Core banking – fintech’s final frontier

If it ain’t broke, don’t fix it. This idiom has acted as a rule of thumb for core banking solution for several years. While analysts has claimed repeatedly that  legacy IT is slowing incumbents down, the existing and sometime ancient core banking systems still work flawlessly. Although, even if something works an upgrade is due when the world around is moving at an increasingly rapid pace.

A majority of bankers consider the cost of maintaining core legacy systems on of their major challenges, and the majority of IT budgets are spent on incrementally improving and maintaining legacy core systems.

While incumbent banks are built around traditional core banking systems, the center of gravity for challengers differ from incumbents. While incumbents built around core banking, challengers like Fidor shift the center of gravity from the traditional core banking view to focus on their API layer. This enables Fidor to maintain a strategic position where anyone can innovate on top of the Fidor platform.

Just like the PC replaced mainframes, changing customer behavior and new digital solutions is forcing banking solutions away from vertical integration to horizontal layers, where user experience and relevance is imperative the closer you get to the user. This becomes even more prevalent with the implementation of PSD2, which forces banks to open up their APIs to third parties. This development favors born-digital challenger banks who are able to build around their APIs and create a new wave of consumer-friendly services that utilize data and services from both their own and third party middle layers via APIs.

Fintech startups have so far been focused on innovating around the traditional core of banking. However, ThoughtMachine is looking to change that with a banking operating system called Vault OS. The solution is cloud-based, and is based on a private blockchain with cryptographic ledgers for security. Furthermore, in addition to providing flexible products based on machine learning and smart contracts the company claims to solve compliance hurdles through automatic and real time reporting of standards like Basel III. Deloitte is also taking a swing at core banking, and has announced that they are partnering with five blockchain startups to build a new core banking system, and Fidor is exploring both Ripple for transaction banking and Ethereum to replicate basic customer accounts.

A blockchain-based approach to core banking could act as a catalyst to fracture the monolithic and vertically integrated approach to core banking. A modular approach to lending, syndication, capital markets could utilize blockchain to tie it all together. All the other elements of transactions management, integrity of transactions, messaging, etc. are inherent features of blockchain. Blockchain is also well suited for digital identity management, enabling efficient KYC and AML procedures as well as an immutable customer perspective across platforms and channels.

While replacing the core banking solution could be considered undergoing an open-heart surgery during a marathon, fortunately some incumbents are audacious enough to embark on this journey. Both SpareBank 1 and Nordea are in the process of replacing and renewing their core banking solutions.

However, when renewing core banking solutions it is not sufficient to modernize architecture, update coding language and comply with industry standards. A core banking renewal should be considered a catalyst for process revision and renewal as well as radical product simplification.

Chris Skinner states several benefits for renewing core banking systems on his blog:

• Real-time provision of service
• Consistency of data
• Ability to leverage deep data analytics
• Single view of the customer
• Enterprise information leverage
• Consolidated risk management

Looking at the development, every layer of the traditional core banking architecture is at play.

• The front-end is moving from proprietary digital channels (online and mobile banking interfaces) to a vast array of personalized interfaces, chatbots (made possible by data analytics and machine learning) and APIs
• Real time becomes a prerequisite for transaction banking, data flow and personalization as well as risk and compliance
• A modular design based on microservices provide the necessary agility to respond to a changing landscape for financial services
• Blockchain could disrupt the core infrastructure and force us to rethink the whole concept of core in core banking solutions

In my opinion, the core-banking solution of the future should be based on a modular design, centered around the customer relationship and API-layer in order to maintain focus on a customer-centric banking-model.