The mainstream acceptance of the cloud as a practical deployment option presents new opportunities for financial services institutions, especially for community banks. A decade ago the cloud was reserved for edge applications like CRM and HR, but today deposits and lending solutions can be offered effectively, efficiently, and securely in the cloud.

The State of Core Transformation

To appreciate why the cloud is just becoming a viable option for core transformation, we need to understand the history of recent core replacements. These fall into two categories:  small bank and large bank. Core replacements at small banks tend to be more successful than at large FSIs. Attaining more favorable contract terms and/or being dissatisfied with incumbent providers drive many of these like-for-like, “bank-in-a-box” replacements. Approximately 200 core platform conversions take place each year within the 4,500+ community banks. For the top 100 banks, it is a different story with only a handful of enterprise core deposits systems replaced over the past two decades.

It’s not surprising that core transformation has lagged at the large banks. At big banks, enterprise core replacements typically come with price tags in the hundreds of millions of dollars and take years to complete with many projects failing or being abandoned along the way. No doubt some bank CIOs fear that CIO can stand for Career Is Over. For large bank CIOs, replacing the core deposits platform is often way too risky to consider or best left to be the next CIO’s problem. The common analogy made for core replacement is “heart transplant surgery”. There are few, if any, on time and under budget successful core replacement stories for CIOs to emulate within the Top 100 Banks.

Barriers to Core Replacement

Most big banks still rely on a multitude of overly complex, outdated applications written in obsolete programming languages to run their businesses. As expected, these systems also have very high total costs of ownership. When many of these legacy core platforms were first offered, they were built for a single channel, the branch, and a dominant payment mechanism, the check. There were no ATMs, interstate banking laws, call centers, online banking applications, mobile banking, etc. This software basically provided (a) system-of-record of customer balances and transactions and (b) posting logic to the general ledger. Over the past 40+ years, these batch processing systems were hastily retrofitted to deal with changing regulations, new business models, evolving market practices, more non-recourse transactions, emerging channels, etc. For large banks, it has proven to be extremely difficult, costly and time consuming to replicate five decades of systems evolution into a next generation platform.

Small banks don’t have it easy either; they also face a dilemma in swapping out core. Community banks traditionally have had many viable options for their core banking platforms. The Big 4 core providers each offer several “bank-in-a-box” platforms mostly acquired from their M&A activity.  As such, these platforms each compete internally for scarce R&D investments. For a new customer, there is considerable risk of not selecting the “surviving” platform lest your bank be forced to convert to another one sooner than expected. Most bank-in-a-box platforms have become so dated and commoditized, that it is essentially a “Ford vs. Chevy” debate as to which one is the best fit. Additionally, platform limitations make it increasingly difficult for community banks to compete technologically with their cross-town, big bank rivals.  A few years ago, a Wall Street Journal article told of the frustrations of community banks in offering Zelle® stemming from core providers’ lack of integration. Around the same time, the American Bankers Association published its “Principles for Strong Bank-Core Provider Relationships” and set up a core platforms committee to understand alternatives to the Big 4, so their community bank members could have better choices.

Core in the Cloud

With the cloud, things change for all banks. By definition, the cloud is elastic and can be deployed across the bank, for vertical E2E lines-of-business or for horizontal enterprise services. Banks can mitigate core replacement risk by taking an end-to-end approach of migrating select functionality to the core.  

Three Areas for Banks to Consider for Embarking on a Core Transformation Journey:

1. Launching New Business Models:  A great place to start is by using the cloud to launch new business models not supported by the legacy platform or by prioritizing the migration of products that are suboptimal on the existing core to the cloud. Get it right, and then move on to the next area for migration. This progressive approach to core transformation will help mitigate the potential risks of “big bang” conversions while accelerating speed-to-value. True this approach may take more time and involve running systems in parallel, but the long-term gains and reduced risk are well worth it. Loans are a great area to start with since you can always onboard new loans to the cloud while aging off the existing book.
2. Fitting the Standard: The broader implication of this shift in technological acceptance of the cloud is that banks need to start thinking more “fit-to-standard” than bespoke. In the 1970’s, implementing a new core banking system was considered a competitive differentiator as most bank still relied on physical ledgers, customer passbooks and numerous manual bookkeeping processes. Today, banks’ processing is fully automated, so differentiation occurs via other aspects such as customer experience, pricing, convenience, channel technologies, etc. There are few benefits to maintaining highly complex, custom deposit processing and loan servicing backend solutions when these business services can be achieved optimally in the cloud.
3. Becoming an Early Adopter:  Early adoption of a cloud-based core banking platform has its advantages. With the “fit-to-standard” nature of cloud solutions, being able to shape and prioritize the “standard” has considerable value as later adopters will have to wait, adhere to the standard, do their own configurations or face costly customizations. By co-innovating with a cloud provider, banks can achieve the very best of both worlds:  a tailored solution to fit their immediate and future needs closely coupled with the agility, elasticity, and cost effectiveness of the cloud.

In Closing

For small banks, the cloud presents a unique opportunity to adopt the robust solutions built for the biggest-of-the-big, but for an affordable subscription price. The widespread use of configurable parameters, conditions and user defined fields make modern cloud solutions highly agile. These cloud solutions are also easier to integrate since considerable data and services are exposed via published APIs. As the public cloud matures and banks become more open to leveraging a “fit-to-standard” approach, core banking implementations and total costs of ownership should plummet.