By Alfred Escala Sisquellas, Vice President, Banking and Financial Markets, IBM
Most major banks will have had application modernisation as a strategic agenda for several years now, however the process has been challenging due to the high stakes involved. At the same time as transforming the core of their applications, banks need to continue to provide operational resilience, pervasive security, and comply with the sector’s inherently complex regulatory requirements.
Some banks have opted to persevere with many legacy applications as a result, leaving new technologies just to new applications and hence ending up with two worlds – the legacy and the new. These hybrid architectures are sometimes inefficient, complex to maintain and have made it difficult to introduce new products and services to adapt to COVID-19 uncertainty, or to identify new revenue streams to offset what are historically low interest rates.
In a survey this year, we found that 58% of Europe’s top 50 major banks consider total cost reduction as the top strategic driver for application modernisation, followed by technology strategy at 22% and reacting to competition at 20%. Application modernisation is now an urgent priority for banks and continued hesitation will see them drowning in what is an increasingly competitive and demanding sector.
The Race for New Revenue
Over the course of the pandemic, interest rates have been locked in at near to 0%, banking fees have decreased dramatically, and many banks posted their lowest returns in years. According to the European Central Bank (ECB) Banking Supervision, the profitability of European banks fell from an already mediocre 6% at the end of 2018 to around 1.5% at the end of 2020.
Many leading banks with a strong capital base were able to absorb the economic losses, while smaller banks relied on Government stimulus efforts to stay afloat. All share the common need to discover new revenue streams and increase profitability to survive in the coming years.
One approach will be launching a host of dedicated sector platforms for vertical customers. An example of this is the Cajamar Cooperative Group in Spain, which has rolled-out a platform called Tierra to provide analysis and monitoring tools for farmers in the agri-food sector and deliver services across the whole industry value chain.
By undergoing an application modernisation process and moving legacy systems to solutions built on cloud, banks can make it easier to access data sets and deliver real-time insights to customers as part of new platform offerings.
The Fintech Threat
As if the economic challenges of the pandemic weren’t enough, customers also spent more time using digital platforms and started to demand more from their online banking systems. According to McKinsey, digital engagement levels have climbed up to 20 percent, the use of cash has halved, and 30-40% of customers have expressed a greater need for advice.
This has resulted in banks coming under new attack from fast-moving technology firms including fintech and digital giants. These companies benefit from being able to innovate with a lower risk profile than incumbent banks – they are not present in the most regulated segments of the banking value chain, allowing them to quickly introduce new platforms and services to meet evolving consumer needs. European regulation, such as PSD2, is unbundling the banking value chain and allowing companies to take on the role of ‘financial product and service distributors’, which are also subject to less regulatory requirements.
Most banks suffer from the burden of legacy technology and inflexible applications that impede productivity gains and jeopardise their time-to-market for delivering new products and services to their clients. Existing core banking systems and applications are linked to past architectures and have not been optimised to take advantage of new technologies. Fintechs are more agile and are therefore getting their share in the most profitable pools of the banking value chain, such as international payments.
This is where application modernisation is so crucial for incumbent banks. By shifting on-premises systems to modern cloud-based solutions, changing their application and data architectures to fulfil their clients demands, and moving to a new micro-services architecture, banks will be able to achieve significant improvements in terms of flexibility, agility and cost reduction allowing them to keep pace with their nimbler counterparts.
The Ecosystem Innovation Opportunity
One rare positive trend of a difficult 18 months for the banking sector, has been increased collaboration between technology and financial services players. Organisations of different sizes, industries and geographies are being brought together on cloud platforms to identify transformative technologies, solve market challenges, and respond to regulatory requirements.
For example, we worked with UK retail and commercial bank TSB to integrate its chat service TSB Smart Agent into its mobile application and use the AI and the advanced natural language processing capabilities of IBM Watson Assistant to improve its conversations with customers. This was critical at the start of the COVID-19 outbreak. We recently announced a milestone of 100 ecosystem partners on IBM Cloud for Financial Services
Over the coming years, we can expect ecosystems to bring a host of exciting new innovations to market that will transform traditional banking models and revitalise the relationship between customers and their financial services providers. However, banks operating on outdated legacy systems will struggle to take advantage of these new financial services innovations.
Application modernisation gives banks the flexibility and scalability to introduce new digital technologies and delivery models on their existing platforms. This will be crucial if these organisations are to maintain pace with agile competitors.
A Simplified Transition
Historically, organisations have avoided application modernisation due to the central position they occupy within banking architecture and concerns about how to maintain those systems in the future. It was a long, uncertain journey which most firms were reluctant to face. Other options such as a total replacement of their core banking systems with packaged solutions could allow for modernisation but risks and uncertainties were still there.
However, the emergence of new technology offerings and management tools has put banks in a better position than ever before to kick off their modernisation journeys. For example, the emergence of open hybrid cloud platforms allows organisations to leverage the most suitable applications for their transformation rather than being tied to the solutions of a specific vendor.
New tools, such as IBM Financial Services Workbench and new industry models such as Banking Industry Architecture Network (BIAN) have become accelerators which reduce both the timeframe but also the risk of application modernisation. While market and business pressures are more acute than ever, banks now have the tools, the reference models, and the partners to successfully deliver this modernisation, de-coupling the client-facing distribution layer from the product manufacturing and transactional layer, enabling them to be more responsive to client needs.
Application modernisation should leverage the current system capabilities and assets and be aligned to the overall strategy of the organisation. It should consider the whole target operating model including products and services, people and culture, processes, partnership strategies and the capacity of the bank to absorb change and manage risk.
It is a process that will underpin the bank’s future operations and prosperity; one which they can no longer afford to delay.
About the Author
Alfred Escala is VP Banking & Financial Markets EMEA Leader since January 2021. He joined IBM in October 2002 through the acquisition of PwC Consulting where he was partner-director of PwC Consulting Spanish Practice. After joining to IBM, Alfred Escala has had several positions in IBM Global Business Services such as Consulting Services Leader for Spain & Portugal, Strategy & Market Director Leader for South West Europe. In 2009 he moved to Global Markets organizations and he was FSS Sector Leader for SPGI (Spain, Portugal, Israel and Greece) and he was responsible for overall IBM business in Banking, Financial Markets & Insurance. In 2014 he became VP responsible for CaixaBank-IBM relationship and Chariman of ITnow (CaixaBank & IBM joint-venture). In 2018 he was appointed VP Cognitive Solutions Leader and Industry Business Development Leader in SPGI. Alfred Escala has deep experience in complex transformation projects in the banking industry, leading large multinational teams across different transformational areas, both at the busines re-engineering side as well as at the IT transformation. Previous to his banking experience, he led large Customer Service & Billing (BSS/OSS) projects at the Telecom Industry.