The core banking system market is booming

Describing a core banking system as the heart and lungs of a financial institution is an oft-quoted cliché, but it is no less true for the perennial repetition. Nevertheless, core operations are changing. Such systems still power critical processes in every bank, but the days when proprietary platforms remained quietly running in the background are slowly disappearing.

The world's assorted financial crises put paid to numerous IT developments globally, but banking technology vendors and analysts alike note continued appetite for core system overhauls. The market as a whole has remained relatively buoyant throughout the past 18 months, worth about $3.5bn in 2009 and expected to grow to $4bn by the end of 2011, according to estimates from consultancy Celent.

The goals of these upgrades are reasonably universal - creating a modern, reactive system to manage and upgrade products and services amid tough competition. But the specific drivers are not always so homogenous. Likewise, region by region, methods of achieving these aims are sometimes dramatically different, according to Bart Narter, senior vice-president of Celent's banking group.

Proprietary problems

The major US and western European banks are often assumed to be running on creaking legacy systems built as early as the 1970s, and struggling to cope with the demands of a banking environment that would have been almost impossible to envision 30 or 40 years ago. There is some truth to this, says Mr Narter, but supposed obsolescence or not, decades of use will have closely intertwined core systems with code from tens, if not hundreds, of other programmes, making replacement a traumatic and distinctly unappetising, if not impossible, prospect for all but the most daredevil of IT heads.

Nevertheless, banking markets are moving faster than ever before, and being able to react to demands from an ever more mobile and tech-savvy populace is vital. While it took years for consumers to embrace ATMs, Apple's not inexpensive iPad sold some 3 million units within 80 days of launch, and in many cases customers will have rushed home with their new toy and looked for their bank's application. "What we're all faced with is [Apple CEO] Steve Jobs causing us grief," says Andrew Steadman, director of product management, bank solutions with financial technology provider Fiserv. "You're not sure what he's going to introduce in 2012, but whatever it is, it will influence the way in which consumers interact with their banks."

A traditional core banking system makes catering to customer demands difficult, adds Mr Steadman's colleague John Macaluso, Fiserv's chief technology officer and senior vice-president of bank solutions. "Banks have to adapt to wherever their customers are going and their core platforms are like a big anchor dragging them back."

Another stimulus for change among the traditional players may be coming from ambitious start-up firms looking to take on the major banks at their own game. The trend is clear. In the UK, supermarket-owned Tesco Bank has been eyeing up the domestic banking space, while Metro Bank - due to have opened on July 29 as the UK's first new high-street bank for more than 150 years - has declared war on conventional banking.

Meanwhile, in North America, Wal-Mart has been granted a Canadian banking licence and purchased 2 million shares of prepaid debit-card provider Green Dot, which is itself currently awaiting regulatory approval for its planned acquisition of Utah-based Bonneville Bank. The timing may be prescient for these new firms. Opinion polls suggest that customers do not feel well served in developed markets: a recent survey of almost 48,000 US retail banking customers by marketing information services firm JD Power and Associates found that overall satisfaction has decreased for a fourth consecutive year, primarily due to low marks in customer service.

Working around

If an entire core system replacement is not an option, larger banks may be left wondering how best to deal with these fresh demands. Many global financial institutions will have the resources to throw at the problem however, as well as the desire to overcome them. As a result, several banking software providers are reporting growing demand from major firms for ways in which to work around their main systems, by adding new modules and capabilities without a drastic refit. "If you're a Tier 1 bank, ripping out everything you have is, besides the cost or time frame, just too risky. But if you look at a piecemeal replacement, where a technology refresh is done under the covers using elements of a system from a vendor, it can be a lot more viable," says Mark Gunning, business solutions director with financial system provider Temenos. Mr Gunning notes that Temenos has experienced an increase in interest from Tier 1 institutions, which five or 10 years ago he would not have expected to consider packaged software.

Nonetheless, some banks are moving away from traditional models altogether, and from build to buy. The service bureau type-model, where a software vendor builds and runs a system, has always been reasonably popular in the US, but as licensed systems in general become more accepted, the momentum for outsourcing has grown, says Mr Narter.

It could end up as the favoured approach among start-up firms. Building a more traditional in-house system was never an option for Metro Bank, says chairman Anthony Thomson. "A proprietary system is, in a sense, obsolete the day it is built. We needed to outsource to someone with an economic model that worked for a very small bank, with the potential to grow into a very big bank."

Metro Bank's selection process hinged on one crucial piece of functionality, Mr Thomson says: "The most important thing for us is the ability to have a single customer view. It was essential to be able to look at the entirety of a customer's relationship with us wherever they are... that was our absolute prerequisite."

He adds that the payment model was also a potential deal breaker. Metro Bank was founded on the back of vice-chairman and backer Vernon Hill's previous, US-based venture Commerce Bancorp, which operated on a pay-per-account-per-month outsourcing contract. This model wasn't as commonplace in the UK, however. "Paying for your system on a per-transaction basis gives you the benefit of it being infinitely scaleable and you pay for what you use, without the cost of creating a platform from day one," says Mr Thomson. "That was an alien concept in the UK when we started Metro Bank three years ago."

Staying in house

So does the current climate herald the beginning of a long prophesised landslide of migrations to licensed systems among Western financial behemoths? Not according to Marco Mukherjee, head of change management with the eurozone's largest bank, Grupo Santander. The Spanish firm has been rolling its proprietary Partenon system out across its various subsidiaries in recent years, most recently in the third of its UK-based acquisitions, Alliance & Leicester (A&L), ahead of a planned UK integration and re-branding project scheduled for completion by the end of this year.

The key advantages of the system reflect those demanded by Metro Bank, according to Mr Mukherjee. Partenon allows a unified view of a customer and all of their holdings whether accessed via the telephone, the internet or in branch. It also eases the product development process as well as increasing efficiency, Mr Mukherjee adds.

He remains undaunted by the supposed downsides of proprietary systems, however, arguing that in-house development actually offers Santander a distinct competitive advantage. "We own and developed the architecture and this allows us to take advantage of the latest in technological developments, while maintaining the advantage Partenon offers our business over other banks," says Mr Mukherjee. He also dismisses questions over the difficulties in future development which are often inherent to in-house systems. "There is clear evidence of the scalability of Partenon if we look at our experience in the UK. In addition to integrating a branch-based banking organisation [Abbey], we have integrated a savings bank [Bradford & Bingley] and a multi-channel remote-based bank [A&L].

Metro Bank chairman, Anthony Thomson

Emerging appetite

System vendors are not just seeing uptake in the West, however. Institutions in emerging economies, many of which suffered far less from the global banking woes of the past two years, make up an ever-larger proportion of customers for core systems, certainly in numbers, if not in deal size. Eastern Europe, Africa and parts of Asia in particular are particularly lively at the moment, according to Celent's Mr Narter.

In many cases, emerging market banks are skipping an entire generation of technology, going from somewhat archaic systems, which Mr Narter describes as essentially unable to do business in the modern world, to a standardised, licensed system in an attempt to gain an early competitive advantage. "In less developed countries we've seen an appetite to do core system replacement as soon as possible to leverage a sort of land-grab strategy," says Temenos's Mr Gunning. "It's all about flexibility and how quickly they can grow, and leverage core technology to do that."

Despite the sometimes different starting point, requirements are often the same regardless of geographical region or financial strength, says Peter Scott, director of bank fusion retail banking with technology vendor Misys. "Institutions in emerging markets with high growth rates are now looking for the same level of sophistication as you would find in more developed markets," he says.

Mr Gunning highlights Vietnam and Thailand as prime examples of the kind of market where this strategy is flourishing, thanks to the combination of significant economic growth, a large population base and a multitude of less established small to mid-sized banks. These include Vietnam's Mekong Delta Housing Development Bank and Sacombank, and Thailand's Government Savings Bank, all of which recently upgraded their core systems.

Mark Gunning, business solutions director with financial system provider Temenos

Changing needs

Of course, other countries fit this description too, particularly parts of Africa, adds Nigel Pinches, head of EU and UK sales with IT services-firm Tata Consultancy Services (TCS). In Tanzania for example, one of the country's largest commercial banks, CRDB, has recently updated its decade-old Misys core banking platform. "We had a system which was put in place 10 years ago, but a decade down the line, the business had grown and requirements had changed," says Elyas Mtenga, CRDB's director of operations.

"These needs could not be addressed by the old system and it eventually got to the point where it had to be changed."

The new system went live in April 2010 and should provide better risk management and more real-time business intelligence, as well as reducing the manual processes inherent to the old platform, says Mr Mtenga. "It allows us to have a better picture of the customer, and enables us to roll out the product quickly and faster than before, giving us a real competitive advantage."

When selecting a vendor for the new system, Mr Mtenga says CRDB considered a number of firms, but that the risk involved in a complete switch precluded a move away from Misys.

"We looked at the business impact and came to realise that the level of risk involved in a complete change of system was too high. We thought it would be best to stay with Misys, because it was already familiar with the platform and knew how to migrate it."

Tough climate

China is arguably something of a different proposition to other so-called emerging markets, given its position as the world's third-largest economy, its historically closed markets and the strong governmental presence in the banking system. Institutional appetite for systems does appear to be growing, and just about every vendor claims to be involved in implementations of some sort in the country. However, almost all will concede that the going is not always easy. "It is a very tough climate. No one is claiming total success, and the best we can say is that it is because of that different business environment and culture," says TCS's Mr Pinches.

For Bank of Shanghai (BOS), however, when a system upgrade became necessary, the advantages of installing a platform from an established vendor won out. "At the beginning of the project, we made a detailed analysis of whether we should develop the system internally or through a third-party channel," explains the bank's vice-president, Jiang Hong. "The core system is so important to the development of the bank that we felt it was necessary to draw on an experienced partner." As a result, BOS implemented a system supplied by Temenos, which subsequently went live across BOS's corporate banking and retail businesses in 2006 and 2008, respectively.

Part of the appeal of a licensed system was the guarantee that it would align with global standards, but it also has significant customer service advantages, Mr Hong adds. "The old system was focused on the account, but now we focus on the customer," he says. It also offers significant speed benefits: mortgage approvals are now 75% faster than before, while development times for new products have fallen by the same amount.

BOS is Temenos's biggest Chinese client, but with 13 million accounts it pales in comparison with some of the country's larger institutions. These larger firms may not be as open to allowing a foreign firm to take responsibility for their systems, however. Agricultural Bank of China (ABC) for example, which has more retail customers than the entire US population (320 million vs 310 million) chose not to buy a complete system, but instead purchased blueprints of how to construct one from Temenos, allowing the bank to run a replacement project on its own. As this shows, the core banking market may be maturing, but some of the largest global players are not ready to embrace licensed platforms yet.