The New Urgency Behind Core Modernization

At the dawn of the new year, growing numbers of retail banks are tackling the project they were inclined to put off in more flush economic times: modernizing their core banking platforms. Four of the nation's top 20 banks are engaged in core system replacements, and more are expected to follow suit this year.

Several forces are driving the trend. With loan losses declining for many banks, pressure to boost revenues, rebuild profitability and jump-start shareholder value is building. But banks face several headwinds in meeting these goals, including a wave of new regulations, declining customer loyalty and more-intense competition.

Revenue streams have been drastically curbed by new fee limits and higher capital requirements. Regulatory costs also will hit the bottom line -- the biggest banks will spend an estimated $20 billion to implement the Dodd-Frank law, according to Standard & Poor's.

In the wake of the financial crisis, banks also will have to work harder to keep customers satisfied. Nearly two-thirds of the retail banking senior executives surveyed recently by Accenture said they see more shopping around, more price sensitivity and less loyalty among consumers. More ominous, perhaps, nearly 70 percent of the bankers expect these new customer behaviors to last indefinitely.

The entry of foreign banks, particularly from Europe, also poses a competitive threat. These banks are raising the bar on operating efficiencies and customer service as they bring their upgraded platforms to the U.S. market, enabling them to operate far more flexibly than U.S. banks that are saddled with multiple, aging legacy systems.

So banks' marching orders are clear: Drive growth in their core businesses by strengthening their ability to generate more sales, create innovative products and retain customers -- while continuing to cut costs.

High Hurdles

Yet, these goals are beyond the reach of many banks because their operating models and technology platforms are simply no longer up to the task. Creaky systems inhibit timely introduction of new products. And the silos within these systems make it extremely difficult for banks to have a single view of their customers, resulting in an inconsistent customer experience across channels and lost opportunities to cross-sell and up-sell.

Banks also struggle to operate efficiently because their core processing architectures are so complex and expensive. Despite several rounds of cost cutting, 80 percent of banks made no efficiency gains as of the end of the third quarter of 2010.

Regulatory compliance will be another challenge. While some of the specifics of the Dodd-Frank law are not yet certain, it is clear that the new regulatory regime will be more demanding of banks. The core platform will have to be adapted and tested to support regulatory changes as they are implemented -- a very costly undertaking with inflexible systems.

A report by Aite Group last year noted how deeply the imperative to upgrade core platforms has spread across the industry. The report estimated that roughly 20 percent of U.S. banks urgently need to replace their core systems or risk losing business to more flexible competitors; and an additional 56 percent would benefit by replacing these systems.

Some banks have resisted modernizing their core systems until they figure out how to transform their traditional operating model -- separate lines of business for each product -- into one that takes a more centralized view of customer relationships. But the industry isn't waiting; some large banks have already begun to make that shift. Banks that fail to revitalize their core systems now will be competitive laggards in a few years when their operations inevitably evolve into a customer-focused model.

An international bank's recent experience in acquiring several financial institutions in Latin America underscores how transforming core technology can improve business performance. After instituting a single technology platform across various Latin American countries, modified to suit local needs, it brought new products to market 75 percent faster than previously and reduced its cost/income ratio from 60 percent to 38 percent. (U.S. banks' cost/income ratios range upwards of 60 percent on average.)

Staying Competitive

Foreign banks often have an advantage in competing for customer wallet share because their core technologies support highly efficient back-office operations. That, in turn, generates savings that can be leveraged to price products more competitively.

Banks that have transformed their core systems can also gain a full view of their customers' relationships with the bank, enabling sales associates to drive additional sales opportunities. Unlike most U.S. banks, which typically sell one to two products per customer, the best-run foreign banks provide as many as five products per customer.

Core system renewals also can help offset the regulatory squeeze on revenue by enabling product bundling. For example, armed with a single view of the customer, banks could bundle a checking account, certificate of deposit and brokerage account together, enticing customers with a higher CD rate or waiver of their monthly checking fees. The ability to package products would give banks an edge over most competitors that, handcuffed by a product-centric view of the world, typically sell a single product at a time.

The banking landscape has changed so much that weaker institutions will continue to disappear. For stronger banks, however, the changing market presents an opportunity to start laying the technology groundwork for long-term profitability and growth as we enter the post-recession world.

About the Author: Fiaz Sindhu is an executive and core banking expert in Accenture's North America banking practice.