banking systems. Be sure to review scalability, availability, security, compliance, and capacity optimization.

• Define KPIs. It’s impossible to gauge the success or failure of modernization project performance without clear indicators or specified targets, so be sure to define these early on in the process.

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Take the first step toward banking modernization with support from the experts at Hitachi Solutions — contact us today to learn more.