The easy option for banks has always been to patch up the legacy platforms for yet another year. However, more banks are now taking the tougher route, opting to finally jettison their old core systems. There are plenty of good reasons for such a move but the main driver is competitive pressure. Banks – existing or new entrants – that have efficient and flexible operational platforms are gaining market share, forcing the laggards into action.
This is particularly clear in emerging markets, where one or two markedly more efficient banks can stand out from the crowd, forcing others to finally address their shortcomings. To continue taking the easy option could ultimately jeopardise a bank’s survival, with the weakest likely to be among the consolidated rather than consolidators.
Core systems replacement is gathering pace. The annual IBS sales league table for 2005 showed a marked upturn in selection decisions, across all areas of banking and across most regions.
In fact, the most activity was in developing markets, with the only real downturn in western Europe. There were markedly more deals in 2005 in central and South America and central and eastern Europe than in the previous few years, with smaller increases in Africa, Asia Pacific/Australasia, and central Asia.
In North America, there was considerable chopping and changing of domestic systems and service bureaux, in part stemming from supplier consolidation and with much of it within low-end and start-up institutions.
Much of the activity on the international stage was in retail and universal banking but there was also a healthy number of wholesale banking systems decisions and a slight pick-up in private banking. Moreover, many of the decisions are strategic in nature, as banks seek to put in place operational processes and platforms that will allow them to survive and prosper in today’s ever more competitive and regulated markets.
The failings of legacy core systems are well understood, not least by those still burdened by them. Most failings go under the term “lack of flexibility”, to do with a restricted view of the customer, poor time-to-market for new products, and lack of control. Cost of ownership is ever more prohibitive and regulatory requirements are adding to the pressures.
Customer service
If 70% to 80% of the IT budget is going on maintenance, and a large chunk of the rest is allocated to regulatory requirements, little is left to improve the bank’s customer offerings. Customers are typically attracted by convenience and products; they tend to leave because of service, but it is extremely difficult to improve service against a backdrop of continuous cost control.
When the other banks in the market had similar inefficiencies, it was possible to paper over the cracks. The big change is when the competition becomes smarter. Of all the reasons for replacing core systems, this is the most likely to unlock the budgets and overcome board level resistance.
The most clear-cut case to date has been in India, where deregulation 12 years ago let loose a new breed of bank with new, centralised systems, better
marketing and attractive brands. The entrants that succeeded started to gain significant market share, attracting huge swathes of the country’s most profitable customers. This in turn forced the existing banks into action, so that today virtually all Indian banks of any size are overhauling their core systems. It was competition that persuaded traditionally lumbering giants to move with unprecedented haste.
Foreign competition
That type of situation is occurring elsewhere. In India, the new competitors were from within, with strict regulations still hampering foreign banks. Elsewhere, the competitive threat is often not only from within but also from outside.
Notably, ICICI Bank has entered the UK and Canadian markets of late with branchless, direct banking utilising electronic channels. Rabobank is following its Dutch counterpart ING Direct, most recently launching in New Zealand. Deutsche Bank is setting up DB Mortgages in the UK.
There are clear commonalities in the product sets – simple offerings with attractive terms, backed by strong marketing. There are also commonalities in the underlying infrastructure – packaged back-office systems and low overheads. ING Direct mainly uses Fidelity’s Profile; ICICI Bank is using Fiserv’s ICBS; Rabobank is using Callataÿ & Wouters’ Thaler; and Deutsche Bank is using the Marlborough Stirling-derived Optimus, which now resides with UK-based Vertex Financial Services.
There is often a centralisation aspect to the operations. ICICI Bank’s systems to support its direct banking are run out of Fiserv’s data centre in Chicago. Rabobank’s version of Thaler is situated in Amsterdam, running in a third-party data centre, so that when the bank hit the New Zealand market with RaboPlus, offering an online savings account with 7.35% interest (no fees, no minimum term, no minimum balance), it did so with 14 staff in Wellington and virtually no other infrastructure.
The impetus for change among incumbents might be because the new entrants are already dropping in or because they can be viewed on the horizon. The Chinese banking market is opening up, with most of the medium to large-scale banks grappling with their core systems in advance of the anticipated arrival of overseas banks. There are similarities with the Indian market in terms of the size of the banks, their decentralised infrastructures, and the country’s communications challenges.
In Europe, the move to a single market has started to break down the barriers to entry and, in its single euro payments area guise, is causing considerable rethink and investment in the payments arena. An inefficient German bank could survive in its inefficient state all the while its primary competition was from other German banks. It is comparable with the airline industry: all of the big national airlines were in a false comfort zone when they only competed with each other. This was shattered by the arrival of low-cost entrants.
Jamaican revival
In some countries, the banks that are really forging ahead and forcing other banks to act are basically those that have already gone through the pain of enterprise-wide transformation. National Commercial Bank (NCB) in Jamaica falls into this category. It was in such a precarious position that it had no option but to undertake radical change, in its systems, culture and delivery channels. In 2001, after more than 150 years in business, under new management it emerged from the ashes of restructuring and has become a major force in the market.
It replaced decentralised systems which, in the words of NCB’s director of transformation Herb Phillipps, were “appalling” and built on its strengths. From only being able to launch one or two new products every few years, it is now able to push out products almost at will, utilising one of NCB’s key strengths, its distribution channels.
All back-office processing was removed from the branches and those staff that remained have become sales and customer focused. Innovation has become a key attribute, such as that embodied within its ‘Merchant Advance’ product, which constitutes a loan for merchants (of which NCB has by far the largest portion as customers) against future receivables without collateral.
Bundling products for different tiers of customers has also been a significant innovation. In a market reduced to five main banks, where NCB is the only indigenous player left (something it extensively states in its marketing), it is gaining strong market share and forcing the other banks to react.
Union Bank of the Philippines is another organisation that has transformed its operations and its standing in its market. In 1993, according to CEO and chairman Justo Ortiz, although profitable, it was “sluggish, non-competitive, inefficient and disdainful of customer needs”. Once more, a new management team brought clear goals and an enthusiasm for change.
“There was no way we could achieve our goals by simply following what other banks were doing,” says Mr Ortiz. It sought to become a “technologically superior bank” churning out new products that were technology-based. Today, it has the best cost-income ratio, at 40 percent, of any bank in the country, has transformed from a two-product bank – deposit taking and lending – to an extremely diverse institution, and it is still forging ahead, having recently put in place ambitious plans through to 2010 and having replaced its core systems.
Several of the core systems that are underpinning the new direct banks are not the newest, to put it politely, but they are more than able to support the limited product sets and can be viewed as more or less out-of-the-box in such a relatively straightforward environment. It is, of course, much tougher to put in place a new infrastructure when you are not setting up a new bank.
The Indian banks have typically opted for Infosys’ Finacle, I-flex Solutions’ Flexcube, or Tata Consultancy Services’ FNS-derived Bancs. The projects are lengthy and phased, with the issues not only to do with the sheer size of the task but also to do with business dynamics.
If a large portion of your profits stem from a relatively small subset of your branches, the business case for rolling out a central system diminishes after a while. NCB in Jamaica and Union Bank of the Philippines are Finacle users. It was interesting last year to see a traditionally strong in-house devotee, HSBC, opt for third-party software, when it chose Temenos Corebanking (TCB) for much of its international retail business, to replace a legacy home-grown system, HUB, in more than 60 countries.
ICICI Bank was formed out of a number of disparate financial companies within the ICICI Group. At the outset, it had no experience of customer-facing technology, it had some back-office automation, and its customer base comprised about 5000 entities, mainly corporates. It also could not open more than 30 branches per year, due to regulatory restrictions. ICICI Bank managing director and CEO K V Kamath refers to technology as a “disruptive tool”.
Technological spearhead
ICICI Bank’s position as a late starter meant that it took up that tool as its main thrust. “Technology was the core strategy, it was a completely different mindset.” Today it has more than 18 million customers and its annual technology spend is 5%-10% of that of global banks. According to Mr Kamath, “what we have done can be done by any other bank”.
ICICI Bank has not succeeded without sustained IT investment but, if done well, the returns are significant. Cost-cutting is unsustainable as a core medium or long-term strategy. However, by no means all banks have the strong management that breeds an appetite for transformation. There are still those that dither and delay, preferring to patch up the old for yet another year, thereby losing ground to those competitors that have already emerged and less ready to contend with those that are on the way.
Martin Whybrow is founder of core banking systems specialist IBS Publishing and editor of the International Banking Systems Journal. He is also chairing the FT’s forthcoming core banking systems conference in Prague on core banking systems
