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Date: 25/02/2019

Title: Banking is Necessary, Banks are Not? Redefine Your Operating Model in Time!

Teaser: The banking industry and its underlying operating model are under pressure from multiple angles. Modernizing the core banking system and establishing an IT archtitecture driven by modular and harmonized applications are the key to success.

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Banking Is Necessary, Banks Are Not? Redefine Your Operating Model in Time!

Technology has already changed the business models of many banks, but some operating models have been slow to catch up. Modernizing the core banking system and establishing an IT archtitecture driven by modular and harmonized applications are the key to success.

Authors: Lukas Hohl | Dr. Simon Alioth

The banking industry and its underlying operating model are under pressure from multiple angles. New technologies like blockchain and artificial intelligence have emerged and are impacting the business models of banks.

Digitalization of the business model

To respond to these industry challenges, banks have begun to adapt their business models. Many banks have embraced the new technologies or are in the midst of doing so. Unfortunately, corresponding changes to their underlying operating models often lag behind this embrace. There is a strong need to realign this part of the bank’s core functions (see fig. 1). So, what does «realign» mean from an IT architecture point of view?

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Fig 1: Building an IT architecture with an API layer

«Many banks have embraced new technology. Unfortunately, the corresponding changes to the operating models often lag behind.»

In recent years, digitalization has created opportunities for new business models across various industries. An example are the fintechs mentioned above. These fintechs are putting mounting pressure on banks to digitalize faster and innovate. The banks not only want to retain their customers but win new ones from the younger generation, e.g. millennials. Though fintechs were once seen as a major threat to incumbent banks, time has shown that embracing these newcomers may at times be more beneficial than competing with them. Challenger banks, which are new and fully digital banks, are increasing competition, especially in Europe. Though these banks are not as prevalent in the US as they are in Europe, they will likely make a significant impact in the US as well.

«Core banking system modernization and the adoption of microservice-driven architecture are key to realigning the operating model.»

It is also worth noting that many banks continue to invest heavily in new products and services. By offering existing products and services through new channels, such as via mobile devices, banks have improved the customer experience. These digitalization initiatives have had an impact on existing business models and on the underlying operating model. Changes driven by regulatory requirements have also had an impact.

By not digitalizing, banks will lower their profitability and lessen the chance to connect with new and existing customers. The operating models of many banks will need to be realigned given the impact of digitalization on existing business models as well as the ever-changing regulatory landscape.

Additionally, to keep up with the fast-paced digital innovation, investments have largely focused on end-user applications. This has helped banks to be seen as innovative and more digital friendly.

However, in many cases these actions have led to operational inefficiency. There are several reasons for this. One is a lack of integration between applications resulting in a siloed data flow. More often, however, the reason is the legacy core that does not allow seamless integration of tools from front to back of an organization. Moreover, M&A activity has led many banks to have several core legacy systems. These legacy systems are often not harmonized or exist as multiple back-end systems catering to a specific set of products. This complicates the creation of a holistic view of the information for both the client and financial advisor.

There are two ways of addressing the above-mentioned challenges to remain successful in the long-run:

  • Microservice-driven architecture
  • Core banking system modernization

Microservice-driven architecture

Establishing an ecosystem of software partners is important to excel amid rapid innovation. Banks cannot do all the application development in house as they have in the past if they want to focus on key competences and stay competitive. A microservice-driven architecture, that is an architecture driven by modular, independently deployable and harmonized applications, is crucial.

The innovation cycles of core banking systems are less frequent than the innovation cycles for client and advisor facing applications. To guarantee seamless integration of the two, banks need to build up their architecture so that it fully supports application programming interfaces (APIs). The API concept is nothing new. To «fully» support APIs, the use of standardized interfaces that enable seamless integration will save time and money. This can be done through a proper service orchestration layer that accommodates seamless integration of a new innovative solution and also complies with recent market directives such as the revised Payment Services Directive, PSD2 in Europe (see fig. 2).

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Fig. 2: Aligning the business and operating model competing successfully and sustainably

Core banking system modernization

Banks are spending a significant amount of their IT budget on running existing IT systems. This allows only specific parts to be modernized. A simple upgrade of your core banking system will likely not have the desired impact in terms of digitalizing processes from front to back. Banks should therefore consider replacing their legacy core banking systems to build a base for future innovation. This can lead to new opportunities to consolidate multiple legacy systems, reducing operational expenditures and mitigating operational risks in the process. In addition, a core banking replacement allows for the business to scale much easier as it grows.

«Banks cannot do all application development in-house if they want to stay competitive.»

A modern core banking system is designed and built in a modular way. This allows flexibility to decide whether a specific system module will be implemented as part of the existing core banking system or if external solutions will be interfaced instead. The latter results in a hybrid model with best-ofbreed applications seamlessly integrated with the core banking system.

Conclusion

Many banks are embracing digitalization but are taking time to make the corresponding changes to underlying operational models. Given rapid technological innovation, investments in modernizing those models will pay off in improved operational efficiency and lower cost. Core banking system modernization and adoption of the microservice-driven architecture are major investments in realigning a bank’s operating model.

Redefining the operating model will increase the ability to innovate, resulting in a positive influence on the top line due to a better client experience.

Contact

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Simon Alioth

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