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By Christine Barry, analyst, Celent Communications
By Christine Barry, analyst, Celent Communications
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Core Systems Replacement - The Time Is Now

Going forward, it will be almost impossible for a large financial institution to remain competitive without replacing its core system. That's why Celent predicts that up to half of the top 100 global banks will replace their core banking systems within the next few years.

Core banking solutions are one of the few technologies in the banking industry still dominated by proprietary in-house systems. In fact, most large financial institutions are still running mainframe systems built during the 1960s and 1970s. Many have been forced--at considerable expense--to maintain and develop new functionality for these systems in order to meet new needs. Today, many are questioning whether or not it still makes sense to continue, year after year, to add more applications to inflexible, antiquated systems. For many the time for core systems replacement has finally come.

Most institutions are proceeding with caution, however, as a core system replacement is perhaps the most complex IT project a bank can undertake. The risks as well as the costs are high, with most projects typically lasting several years depending upon the structure of the bank. A full replacement at a domestic bank with branches within only one country is estimated to take approximately 1-3 years, while institutions with more geographically dispersed branches take an average of 3-4 years. Projects can run several hundred million dollars.

In fact, Celent predicts that the top 100 global institutions will spend in aggregate, approximately $3.0 billion in 2003 and approximately $6.5 billion in 2005 on new core banking software, hardware and services. Those projections assume approximately 10-20 of those institutions will replace their core systems each year for the next few years.

The idea of a bank replacing its core system is not new. In fact, several large banks attempted to do so during the 1980s and 1990s, but almost all met with failure as the projects fell short of expectations and proved to be unmanageable. The most difficult hurdle was catching up with the capabilities of existing core systems. New systems had to first offer exactly the same set of features as the mainframe systems. However, these mainframe systems were not static targets--new modules were constantly being added. As a result, the systems could never reach their goals. Few banks have forgotten this experience of trying and failing.

Many banks now realize that such a project is too large to take on alone and are turning to licensed/packaged solutions instead. Packaged solutions promise flexibility, faster time-to-market, greater efficiency, and a single view of the customer. While the costs are still high, these solutions promise greater success in implementation and the ability to better handle market demands. Whereas in the past, packaged solutions were often only used by small and mid-sized financial institutions, today even large global institutions such as Citigroup are deploying them. This represents a major paradigm shift for the industry.

Reasons for Replacement:

Despite the costs and risks associated with core systems replacement, there are several factors continuing to push financial institutions in this direction:

Greater Flexibility and Efficiency. Before open systems and standards were available or widely used, core banking systems were created in closed proprietary environments, making communication with and adoption of new technologies and databases, extremely costly and difficult. This lack of flexibility frequently makes building new functionality into the systems and accessing customer information a challenge. Some banks, for example, have as many as 120 different banking applications operating simultaneously. With so many systems unable to communicate, functions as simple as an address change become nearly impossible to perform. Newer systems are more adaptable and integrate more easily with new third-party applications. They are database-centric (allowing easy retrieval of information), modular (allowing changes to be made to one part, without repercussions in others), and flexible (allowing new functionality to be readily added).

Focus on CRM. When older systems were built, data storage was expensive and archiving was minimal. Today, storage is much cheaper and management of information and CRM often is the difference between success and failure. Banks' core systems must be capable of not only storing customer data but also making it easily accessible to bank employees to provide more personalized service and recognize cross-selling opportunities. Unlike older solutions, new systems use data-mining tools and the bank's customer information file to make information easy to access and use. They work on the premise that bank personnel should be able to see the entire cus-tomer relationship during a transaction. In this way, new solutions are more cus-tomer-centric than older ones, which were transaction- and account-based.

Obsolete Technology. As mentioned previously, core banking systems are often antiquated using the technology from the 1960's and 1970's. Most banks continue to use these mainframe-based applications, written in Cobol or even older programming languages. In addition to problems associated with inflexibility, older technologies are costly to maintain and less efficient.

Old systems have been squeezed dry. Over the past two or three years, banks have placed an increasing level of pressure on management to squeeze all possible efficiencies out of existing systems. Virtually every major bank in the world has implemented, with varying degrees of success, initiatives to keep costs within very tight bounds and to reduce those costs wherever possible. In the next one to two years, most banks will find that few opportunities to cut costs remain within existing infrastructures and that further reductions in expenses are not feasible without seriously undermining and endangering the ongoing operations of the bank.

Conclusion:

Going forward, it will be almost impossible for a large financial institution to remain competitive without replacing its core system. While transactions have not changed much over the last few decades, external requirements have. Customer expectations are greater, as is the need for information. Older systems are too difficult to integrate and making changes within them are at times impossible. Financial institutions also face external pressures, like Basle II, which have placed new requirements on their already overburdened systems.

Despite these factors, replacement projects among large financial institutions have been slow to take off. Fear as well as cost continues to make institutions hesitant. Celent expects that some will continue to hesitate as they watch to see the success rates of industry leaders. Momentum will increase, however, as current systems increasingly hamper productivity, leaving many of the largest institutions with little choice but to replace their core systems. For many, the time has come and they are ready to take the plunge.

Christine Barry is an analyst in the wholesale banking group at Celent Communications where she covers topics such as cash management, small business banking, commercial lending, and secondary loan trading. Celent is a financial services research and consulting company headquartered in Boston, Massachusetts. You may reach Ms. Barry at [email protected]

This article originally appeared in Bank Systems & Technology eNEWS,a weekly e-mail newsletter. To order a free subscription, click here:www.submag.com/sub/by?tc=1&wp=wpdly1&pk=WMNE

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