As the financial services industry continues to evolve, the onus is on banks to keep up. Meeting the needs of today’s ever-demanding customers means offering the latest, most innovative, hyper-personalized products and services. But without a modern core banking solution, incumbents struggle to compete with younger, more tech-focused, agile entrants.
Indeed, over a third of banks (34%) surveyed say issues with core banking systems are the biggest challenge they face around developing a digital ecosystem of products and services, per a former edition of our Digital Banking Experience (DBX) Report.
Additionally, a Cap Gemini World Retail Banking Report revealed the vast majority of senior executives surveyed – 95% – believe “outdated legacy systems and core banking modules inhibit efforts to optimize data and customer-centric growth strategies”.
However, many people are still unclear about what core banking means and why it’s important. Below, we explore the topic, including key steps financial institutions (FIs) can take to modernize their systems.
Core banking defined
A core banking system is the back-end software FIs use to manage mission-critical processes; it can be on-premise or cloud-based.
Described by TechTarget as the “central nervous system of a bank”, it supports an array of common day-to-day transactions, maintains compliance, and helps provide a frictionless customer experience (CX). A core banking solution generally comprises the following modules.
- Accounting – recording and monitoring financial transactions like deposits, loans, payments, and withdrawals.
- Customer relationship management (CRM) – storing data, generating reports, and tracking interaction.
- Day-to-day operations – processing transactions, managing accounts, and calculating interest.
- Reporting – generating output to track performance and help make decisions.
- Risk management – identifying and mitigating potential fraud, credit, and compliance issues.
Secure, reliable, and resilient, a core banking solution manages customers’ financial operations, yet it sits invisibly behind the scenes.
The global core banking software market was valued at $14.54 billion in 2023 and is predicted to grow from $17 billion in 2024 to $62.75 billion by 2032. Key trends influencing the sector range from adopting technologies like the cloud and artificial intelligence (AI) to leveraging big data for real-time insights.
Creation and evolution of core banking
The genesis of core banking goes back to 1959, with the creation of COBOL (common business-oriented language) by Grace Hopper, a mathematician, computer scientist, and US Navy Admiral. Many of the first core banking solutions used the programming language, and even today, it’s estimated that more than 800 billion lines of COBOL code are used globally.
During the 1980s, widespread computerization and digitization of the global banking system really kicked off, and by the 1990s, core banking had become a mainstay.
Between 1990 to 2005, core banking systems became more “product-centric”, with banks often outsourcing development to address specific service areas. In the years that followed, solutions became increasingly “customer-focused,” with infrastructure changing to reflect that.
For example, banks abandoned the traditional silo approach in favor of new software based on modern digital models like service-oriented architecture (SOA) and application service providers (ASPs). In terms of customer experience, the evolution increased accessibility via digital graphic interfaces on the Internet.
Fast forward to the present day, and core banking is “process-centric,” with greater emphasis on the mobility needs of consumers and banking institutions. In turn, there’s more focus on cloud-based models, composability, microservices, and efficient ecosystems to optimize day-to-day banking services and foster innovation.
What’s more, since the advent of open banking, application programming interfaces (APIs) have become increasingly prevalent, connecting core engines with new apps and services and driving innovation further.
Legacy core system challenges
Despite technological progress, many banks still rely on decades-old core banking solutions – on-premise, monolithic, and mainframe-based. Known as legacy systems, they continue to support banks’ back-end operations across integral functions like account opening and transaction processing.
But their archaic and complex nature means it’s difficult to interface with partners and other platforms. That hampers the development of a collaborative ecosystem approach and the creation of new revenue streams via banking-as-a-platform (BaaP) and banking-as-a-service (BaaS).
Moreover, legacy systems can experience data quality issues, impeding real-time analytics. In turn, that restricts banks from offering state-of-the-art products, services, and experiences to their customers.
It’s also hard to integrate artificial intelligence and other increasingly popular technologies with legacy systems. With that in mind, as we enter the AI-enabled banking era, “the cloud is an unmissable starting point to improve banks’ future readiness”, as per our 2023 Digital Banking Experience report. Moreover, “banks need to embrace new technology, including a hybrid-cloud core technology stack” – more on that below.
Alternative core banking operating models
Given the challenges faced, incumbents are considering other options, including software-as-a-service (SaaS), cloud-native, and hybrid core banking models, facilitating innovation and collaboration while removing integration obstacles.
Meanwhile, new market entrants like challengers and neobanks have the luxury of being unencumbered by legacy systems and can choose an approach that best suits them from the outset.
SaaS model
This subscription- and cloud-based approach helps banks move away from the hardware infrastructure of traditional software. Unlike legacy models, a third-party company operates SaaS platforms, rather than the bank’s data center. The service provider manages and delivers core banking services over the Internet, and the bank accesses them via a web browser.
SaaS is a cost-effective method, allowing banks to use services on demand and minimize the use of cumbersome legacy platforms. Moreover, by leveraging the expertise of experienced partners, banks can integrate more easily with other players in the financial services industry and offer pioneering products and services that delight customers.
Cloud-native SaaS model
Cloud-native is an approach to structuring software – a methodology that uses cloud computing to develop and deploy applications, typically as microservices. The software can be SaaS and cloud-native, SaaS, or cloud-native (or neither).
Third parties operate cloud-native SaaS platforms; notable providers include Amazon, Microsoft, IBM, and Google. The core banking solutions are developed, designed, deployed, and managed from the outset as cloud-native. They allow incumbents to categorize and analyze banking data and transactions using advanced technologies like AI and machine learning. Cloud-native SaaS models offer banks a number of advantages, including:
- Significantly lower total cost of ownership (TCO).
- Scalability.
- Increased processing power.
- Lower operational costs.
- Seamless integration between APIs and back-end systems.
- Enhanced flexibility and agility.
- Reliable security and collaboration.
Mainframe hybrid model
Given the environment is rapidly changing, harnessing the power of data and AI and forging further ahead with digital transformation are competitive differentiators. With that in mind, IBM advocates “the incremental modernization and optimization of the mainframe landscape”.
By integrating core systems with a hybrid cloud architecture, banks place themselves in a best-of-both-worlds situation, capitalizing on:
- Mainframe reliability and security.
- Cloud scalability and innovation possibilities.
In that sense, it’s not about fully replacing legacy systems. Instead, they’re being modernized step-by-step, by adding and combining cloud-native features.
Mainframes aren’t a thing of the past. Indeed, during a “myth-busting” podcast, Brent Ellis, Senior Analyst at Forrester, shares insights on their current state and future, with the general theme being they “aren’t dying”.
Coreless model
Still in its formative stages, this composable approach follows the MACH architecture: microservices, API-first, cloud-native, and headless. Coreless banking allows FIs to decouple from centralized and monolithic systems and offer distributed services that are flexible, reliable, and secure.
Modernizing core banking systems
When it comes to upgrading a core banking system, there’s no one-size-fits-all. Picking the optimal route involves a strategic evaluation of existing infrastructure and a risk assessment of potential alternatives.
According to Cap Gemini’s 2024 World Retail Banking Report, 70% of chief experience officers (CXOs) surveyed plan to “increase investment in digital transformation by up to 10%, with enhancing data management capabilities and modernizing legacy systems taking precedence”. Concurrently, they’ll “migrate core functions to the cloud to establish a nimble, economical foundation”.
That may involve application modernization by migrating existing apps to the cloud. Indeed, the application modernization tools market is thriving – expected to reach $36.86 billion by 2027, up from $8.04 billion in 2018.
Meanwhile, Deloitte puts forward several modernization options, including:
- Re-platforming to an upgraded platform.
- Refactoring the codebase to a more modern language.
- Augmenting with a parallel (and more advanced) core.
- Replacing the existing core with a solution like cloud-native or SaaS.
When banks review their options, they should ask themselves several questions according to management consulting firm Oliver Wyman.
- Is our core system inhibiting operations?
- Has the market changed?
- Do we need to upgrade our core to meet evolving needs?
- How can we future-proof ourselves?
Core banking modernization also requires a cultural shift that trickles down from the C-suite across the entire bank.
Implementing a core banking system with SBS
Replacing or upgrading a core banking system can be costly and time-consuming, with concerns about operational risk, data inconsistency, and service downtime. To mitigate those worries, banks need a solution that allows a smooth, step-by-step transition, where day-to-day operations aren’t impacted.
Sopra Banking Software’s core banking system is composable and ultra-flexible, meaning banks of any type can select the functions and APIs they need. The solution offers a full range of functionalities to meet customers’ expectations in an era where accessibility, mobility, and scalability are key. Additional best-in-class features include:
- Lower TCO and cost per transaction.
- Robust API-first architecture.
- Access to an open ecosystem of trusted partners.
- Compliance with 50+ regulatory standards.
- Flexible delivery models: cloud, SaaS, on-premises…
- Advanced security and fraud prevention.
We generally give banks three scenarios to consider if they’re thinking about using our cloud-based core system. Their strategy, needs, and goals determine which they choose.
- Innovate: Take a single feature of our cloud platform and integrate it with their legacy system to achieve an on-point innovation.
- Renovate: Replace a mature domain – for example, payments – and leave the remainder untouched.
- Full migration: Switch bit by bit, function by function, and domain by domain, lowering the risk.
By partnering with an experienced player like Sopra Banking Software, financial institutions benefit from a wealth of knowledge and expertise – all-important when making a decision that impacts back-end operations, the lifeblood of a bank.
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