Sarp Demiray, CEO of EMBank
Since the Internet entered our daily lives in the late 1990s, the banking industry has been ‘digitalising’. Over twenty years later, we live and work in an environment where banks and their customers have overwhelmingly adapted to digital practices. We have online and mobile banking, voice assistants, and chatbots widely used across the industry. Still, nowadays, we are discussing digital transformation in banking more than ever. Let’s uncover the underlying story behind these discussions.
The Digitalisation Journey and Milestones
So far, we’ve seen digitalisation in finance occur in four major phases. The first phase, which some refer to as the ‘digital disruption’, started in the late 90s with the increasing availability of internet connectivity and of internet-enabled devices. Digital channels were convenient and accessible, especially to early digital adopters. Online banking and e-commerce kept growing, and marketplaces like Amazon and eBay became mainstream. Fintechs were more of a thought than a reality, but early players such as PayPal had already emerged.
The start of the second digitalisation phase dates back to around 2008, when more than one inflexion factor was at play. The introduction of smartphones, the rise of social media, and the financial crisis of 2008 had a seismic impact on banking. The crisis brought new regulatory scrutiny, while banks grew more reluctant to invest and change. There was also a credit boom to subside the effects of the crisis and rapid innovation in mobile and cloud computing. This perfect storm spurred the introduction of disruptive players – fintechs. This phase can be dated to last until 2014-2015.
The following phase, from 2015 to 2022, saw the hypergrowth of fintechs. However, this change in the finance industry had a driving effect on banks, too, due to new competition and new opportunities. Concurrently, the pressure to digitalise has increased in multiple industries, including banking. COVID-19 and the digitalisation demand it caused also took effect. We’ve had more and more conversations about digital transformation in this past decade.
The fourth phase, which we’re in, has been defined by the incredible enhancements in artificial intelligence (AI) and other technologies. These technologies include generative AI, API-based open connectivity, quantum computing, the Internet of Things (IoT), and biometrics. Their impact will be felt at multiple industries, financial institutions included, and by society at large.
The Banking Core and The Periphery
First off, much of the digital banking that the users experience is peripheral. When a user checks his/her account balance, pays off a credit card, or transfers money via the bank’s mobile application, what happens at the core is no different than going to a branch and running the same transactions by talking to a teller. ATMs, online banking, or phone banking are mere interfaces. Introducing or enhancing the functionality of such interfaces typically does not require structural changes in the banking core.
A core banking system is “a back-end system that processes daily banking transactions and posts updates to accounts and other financial records. Core banking systems typically include deposit, loan and credit processing capabilities, with interfaces to general ledger systems and reporting tools”. A seamless customer experience, security, and regulatory compliance depend on this foundation.
There’s no single source with a complete, publicly available list of banks’ specific IT hardware in their systems. They are often considered proprietary information by banks. They might not be publicly disclosed for security or competitive reasons. Legacy banks’ systems are heterogeneous, a complex mix of hardware and software from various vendors and eras.
Core banking software solutions support essential functions like account management, transaction processing, loan servicing, and customer relationship management. They come in two main forms: on-premises software and platform-based services (SaaS).
On-premises software allows banks complete control over their systems for customisation, data security and compliance. The software is installed and runs on the bank’s own servers and infrastructure, but it is more costly and slower to update.
Platform-based solutions (often referred to as Software-as-a-Service or SaaS), hosted on providers’ servers and accessed via the cloud, reduce the need for extensive IT infrastructure and offer greater flexibility. They can improve scalability and adapt quickly to changing needs but rely on third-party providers for data security and customisation.
SAP, Oracle, and Infosys are among the top vendors for core banking solutions. Temenos and Finastra are amongst the top leading market players, owning 15-20% of the market share. North America has the largest market share in core banking software with 30%. This sector is growing and is estimated to reach a size of USD 14.7 billion by 2028.
Legacy Systems vs. New Generation
Older banks often operate on legacy infrastructure, which, while reliable and stable, is often heavily customised with hard-coded business rules. This approach was critical in the past but is now a big liability. Many core banking systems in Europe were developed in the 1970s or 1980s. The hardware used is nearing or probably exceeded its expected lifespan. They were not designed to handle today’s demands. Legacy core banking systems are monolithic (all system components are interconnected), so they are harder to update and integrate with new technologies or new products. They often run on a single server or mainframe. They rely heavily on batch processing, which delays real-time data access and decision-making.
The solution has been to layer new interfaces—such as mobile and web applications—on top of outdated systems over the years. Hardware and software at the core have also been upgraded, but there’s always a paramount need to maintain legacy systems. This is difficult and binding for both banks and the tech companies that service the banks. So far, digital interfaces have done well enough for the banks, helping them keep up with the expectations of their customers and display a tech-savvy character. However, this ongoing scheme has also kept them postponing the need for a comprehensive overhaul, and it has started to cost them.
Comparatively, API-first banks are built with a new generation architecture that is open modular, so components are decoupled and can run independently on servers or on the cloud. This allows for seamless integration and flexibility. Such banks can quickly adopt new technologies like microservices, APIs, and cloud computing. They can bring innovative services faster to the market. Cloud-native infrastructure depends less on hardware, so it is cheaper to run and maintain. You can choose different solutions from vendors according to your specific needs or size. They support real-time processing and offer better scalability and easier integration with third-party services.
The Decision To Delay Is Not Without Reason
A top-level comparison of the old and the new looks like an easy choice in favour of API-first, cloud-native systems. I feel no different. If you’re founding a new bank and setting up its banking core, you would conveniently employ a new-generation banking system – either if it’s cloud-based or on-premise. But a systems overhaul is a different story. Trust me when I say that there’s also merit in resisting or delaying the shift, especially when a complete overhaul of systems is in question.
- Expensive Outlay: Upgrading or replacing core systems involves significant financial investment. This is very hard, or financially impossible for the many small and medium-sized European banks.
- Operational Risk: Banks’ legacy systems are complex. The transition process can disrupt daily operations, risking customer satisfaction.
- Regulatory Compliance: Ensuring the new systems comply with stringent banking regulations adds another layer of complexity.
Being an early adopter of platform-based solutions may not be the best choice. We’ve all experienced that throughout the digital age, hardware gets cheaper, and software gets more robust after a couple of years. New versions come out. Early adopters can face the worst operational risks. People and companies learn from mistakes, and it’s more favourable if it’s not your mistakes they learn from but someone else’s.
Having access to the right skillsets to manage the technology transformation (and to maintain it over the longer term) is another aspect to consider. The absence of such talent in the organisation, or the ability to attract and retain them may keep the bank away from exploring emerging technologies and switching to modern infrastructure.
Another reality is that there will always be a ‘catching up’ to do. Not just in terms of banking technology but also regarding regulations, compatibility, and functionality. Imagine undergoing an overhaul of your banking system, and just a few years later, you face an inflection that renders your new systems majorly outdated. Nightmare. I can understand the hesitancy of fellow executives to sign off on a major investment that’s not at all without risk.
Is The Time Now?
I believe we’re at an important turning point in banking, particularly in Europe. A convergence of the factors below renders any more delays in the modernisation of banking system unviable. I do think the time is now.
The first factor is demographics. Kids born into the digital age are now young adults, and the young adults of the beginning of the internet era, myself being one, are financially in their most active years. We grew up partly analogue and partly digital, but even our generation came to expect good digital services all around, especially from banks. The new generation was born digital, and there’s no halfway around their digital expectations. When depositing income, making investments, drawing loans, or managing payments, they prefer digital.
Secondly, technology. Technology is ever-changing, but when it comes to inflexion points, looking back, it’s not difficult to name when and where the seismic shifts happened. Widened internet reach and broadband connectivity around year 2000 was one. Another was the mobile revolution when smartphones rapidly became mainstream following the introduction of the iPhone in 2007. It is widely accepted that smartphones also paved the way for the fintech ecosystem.
Are we close to a critical juncture today? I would say so. On the tech side, widespread use of cloud computing and cloud-based services, API-driven software, increased adaptation of online systems and e-commerce, blockchain technology, and finally, wide application of AI portray such a juncture. All this technology is now rather widespread, accessible, and decently priced, and the talent around these technologies is developing rapidly.
On the industry side, fintechs are maturing, and regulations are catching up. It’s viable, even preferable, for banks to collaborate with fintechs to expand their services to new audiences. Refraining from such collaborations would allow a bank’s competitors to take advantage, and legacy banking systems may keep a bank away from working with fintechs, even if they’re resolved to collaborate.
On the regulatory side, EU policymakers are keeping busy to help us cope with and thrive in the digital era. A legal framework is formulated through a number of new regulations, such as DORA, MiCAR, The AI Act. This means that we can expect stability in the regulatory environment, and new regulations will be easier to adopt in terms of banking systems.
Banks are already spending big resources to comply with existing regulations and must act fast to comply with the new measures as better risk management and compliance reporting also rely on their technology.
The Cost of Delay
The ECB recently stressed the need for banks to modernise their IT infrastructure to remain competitive and secure: “Almost 90% of banks under ECB direct supervision depend on at least one end-of-life IT system for business-critical activities. This affects their ability to compete in an increasingly digitalised economy and to strengthen their resilience against cyber attacks”.
Over 75% of banks are considering major platform replacements within the next five years. This often means replacing outdated hardware with newer, more secure, and scalable solutions. Banks have adapted to the digital revolution better on their front end in the last decade, offering digital consumer experiences. For instance, in 2011, banks globally set aside nearly $13bn for investments in digital channels, with ⅓ dedicated to mobile banking. Yet consultants noted as early as 2013 that banks relying on core legacy IT systems was a threat to their business.
The additional applications that provided customer interface, straight-through processing and point-of-sale functionality around the legacy core have resulted in disconnected silos of information and duplicative processes. The problems with legacy systems are also compounding over time:
- High Costs (Labour costs, infrastructure maintenance costs, error and rework costs): Banks spend an estimated 78% of their IT budgets on maintenance alone.
- Poor Agility (Inability to launch new products rapidly, collaborating with others, such as fintechs)
- Low Customer Satisfaction (Delayed response time, lack of a seamless experience)
Banks with modernized core banking systems have seen cost savings up to 25%. Newer core banking systems can reduce a bank’s operational risk by up to 30%. The decision to move away from legacy core systems is not just about technology, it’s about survival and growth.
The Human Factor
New IT adoption can bring success and a bank’s productivity increase will go beyond initial gains if it goes hand in hand with organizational changes: People attain the skills to use the data, software, and new procedures to wield the digital technologies.
In my view, a truly transformative banking technology leap calls for a mindset shift right at the start, in the way leaders understand banking’s role in the future economy. We had better believe, then lead our people and convince stakeholders to make that change. It’s when a clear-eyed vision of the task and the stakes, motivation, timely education and clear communication from the leaders matter the most.
Successful digital transformation hinges on your people aligning with the new technology. This means skill development: Investing in training and growth for existing staff is crucial. Additionally, attracting and retaining skilled software developers and engineers will make a significant difference.
Cutting the Cord: Transitioning from Legacy Systems
So, the ‘why’ is clear. But how and to what extent should the cord be cut, so to speak? Investing in IT with new hardware, migrating totally or partly to cloud-based solutions, and adopting modern programming languages and frameworks are major strategic investment decisions that will impact a financial institution’s viability. It brings ground-level changes in how banks bank. Fear of the costs or blunders cannot freeze us into inaction while the rewards are so many and not just limited to our sector, for improved banking leads to a revitalised economy.
Cutting the cord from legacy systems requires a well-prepared strategy that would more or less follow these steps:
- Making a thorough assessment of the current system’s features, limitations
- Identifying critical areas that need immediate attention versus non-criticals, nuances
- Defining clear goals, scope, and desired outcome
- Mapping of current data and architectures so that developers get a clear picture to transform successfully
- Assessing the product implications and what needs to change in terms of clear actions to improve operational processes. This will be the basis of your new workflows.
- Picking the right technologies for your status and needs
- Create a phased migration plan that minimises disruption and sets realistic timelines. There must be reserves for mistakes and latency.
Future-proofing is critical at this stage. Your decisions on systems should cover several criteria:
- Scalability: The system should be able to grow with the bank’s needs.
- Security: It must comply with the latest security standards to protect against cyber threats.
- Compliance: The system should facilitate easy adherence to regulatory requirements.
- Cost Efficiency: Evaluate both the initial investment and the long-term operational costs.
Different Ways To Transform
Cloud-based core modernisation stands out as the solution if the legacy system fails to meet business needs at all. Banks spend 38 billion USD annually for cloud computing at the moment. It is forecast to increase from 26% to 56%.
The Gartner Report lists the key trends in core banking transformation currently as follows:
Industry best practices, including rollback techniques and disaster recovery planning, are necessary but may not be enough. Experts note that banks should consider a new approach at the start of software design to assure long-term sustainability by simplifying their system architecture and using a decoupled design with explicit abstraction levels.
Refactoring is a transformative method that preserves the benefits of the old core while utilising microservices architecture. It involves updating the codebase without altering the underlying behaviour. Replatforming involves minor adjustments to improve functionality without disrupting the core system. Rehosting involves lifting the entire legacy system and data from the local environment and moving them to the cloud. Retiring is a strategy that decommissions or archives the application, allowing banks to test systems before going live. Retaining is suitable for banking applications that are not ready to migrate but plan to do so in the future. Relocating involves moving the data centre or large parts to an equivalent cloud infrastructure, reducing the costs of maintaining and operating local data centres. Repurchasing is replacing banking applications with another version or product, such as a shift from a traditional license to SaaS or a third-party cloud equivalent. This strategy often makes banking services available from any location and reduces costs related to maintenance, infrastructure, and licensing.
The final formulation will rest on each bank’s goals, desired business results, the financial impact on the whole bank and the technical merits of replacement. Several options emerge:
- Total replacement with a new generation core, cloud-based SaaS model.
- Build a Banking-as-a-Service model, possibly collaborating with fintechs. (This is not a replacement, but a new banking model that may emerge aside or replacing the existing, traditional banking model)
- Partial modernisation of select functionalities, compatible with the banking core, using APIs and microservices.
- Build a new, digital-first (or digital-only) entity from the ground up with a new generation core.
Core vendors are now doing better than, for example, 3 years ago to stem the full replacement tide. They offer better products, so banks may now be better served to stay with their core vendor yet insist that their core now allows for other vendors to be able to come in and create innovative digital experiences within that modernised architecture.
EMBank’s Own Digital Transformation Journey
EMBank is a native-digital, fintech-friendly, API-first bank. We have a Banking-as-a-Service model in place, and we also provide traditional corporate banking services. We embrace digital transformation in financial services and work towards enabling our customers to go through it. Our recent migration to Oracle Cloud is a testament to our commitment to our own digital transformation. This move has enhanced our operational efficiency, improved our ability to serve our customers better, improved data accessibility, ensured compliance with the latest EU banking regulations, and we have reduced our infrastructure costs.
As a relatively new bank with only five years of operation, we naturally have little complexity with legacy systems. Yet, I believe our prioritisation of investing in our own transformation tells a story.
The Road Ahead
The future of banking is digital. Embracing new technologies and modernising core systems is no longer optional or limited to tactical or even strategic solutions; it had better be made with a transformative focus and the budget it entails. Banks successfully navigating this transformation will be better positioned to meet customer expectations, comply with regulations, and drive growth.
While the journey is fraught with challenges, it offers unparalleled opportunities for growth and innovation. By adopting a strategic, phased approach and focusing on technology and people, banks can successfully transition to a new era of digital banking.
For more insights and detailed reports on banking transformation, let me share some of my resources:
https://www.ecb.europa.eu/press/key/date/2024/html/ecb.sp240514~aff1495bc4.en.html
https://gitnux.org/core-banking-industry/
https://www.techmagic.co/blog/core-banking-modernization/
https://www.10xbanking.com/engineering/rethinking-core-banking
https://www.temenos.com/insights/white-papers-reports/modernising-banks-europe-ibsi/
https://www.bcg.com/publications/2023/future-of-fintech-and-banking
