How many metaphors will it take…?
How many more metaphors for aging core-banking systems will we hear before banks seriously consider updating their core systems?
A gothic house of horrors, the noose around the neck, the kettle about to boil…how many more metaphors for aging core-banking systems will we hear before banks seriously consider updating their core systems, writes David Arnott?
The retail banking landscape is changing. Incumbents are vulnerable. Regulation weighs on their profitability, but also opens doors for new entrants. Their brand equity is weak. Their pre-online core banking infrastructure is stretched to breaking point; it burdens them with high costs, yet fails to meet customer expectations in a digitally-connected era of anytime, anywhere. These systems must be radically overhauled or they risk evaporation in a boiling kettle of technological disruption.
There are four known issues facing retail banks; increasing regulation, cloud, new channel technology and waning customer loyalty. These elements will force banks to address shortcomings in their core systems, or worse, they will cease to be competitive in the same way that Blackberry did when smart phones developed quickly and it failed to keep up. Then, of course, there is the one unknown. Who will the disruptor be? Guesses point towards GAFA (Google Amazon Facebook & Apple) which are very likely candidates, however it could be a lesser-known name, or even one we’ve not heard of yet.
Let’s take a look at the known factors in turn.
There is no doubt that regulation is having and will continue to have a large impact on the banking industry. Regulations such as PPI, CCP and EPD are causing massive amounts of work for banks as they try to keep up with regulatory issues. Some banks are pre-empting regulatory changes by making operational changes such as changing commission structures or removing them altogether to remove the risk of conflict of interest between customer requirements and business profitability.
But, on the other hand, regulation is also making it easier for new entrants to enter the market – testament to this is the fact that Metro Bank is Britain’s first new high street bank in over 100 years.
The post-banking crisis customer is demanding and savvy. Their expectations are high and they can be dubious about whether their bank is working in their best interest, using comparison sites and switching provider to get the best deal. Then there’s the new regulation that came into play recently, the Current Account Switching Service – requiring UK banks to move a customer’s mandates for them – effectively making account switching easy and quick. Managing these demands requires greater attention to detail and changes to sales practices – simpler, more transparent products and a less conflicted sales channel.
Retailers, notably supermarkets such as Tesco, are acting upon the opportunity to leverage their brands, their customer service ethos and their loyalty driven analytical capabilities by moving into the provision of financial services.
The digital age is turning banking on its head. Individuals want to apply for savings, investment and loan products online or via smartphones and tablets, at a time that suits them, not just during traditional working hours. They also expect transactional processes – cheque clearing, direct debits and standing orders – as well as online payments to retailers to be easy, real-time and low-cost or free of charge.
Furthermore, technology companies, such as Google, are confident that technological know-how in an increasingly digital age can see them capture a share of the market. What’s more, they have a comparative advantage in proximity to customers. Google is rolling out a feature that lets you connect Gmail to Google Wallet. But what is interesting is not that you can use it to send money via email, rather, that it will encourage its 450 million active users to sign up to Google Wallet enabling them to capture the bank account and credit card information of those users.
So what’s holding banks back from biting the bullet? From our perspective, banks need to establish three things. The first is that their system is not fit for purpose, resulting in an unsustainable situation that leaves managers in some circumstances barely able to meet the demands of the marketplace. Banks then need to establish that a system exists that is fit for purpose: real-time processing with 24×7 availability, and both customer- and product-focused. Lastly, they need to know that there is a low-risk route to get them from where they are now to where they need and want to be.
What most retail banks are often failing to consider is that system renovation leads to materially improved profitability. In fact, over the past five years, banks using modern, third-party banking systems have enjoyed on average a 19% higher return on assets, a 28% higher return on equity, and a 6.5% lower cost-to-income ratio than banks running legacy applications. This enhanced profitability is derived from several key attributes of modern banking technology: the ability to move into more profitable markets and segments, raise the asset yield within existing business, cut costs sustainably and achieve economies of scale. Furthermore, having the right platform in place allows banks to gain a competitive advantage by taking new products to market in days, rather than months, while providing the secure banking service that customers expect from long-established institutions.
So, in short, not only is technology renewal essential for banks to cope with the demands of the digital age – high volume, high customer care, lower margins, real-time – but the investment will quickly pay for itself.
Some large retail banks are showing an appetite to move forward. In the UK, Nationwide Building Society’s FlexDirect account runs on modern standard software. Outside of the UK, The Commonwealth Bank of Australia, National Australia Bank and BBVA Compass in the US have all made moves. Accelerated activity is anticipated in the near term in other markets, such as Latin America.
What these moves tell us is that the kettle is beginning to boil. Disruptive entrants such as Tesco, Google and Metro Bank are starting to whistle. There are probably other things that are bubbling away too – unforeseen regulation, revolutionary technological advances, the unknown unknowns. But one thing is certain, banks that don’t replace their legacy systems will evaporate. Now is the time to act. If they do not, disruptive innovation will do to banking what it did to retail, media, computing and many others before.
 Restoring Profitability in the Digital Age, Deloitte/Temenos white paper, 2014