IDC

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September 2018

It's Time to Transform the Core Banking System

Written by: Jerry Silva, Research Director, Global Retail Banking
Product Type:
IDC: Spotlight
Sponsored by: Oracle

It's Time to Transform the Core Banking System

The core banking system is the most critical and hard-to-transform infrastructure for financial institutions; yet it must be modernized. Progressive transformation based on componentized, open API technologies is a strategically sound way of de-risking transformation and bringing “wins” to the process.

Introduction

Replacing core banking systems has historically been the single most difficult initiative to accomplish at most banks of size worldwide. The complexity of the systems, customized and integrated with hundreds, if not thousands, of applications, has made the “rip and replace” approach — the replacement of the entire core system all at once — completely untenable. A core replacement project gone bad is at best a nightmare scenario for the executives responsible for budgets and schedule expectations and at worst a quantifiably negative event stemming from operational failure and damaged customer service.

Nonetheless, market forces around the world are driving banks to respond by increasing the pace of innovation and becoming connected to the ecosystems that surround consumers’ lifestyles — trends that are encompassed by the need to digitally transform. IDC believes that for these reasons, core transformation can no longer be put off and sees evidence from the industry that a successful core replacement strategy, using progressive transformation, can be carried out in a manner that de-risks core modernization while delivering business benefit at every stage of an enterprise’s transformation.

Connected Banking: Context

IDC defines digital transformation as the overall business and technology initiative that creates an enterprise that is agile, efficient, and able to respond quickly to market forces; enables product and service innovation; and leads to the institution creating disruption by adding new business models that bring nontraditional value to customers.

Associated with digital transformation, connected banking is defined by IDC as an institution’s strategic response to calls for “open banking” from consumers and regulatory bodies. Unlike open banking per se, connected banking is a bank’s proactive effort to create an open but controlled environment in which the institution develops an open architecture internally and selectively controls a heterogeneous ecosystem of external partners with different value propositions and security, governance, and compliance requirements.

Within this context, “core systems” as described in this document refers to the systems of record in the institution that drive the various lines of business such as deposits, lending, general ledger, transaction processing/archival as well as some ancillary systems necessary to conduct business. Core modernization applies to the need to replace (regardless of time frame or approach) often homegrown or licensed systems built on dated technologies, such as Cobol, for which support and costs have become significant challenges. Complete replacement of the core system, including its data handling, transaction processing, and accounting functions, isn’t necessarily called for in modernization initiatives. There are arguments to be made that only the business-critical components of existing core systems should be modernized because of the reliability and high performance of even legacy systems.

Benefits

Since 2010, banks worldwide have turned their attention to the need to improve customer engagement. The rise of consumer and business mobility led to a particular challenge in that it fueled the appearance of fintech companies —typically small technology companies that offered point solutions, such as mobile-based loan origination, that effectively leveraged mobile (and online) channels and used more technologies that were more nimble and efficient than those at the disposal of the typical bank. These firms represented at worst a competitive threat to banks and at best a standard of customer engagement that few banks could match. Banks quickly responded by offering improved online and mobile platforms; in the eight years since the start of that response to mobility (and all of the secondary effects that came with it), financial institutions are starting to be on par with fintech organizations. But front-office improvements go only so far, and institutions are quickly approaching a plateau that will limit their ability to continue to further engage their customers.

The constraint for these institutions is embodied in their back-office infrastructure, importantly including core banking systems (deposits, lending, account opening, etc.) that have historically used older technologies that don’t lend themselves easily to agility and openness. Over the decades, banks built elaborate, complex point-to-point integration architectures that intrinsically created complexity and risk in change.

By modernizing these core systems through progressive transformation and by using modern API-based architectures, financial institutions often can mitigate the risk and complexity of core transformation. They can use a phased approach based on a line of business, an operational challenge, or any other priority they wish to transform and over a flexible time frame. Figure 1 is a high-level symbolic depiction of what an open core architecture might look like — what IDC calls the connected core.

Figure 1: The Connected Core: An Open API Core Architecture

By using a progressive transformation strategy, a bank will gain the following immediate benefits (based on what business functions are moved to the modernized systems) over the length of the transformation effort:

Figure 2: Success Measured by Participation in Digital Marketplaces

Source: IDC’s Digital Transformation Leader Sentiment Survey, 2017

Key Trends

Financial institutions worldwide are already embracing the need to modernize legacy systems. The lone exception, when there is one, is the core system. But the concept of progressive transformation, in which business logic is abstracted from the legacy system and placed one piece at a time in the context of an open API/microservices architecture, is winning over even the most risk-averse institutions.

Of course, accepting the argument that core modernization is necessary does not dictate a single strategy for doing so. The banks that have embarked on journeys to modernize their core systems are taking advantage of progressive transformation but choosing different approaches and prioritizing different workloads to lead the way to transformation. Some institutions are choosing to start with smaller parts of their businesses to constrain risks to the absolute minimum in case of failure. Other banks, conversely, are starting with the area of highest impact — business lending, for example — to gain the biggest benefit of transformation at the start.

The modernization of core systems at the largest of institutions will take years to accomplish. But as banks do so, they will be generating business benefit at every stage, as well as slowly reducing the complexity and inherent risk of operations, while creating open environments that will make the institution much more responsive and agile.

Considering Oracle

Redwood City, California–based Oracle Corporation has been offering products and services to the financial services industry for decades and has built credibility in various technology areas for the industry. In 2005, Oracle began acquiring an increasing stake in i-flex solutions, which offered a core banking solution called FLEXCUBE. The FLEXCUBE core product continues to have significant global market share.

In 2012, Oracle announced the availability of the Oracle Banking Platform, a set of banking applications and component architecture targeted at large financial institutions to manage consumer, small and medium-sized enterprise (SME), and business banking. The Oracle Banking Platform is based on a service-oriented architecture (SOA) using components from Oracle’s Fusion middleware solution and Oracle Database technology. Because of the SOA foundation and component architecture, the Oracle Banking Platform can be deployed one component at a time, consistent with a progressive transformation strategy and enabling an institution to de-risk core modernization by transforming legacy systems over time. Oracle offers over 1,500 open APIs specific to financial services pre-integrated with its solutions for core banking, payments, identity, security, and API monetization.

The Oracle Banking Platform covers deposits, lending, and payments products for retail, small business, and private banking customers. New product development can be reduced to functional configuration instead of coding,
saving time and supporting faster time to market. The platform includes modules to support compliance and security.

The Oracle Banking Platform provides capabilities for:

  • Originations
  • Collections/default management
  • Credit and collateral management
  • Deposit and loan servicing » Customer management
  • Relationship pricing

Challenges

As with any system transformation, core modernization, particularly at large institutions, is a complex process involving strategy, hardware, software, services, training, and oversight. Oracle is well respected as a software and services provider yet often works with systems integrators or advisory companies in areas such as operations, governance, and process reengineering to deliver a solution. Involving multiple technology providers in such initiatives inherently increases the complexity and requires additional oversight from bank executives and project management to track progress and ensure ultimate success.

This kind of challenge, in itself, is not a major roadblock, nor is it unique to Oracle. But it does mean that Oracle cannot completely control the success of a core modernization initiative; rather, it must rely on its ability to work with partners on behalf of an institution. The firm has worked with multiple partners in the past to deliver successful core transformation projects.

Conclusion

Given the pressures to improve customer engagement while increasing agility and efficiency, large banks are reconsidering core modernization to overcome the challenges of legacy system inertia. However, new parameters required for core transformation are as follows:

  • A phased modernization over time
  • Component-based, API-driven solutions that build simplicity, openness, and reusability into the core architecture
  • The ability to prioritize workloads, functionalities, or lines of business to transform progressively
  • Modernization strategies that include business benefits at every phase of transformation

To the extent that Oracle can deploy the Oracle Banking Platform to help institutions transform their core banking systems with these guidelines in mind and deliver a complete solution through its own resources and effective partners, the company has significant opportunities to take advantage of the emerging drive to modernize core banking systems worldwide.