Innovation doesn’t have to become collateral damage to FI legacy system budgets

Technology investment has continued apace and, according to Gartner, IT spending in the banking and investment services market is forecast to increase by 8.7% in 2024 and is expected to reach $1 trillion by 2028. But even with all this money being thrown at IT, many Financial Institutions (FIs) are still unable to deliver the innovation they need to attract future customers, held hostage by legacy systems that consume the lion’s share of their tech budget. 

One of the biggest struggles for Tier 1 traditional banks is to ensure they have properly modernised their core in order to stay competitive, boost operational efficiency, and meet evolving customer expectations. However, legacy systems are consistantly shown to hold banks back when it comes to innovation - specifically when it comes to the use of emerging tech. Legacy systems more often than not still process, run and manage vital functions and hold much of the data that keeps operations running. 

Forrester research into global legacy systems shows that when it comes to ATM usage, around 95% of transactions are still run on old Cobol programmes. The computer programming language was commonly used by FIs in the 80s and 90s and Forrester reckons that around 220 billion lines of the code are still used in production around the world today. 

There is a lot of talk about AI, like the TuringBot, being used to deal with legacy code, but we are still seeing most FIs relying on those very rare skills that are proficient in Cobol or the older versions of Java. What many of the Tier One banks are doing is taking a hard look at their legacy systems and determining what is essential for them and depreciating everything else. If they do manage to find innovative workarounds to these ageing systems they could look at commercialising them and sharing them with other FIs. This is a great revenue opportunity and this innovation could be of huge value to other banks.

Neobanks aren’t immune to the pain of legacy systems

While legacy systems are an immediate pain point for the older, more traditional FIs, neobanks are not immune to the challenges that come with these ageing systems.  

South Africa already has some very successful Neobanks, but when they want to expand their offering, they will have to either get a banking licence (if they don’t have one, which is incredibly expensive and difficult), or partner with an established local bank to roll out services – either way this will require an integration. It’s here that they will hit the same legacy wall their more established competitors are facing. 

Regulators could force modernisation  

It’s clear that the challenges of legacy systems are holding the entire FI ecosystem back, and one of the big industry challenges would be to find ways to incentivise FIs, as well the legacy core providers, to modernise. 

The EU regulators really made a huge difference with their enabling PSD2 regulations, making it much easier for fintechs to connect with FIs and injecting innovative offerings into the market that really benefit consumers. Regulators could also take a view on the potential for system risk that comes with legacy systems. While there are criteria on how banks must report to central banks, there are no technology standards on how that reporting should happen. If there was standardisation this could force institutions to update their core and would ultimately drive the industry modernisation. 

While middleware platforms, acting as the glue between a bank and a third-party provider they want to integrate with, are a major means for FIs to overcome many of the challenges of legacy systems, he also acknowledges that having the additional help from a bottom-up drive, such as the regulatory option would ultimately benefit the entire industry.  

The established institutions still control so much of the greater financial ecosystem. And, while APIs sit at the top of that ecosystem and are facilitating some great new products, there is still so much that needs to change deep within these ageing systems that dominate the industry. A meaningful resolution to the challenge requires a multi-pronged attack. We believe that another solution to add to the mix is the use of central bank digital currencies. 

To this end, the South African Reserve Bank (SARB) has confirmed that it is progressing its central bank digital currency (CBDC) work as part of Project Khokha 2x. This will focus on a wholesale CBDC and bank-issued stablecoins that will be used for regional payments in Africa. The ZARP stablecoin has been a notable South African example. 

Limiting core functionality 

By keeping the legacy cores as a utility, limiting its functions and focussing solely on keeping the regulators happy, it would allow affected FIs to get on with the business of innovating new products and services relevant to current and future customers - whether through its’ own development, or by partnering with agile fintechs. 

Institutions should also examine the viability of a co-existent core. These new players plug their core alongside the existing legacy one and then offer the new products through the new core. 

Along with middleware platforms, FIs can provide an additional layer that will give them a single view of the customer, allowing the delivery of new products with exactly the same user experience, despite running on a different core. So a customer may have three accounts, and the two of them are serviced by the legacy core and one service by the new age core. This allows banks to migrate to the new core over time without a massive capital outlay or the operational risk. 

It’s clear the challenge of legacy systems is weighing heavy on the FI industry. Their useful lifespan is well and truly over and they are impeding the vital innovation that is necessary to keep institutions relevant. Far more than a simple budgetary headache, addressing legacy systems is a sectoral challenge and, if the financial sector wants to limit systemic risk, finding collaborative ecosystem-wide solutions is the only way to sustainably solve the issue.