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How to Start Your Journey Toward Core Banking Modernization

March 20, 2024

The rise of digital banking platforms and channels has paved the way for fintech advances, enabling businesses and consumers to engage with financial services in more convenient, personalized and contextual ways than ever before. 

The proliferation of digital banking capabilities has reshaped expectations. It’s why there’s been a rapid investment in offering payment solutions that align with today’s customer demands, such as instant payments, embedded finance and buy now, pay later.

This seismic shift toward digital financial services has created a significant challenge for established financial institutions. Despite significant advancements in cloud ecosystems, the legacy banking architecture has remained largely unchanged since the 1960s. Unlike core banking technology platforms, these legacy systems lack the flexibility and scalability required to cater to the evolving needs of today’s customers in banking and payment services. 

Often built decades ago, these legacy systems tend to be siloed, clunky to operate and difficult to build upon–especially compared to the nimble, cloud-based frameworks of newer market entrants, which can quickly build, deploy and integrate new digital financial services using APIs. These monolithic systems that underpin the transaction processing operations of most established FIs simply aren’t up to the task of supporting modern, digital-first financial experiences. 

Faced with this technological disadvantage, established FIs simply can’t compete with fintechs, challenger banks and other digital-native providers when it comes to offering the types of digital financial services that increasingly are becoming table stakes.

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Why core banking modernization is a competitive differentiator 

To stay competitive and maintain market relevance amid financial services’ digital transformation, FIs need to modernize their core banking systems by adopting a next-generation platform capable of rapid innovation to meet the demands of today’s dynamic financial landscape. Although the idea of revamping an entire banking core may seem overwhelming – involving a significant investment of time, effort, expense and business disruption – the consequences of inaction could prove far costlier in the future. 

The Age of Digital Transformation - How Should Banks Adapt?

What’s more, the process of modernizing a banking core does not necessarily require a complete “rip and replace” overhaul. Instead, banks can employ a more incremental strategy, updating certain elements of their tech platform on a piece-by-piece basis – implementing a limited number of modernizations first, and then assessing the results and gauging the return on investment to justify the cost of further upgrades. 

By taking this incremental approach to core banking modernization, banks can adopt the technology necessary to offer their customers must-have payment and financial tools in a maximally cost-effective, minimally disruptive way - in real time, in the channel of their choice. 

But with financial services' digital transformation picking up speed, FIs can’t afford to wait any longer; they must act now to begin the journey toward banking core modernization, lest they risk falling too far behind to catch up. 

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The ROI of core banking modernization 

Simply put, legacy core banking systems are holding financial institutions back – and costing them lots of money. Research from McKinsey found that operating costs for banks still running off of outdated cores averaged 10 times higher than those with next-generation core systems. 

Beyond the high price associated with operation and maintenance, these legacy cores incur an arguably even more significant cost: limiting banks’ ability to effectively provide digital financial services that require a modern banking core, such as real-time payment (RTP) processing and buy now, pay later (BNPL).

Outdated core banking systems also have hindered banks’ adoption of high-potential next-generation distribution models such as banking-as-a-service (BaaS) and embedded finance. In an American Banker study, nearly half (47 percent) of FIs surveyed said complexity with implementation and integration was a hindrance to BaaS adoption – despite the fact that 62 percent of top banking leaders ranked BaaS as a priority. 

In the short term, these technological limitations cause banks to miss out on significant revenue, user engagement, customer acquisition and efficiency benefits that can be gained by providing next-generation financial services. 

Create New Revenue Streams with a New Core Banking System

Looking ahead, the challenge of meeting customers’ rising expectations for digital, personalized and highly contextual services underscores the imperative for FIs to embrace digital transformation and growth. 

This transformation is essential for FIs to enhance their capabilities, establish a dependable, scalable digital banking ecosystem, and remain competitive in the evolving landscape. Failure to deliver these services may result in FIs losing customers to digital-first competitors who are swiftly incorporating features and functionalities that cater to customer preferences. 

In this way, shortcomings in banking core technology may represent a critical – and even existential – threat to an FI’s long-term viability. 

The core banking modernization dilemma FIs must face

The urgency of the issue is not lost on established FIs, who are well-aware of the need to upgrade their legacy core systems. Financial leaders know they must evolve, but many report they are unsure about the ROI, or how to get started. 

In a 2023 report by the American Bankers Association, fewer than half (47 percent) of the nearly 350 banking leaders polled said they were satisfied with their core banking provider, while 42 percent reported being either “extremely” or “somewhat” unsatisfied. 

Meanwhile, 49 percent of c-suite and senior unit executive-level respondents in the American Banker and Galileo study said that implementing a next-gen core banking platform was a top IT priority in the immediate term. 

While financial institutions recognize they need to modernize their legacy core systems, many struggle to figure out the best approach for such a complex, large-scale undertaking. Currently, many FIs are locked into disparate data silos that don’t talk to each other, making it impossible to improve the customer experience, quickly launch new products, reduce operational costs or scale profitably.

Given the central role that core systems play in banks’ day-to-day transaction processing operations, switching to an entirely new system all at once – often referred to as the “big bang” or “rip-and-replace” approach, carries substantial risk of service disruptions and potential failures that could jeopardize the security of customers’ funds and data. 

In a 2023 IDC survey of banks in Asia/Pacific, the biggest pain point for banks when navigating digital transformation was maintaining stability and minimizing downtime (cited by 47 percent of respondents), followed by managing the operational risks of migration (43 percent).

Along with potential operational interruption, installing an entirely new core banking system all at once can involve a significant upfront financial cost. And because the benefits of core modernization will accrue primarily over the longer term, financial institutions – especially smaller FIs – may be wary of making such a large initial outlay with a longer timeline to significant measurable ROI.

Taken together, these risk and cost factors have caused many FIs to delay a fundamental banking core overhaul and instead opt for short-term workarounds and quick fixes – a patchwork approach that lacks scalability, has no development potential and isn’t sustainable over the long run.

Thankfully, for banks willing to implement critical core technology upgrades, while being cautious of potential challenges, there exists a smarter, more strategic approach than resorting to either a drastic rip-and-replace or insufficient patchwork fixes.

A smarter approach to core banking modernization: the core sidecar 

Switching a bank’s entire customer base to a new banking core can be compared to swapping out a plane’s engine while in flight; a risky process replete with the danger of highly disruptive errors – and even catastrophic failure.

By contrast, a sidecar approach to core banking modernization enables an FI to establish a separate core banking system that coexists alongside its legacy core, with the new core only responsible for servicing a limited subset of specific services, products or customer segments. 

For instance, a bank may choose to migrate existing or onboard new customers that use instant payments to the sidecar core as a trial. Or, it could create a unique deposit account, such as a savings account earning both reward points and interest, which might not be feasible on a traditional core. Additionally, an FI could launch a new, digital banking sub-brand that runs on the sidecar core, or use the sidecar to underpin its BaaS and embedded finance integrations and activities. 

While these customer and product segments would run on the new core, the bulk of the bank’s operations would continue to run on its primary, legacy core. This approach would mitigate the effects of any unforeseen disruptions that may take place during implementation of the sidecar core, which would be segregated from the primary core. 

Start Your Bank’s Tech Modernization Journey With This API

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Along with risk mitigation and cost effectiveness, another key advantage of the sidecar model is in allowing for a strategic, phased technological transition, wherein the FI can assess the impact, effectiveness and ROI of the new digital core – and glean valuable operational insights – before gradually migrating more customers and products to the modern core. 

This incremental approach to core banking modernization is gaining traction with financial institutions. Industry research shows that more than half of mid-market banks (those with $10 billion to $100 billion in assets) said they favored a progressive transformation to gradually reduce their dependence on legacy core banking systems. Meanwhile, 40 percent of global banks will be pursuing a sidecar banking core modernization strategy by 2026, IDC projected

Once an FI has confidence that the parallel core is stable, compliant and is delivering on the revenue strategy, it can evaluate its appetite and ability to migrate data and customers to the new core gradually.

And given the powerful advantages of a modern, digital-native, cloud-based banking core, FIs that undertake this approach may well find themselves promoting the “sidecar” core to a much more central role as they continue on the journey to technological transformation. 

By taking a phased approach to implementing an API-centric core banking architecture, FIs can accelerate time to market; offer more connected, personalized experiences; leverage integrations to expand capabilities and build a reliable, scalable digital banking ecosystem.

Start your journey towards core banking modernization today 

Ready to explore how to get started on your journey to modernizing your banking core? Connect with the Galileo Financial Technologies team to learn how you can offer more to your customers. Embrace a multi-core banking platform with integrated payment processing to give you a technology and data strategic advantage with substantial cost savings. Our experts are here to guide you through every step of your digital transformation journey. Let's innovate together.

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