Both challenger and traditional banks are looking to leverage cloud-based core banking systems to foster new business models, reduce operating costs and deliver better customer experience. Joy Macknight reports.

Cloud

Even just a few years ago, the idea of putting a bank’s 'heart', or core banking system, into a cloud environment was a non-starter. But the rise of cloud-native challenger banks, without legacy IT millstones around their necks and with much lower operating costs, has made the incumbent banks take a closer look.

In addition, a new wave of cloud-based core banking platforms, such as 10x Future Technologies, 11:FS Foundry, Avaloq, Finxact, Five Degrees, Leveris, Mambu and Thought Machine, to name just a few, has fuelled interest. Incumbent vendors, including Finastra, FIS, Infosys, SAP and Temenos, are also moving their core banking systems into the cloud.

Increasing confidence

Many have been working closely with large cloud platforms, such as Amazon Web Services, Google Cloud Platform and Microsoft Azure, to build confidence across the financial services industry. This has enabled banks and regulators to become more comfortable with cloud technology, particularly regarding security.

“With core banking systems, security is critical because they hold personal information and other sensitive data,” says Andrew Reeves, managing director of cloud business at Temenos. “Many banks had already moved auxiliary systems, such as Office 365 and Salesforce.com, to the cloud, but are now considering putting their core systems onto cloud platforms to leverage the benefits, such as scale and up to 10 times in infrastructure savings.”

Juerg Hunziker, CEO of Avaloq, a provider of software-as-a-service and business process-as-a-service solutions to banks and wealth managers, agrees cloud has reached a “maturity, acceptance and security level” that allows banks to consider it as an alternative to traditional models. Whereas two years ago, 80% of Avaloq’s pipeline was looking for a classic, on-premise solution, customers are now more interested in cloud deployment, he says. Today, Avaloq runs 30 banks in a private cloud.

Part of the shift to cloud is driven by banks adopting a fundamentally different approach in how they build and run their operations, according to Eugene Danilkis, CEO of Mambu. He says: “They want agility and flexibility to adapt to customer needs and respond to accelerating market opportunities or threats, as well as to what is happening in the competitive and technological environments.

“Instead of developing a monolithic architecture, banks realise that they need to be always evolving their products and services; hence they want systems that connect well together and allow them to effectively plug and play different solutions for specific markets and use cases. That is why cloud-based banking engines are so valuable and important to the industry right now.”

Standard Bank group chief information officer Alpheus Mangale sees cloud as the future and mainframes as the infrastructure of the past. He says: “Looking at where cloud is today, any organisation of our size would be at a disadvantage if we didn’t embrace it. Cloud has all the capabilities to help us become a digital bank.”

Cloud advantages

Going digital is Standard Bank’s main driver for cloud adoption, according to Mr Mangale. “A decade ago, a bank was a physical place to visit, with branch hours from eight to five; but the reality today is that a bank must be always on,” he says. “A bank won’t be able to provide that always-on environment if it doesn’t leverage the economies presented by being in the cloud. That one element alone is pushing us into the cloud – the always on, always available and always secure nature of the cloud. Plus, the ability to access digital-native capabilities that we could not develop ourselves.”

Cloud has several attributes that can help banks progress on their digital transformation journey, including:
• Availability/resiliency: no downtime for upgrades or if a server goes down; it is possible to run multiple instances of a core banking system in multiple data centres at the same time;
• Elastic scaleability: a bank can tap more cloud capacity on demand;
• Flexibility/agility: the ability to quickly test new functionality and enter new markets; plus, more opportunities to introduce change into the organisation;
• Productivity: upgrades happen seamlessly, with no impact on employees or customers;
• Cost efficiency: infrastructure savings through a pay-per-use, or utility, pricing model;
• Plug-and-play functionality, through application programming interfaces.

In addition, cloud will also help to drive standardisation in the industry, according to Avaloq’s Mr Hunziker. “If a bank chooses a provider using cloud technology, it must adopt certain standards. It can’t completely individualise the system because then it won’t get the full benefits,” he says. “Cloud technology will be the catalyst for more standardisation, which delivers greater efficiency that will enable the incumbent bank to draw closer to the start-up players.”

Hurdles to overcome

Despite growing industry confidence, some risks – perceived or real – remain. For example, Joseph Edwin, head of the core banking transformation programme at Nordea, identifies interoperability as one of the risks. “Not all applications are cloud-native, which means a bank needs to re-engineer many applications to operate inside the cloud. And the applications that are in the cloud must interoperate with applications inside the on-premise infrastructure. That is a risk and banks need to bake that into their planning when moving to the cloud,” he says.

Mr Mangale warns that the move to cloud could prove costly if not planned properly, because most banks do not retire what they have on premise. To ensure that costs are not spiralling out of control, Standard Bank is putting in place a cost management tool to monitor cloud usage across its IT estate.

Another risk Mr Mangale identifies is data residency restrictions. “We don’t have a ‘United States of Africa’; each country has its own regulatory environment. Some regulators may not allow us to move data out of the country, especially when it comes to core banking,” he says. “That is a big risk for us and we are working with the regulators across the continent to educate them about security and liberating data, ultimately for the benefit of the end consumer.”

Rebecca Skitt, CEO of 10x Future Technologies, believes some banks are fearful of losing operational control. “Some clients have a sense of losing control of their performance and, importantly, their ability to solve problems. This stems from banks’ senior operations and technology folk being used to dealing with one crisis after another,” she says.

Initially, clients want to set the boundary where they still have some hands-on components and connection points, adds Ms Skitt. “But when we explain our architecture, why we designed the 10x SuperCore on a single unified data model and how the cloud-native tooling provides the outcomes that they are not able to achieve on premise, then that fear goes away. They are then willing to put more of their operating footprint into the cloud-native solution,” she adds.

Stephen Greer, a senior analyst at Celent, lists vendor size among his concerns. “There is a risk with some of these start-up core banking vendors, as they tend to not come with the same service levels that a larger incumbent vendor could provide. These are small vendors with few staff and limited capabilities around operationalising the core that a bank might want,” he says. “There is also a risk with the exit strategy of some of these organisations and whether they are going to be around for the long haul, or only until they are acquired.”

He points out that many new vendors are pricing themselves to attract new customers, presenting a combination of flexibility and value. “Their pricing models are such to attract a core customer base and show growth to attract venture capital investment, which they have, but the question remains: how does the business model evolve from there?” 

Migration path

While challenger banks, such as OakNorth and N26, are likely candidates for adopting a cloud-based core banking system, many vendors report that interest is also coming from incumbent banks on the journey towards navigating a core replacement. Anand Subbaraman, general manager, retail banking, at Finastra, says: “We are starting to see traditional banks that do not want to do a full rip and replace of [their] legacy core looking at which components can be taken to cloud, such as the lending book, so that over time they hollow out their existing core.”

Additionally, some are spinning up new digital entities. “Many of the big banks’ IT [structures] might be beyond repair, so they are setting up their own challenger banks and new labels,” says Peter-Jan Van de Venn, executive vice president, business development, at Five Degrees. He points to a Five Degrees client, ABN Amro, which has set up several neobanks, including Franx.

“ABN Amro set up a separate team in a separate building, and purposely keeps the organisational legacy away,” he says. “While IT legacy is an issue, organisational legacy is also a big problem. By creating a separate team apart from the old organisation, it becomes possible to spin up new initiatives within a few months, versus a few years from the inside.”

Paul Taylor, CEO at Thought Machine, adds: “The bigger banks are launching digital challengers to keep up with market and customer expectations, but they are also looking at whether the whole bank could look like this in the future. There are many paths for that, but if they launch a successful greenfield bank with a few thousand customers that love it, the next step is to move some of the existing customers over and do that in a non-disruptive way.”

However, Mr Danilkis at Mambu says it is not necessarily a one-to-one replacement, where an established bank builds a new bank which then becomes the future vision of that bank. “What we are seeing more is that incumbents are considering specific markets segments, products and services that they can build up into a more digital first and modern way. And then spinning them up into individual business lines that could, over time, attract their established client base but with better service, lower servicing costs and a faster platform on which to evolve,” he says, echoing Mr Subbaraman’s point.

Mr Reeves reports an evolution in incumbent banks’ approach to core system transformation. “Previously they talked about progressive renovation, where the bank sequentially migrates by product line or business function to the new platform; then it was build and migrate, where banks establish a new offering running on the new digital system and gradually migrate customers across. Now we are seeing a lot of success with build and renovate, where an incumbent bank creates a new, fully digital stack and launches new services, effectively allowing customers to move across themselves,” he says.

Ensuring success

Some incumbents are continuing along the progressive renovation path. Nordea’s approach is to migrate away from as many legacy systems as possible and onto a modern platform, such as the one it is implementing with Temenos, according to Mr Edwin. But that is not without its challenges. He says: “Going after a core transformation is a no-brainer but it is a disruptive exercise for most banks because of the amount of touch points a core banking system has across the entire business and technology architecture. Plus, every bank set-up is different, so there is not a cookie-cutter approach to doing a core banking transformation.”

To be successful, he says, the transformation project needs to be prioritised, sponsored and anchored at CEO or chief operating officer level, and there needs to be willingness to accept some pain for the long-term gain that comes from a simplified business and technology landscape that is created by having a new core in place.

It is also important that small successes are demonstrated on a continuous basis to illustrate that the investment going into the core transformation is delivering results. Mr Edwin adds: “In this context, a cloud-based implementation helps because it is possible to turn something on relatively quickly such as basic banking services, before enhancing the capability to suit all the banking needs of our customers. And once cloud-based core banking offerings mature, I think that will speed up the transformation journey at the banks.”

Mr Subbaraman’s advice is for a bank to have a clear vision of where it wants to be in the next three to five years. He says: “Replacing a legacy core with a modern cloud core doesn’t do much if the bank retains its legacy processes. It could be a starting point for the bank to solve its burning technology platform issue, but it won’t give the bank true success. A bank must have the business case in mind and be comfortable with adopting new business processes and new software configurations, as against a mindset that has been much more attuned to customising.”

Mr Subbaraman warns that a bank could end up tailoring its new cloud core to the point where the benefits of cloud in terms of upgrades, technology service and maintenance evaporate. “The bank might achieve short-term gains of moving to a new platform, but it will be obsolete again in the next few years,” he says. “So [banks should] embrace the cloud and be willing to change the status quo of the business.”

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