B ANKING I NFORMATION S YSTEMS

BANKING INFORMATION SYSTEMS LECTURE 8

Core banking system Definition: •  They are applications responsible for processing and posting transactions in the domains of payments, current and saving accounts, loans and securities. •  Today’s solutions are capable of completing these tasks in an integrated, browser-based environment across multiple delivery channels.

•  Replacing a core banking system is often compared with replacing the engine of a Boeing 747 in mid-air. •  Experts consider core banking replacement to be the most complex, risky and expensive IT project that any bank can undertake. •  A core banking system forms the backbone of a bank’s IT infrastructure and contains records of all customer transactions and the processing of those transactions. •  A minor error in this area can cause a bank’s entire system to crash, tarnishing its reputation in the process. •  Two factors stand in the way: risk, and complexity.

CBS Complexity •  Technology is a key driver of change: flexible development, speed to market, real-time processing and a single view of the customer across all lines of business. •  Many of the largest institutions are still battling with the self-imposed handicap of old- fashioned, outmoded and inadequate core systems.

CBS Risks •  The costs as well as the risks are high, but the benefits are far greater. •  Financial institutions that have already announced plans to undertake such projects, will quickly reap the benefits and set an example for others in the industry. •  They will benefit: 1. Greater efficiency 2. Easier access to information 3. The ability to add new applications without the fear of system crashes •  Memories of failed attempts continue to haunt many in the industry, however, making progress slow (one of the largest banks in the world spent around $ 1 billion in the 1990s and still did not succeed!). •  Getting approval for projects of this scale is also very difficult because banks are currently trying to cut costs.

CBS Costs •  The project budgets required for software and service are huge: up to € 250 million in extreme cases. • Software and services costs for European banks’ renewal initiatives, spread over at least ten years, will be in the € 100 billion range.

Core Banking Market •  A Forrester research study in October 2005 stated that banks are racing to renew their banking platforms. •  46% of European banks had already started to renew their application, 23% planned to do so. •  The smaller banks began earlier.

Core Banking Market •  Most of the top-tier banks in Europe are now busy replacing their legacy systems with a single global system. •  Europe identify it as a key opportunity, contrary to the US market, in which large banks in particular are still reluctant to proceed. •  In Australia, the big four started to select and replace the old systems, and the same applies to Russia. •  There is a great deal of activity in the very large consumer markets of India and China. India started a few years ago, while in China - especially in the last few years - banks have been very actively implementing modern systems in their extremely fast-growing operations.

Major Drivers for CBS Replacement § The severity of regulatory requirements and penalties; § The appeal of a component approach (SOA - Service Oriented Architecture - and BPM - Business Process Management); § A strong focus on architecture for the industrialization of banking, infrastructure and multi-channel enablement; § Availability of global resources to tackle back-office systems; §Industrialization and the shift to transaction banking for core banking back-office systems; § New cross-border mergers and acquisitions wave in the European financial services industry.

CBS Clients 1. Retail/ Consumer Banking 2. Wholesale/ Corporate Banking 3. Others

1. Retail / Consumer Banking •  The most important issues in top-tier retail banks are volume handling and mass products. •  Ability to manage large volumes of data is the main challenge for core banking software. •  Only recently, packaged solutions have become available which have overcome the technical challenges in replacing the 30-year- old legacy solutions that are predominant in the hearts of the top-tier banks. •  Retail banking represents the most significant source of income for the global financial services industry. •  The key differentiator between market leaders and poor performers will be profitable growth rather than cost cut- ting to improve profits in the long run.

Findings •  Banks feel increasingly limited by the capabilities of their existing core banking systems. 1. Lack of flexibility is causing the most pain in banks’ current core processing applications; 2. Technology influencers are still dominated by cost considerations as the total cost of ownership becomes increasingly important; 3. Complexity of implementation is a key challenge for retail banks.

2. Wholesale/ Corporate Banking •  The core banking market for wholesale/corporate banking is not as large and as fast-changing as the core banking market for retail banking. •  Some interesting trends: 1. A single core banking system is increasingly being chosen for both wholesale and retail operations. 2. A global roll out of a centralized system with central data. The corporate banks (and their clients) want an integrated global view of the customer with the possibility for treasury departments to have transparent online and daily insight to all accounts globally.

3. Others •  There are some other interesting developments regarding core banking solutions: 1) Start-up of banking activities in new (emerging) markets. Sometimes this is carried out by existing banks from other countries, sometimes by other companies. The internet is usually used as a delivery channel and business can be conducted using a bank-in-a-box solution (less risk); 2) Finance departments/subsidiaries of car companies oLen choose core banking solutions for their finance activities; 3) Retailers are also offering retail banking for their consumers in order to improve customer retention; 4) Major corporates are developing in-house banking capabilities, often not only for their own company, but also for the outside world.

Core Banking Domains 1. Payments and Cash Management 2. Savings 3. Loans and Mortgages 4.Securities

1. Payments and Cash Management •  Compliance, in particular and cost reduction are the main drivers for renewal of back-office systems. •  Leading banks, which saw payments as a back-office issue, are now tending to bring payments much more to the forefront. •  The processing of payments, domestic and cross-border, with clearing houses and correspondents but also with strategic sourcing, is at the top of the board’s strategy agenda. •  To be among the major players in SEPA, a bank will need to process at least five billion payments transactions a year.

1. Payments and Cash Management •  Banks are looking to develop a unified and integrated payments infrastructure, which would essentially blur distinctions between various payment types: check, cash, debit, credit and e- and m-payments. •  Payments need to be seen as transparent both to the organization and the consumer.

2. Savings •  As in many other markets, the old and long- established savings market is undergoing major change. •  Previously banks offer a simple and straightforward savings product differentiated only on the basis of interest rate. •  Now, a dynamic and increasingly competitive market, combined with a more demanding customer, is forcing banks to reinvent their savings product strategies.

2. Savings •  Primarily, the financial legislation landscape continues to change as many governments worldwide are revising laws to open up markets and meet the current standards for integrity, transparency, and duty of care. •  While on the one hand this is causing banks to revise their current products and hence increase cost and competition, it is also creating opportunities for them to create new (combined) savings products.

2. Savings •  Security investments, bonus interest, pension savings, and mutual fund savings are still common. • Reduction in the number of branches is slowly continuing, preference for internet savings accounts is steadily increasing and people are moving their cash around more easily to different accounts.

2. Savings •  Leading banks are forced to increase their range of savings products and place greater emphasis on product development. Targeting multiple, segmented parts of the market with a high number of savings products seems necessary in order to contend with the competition. •  The need for savings products is forcing banks to cope with higher volumes over a wider product range and requires a greater focus on product, process and system development and adaptation.

3. Loans and Mortgages •  Mortgage offers have included a wide range of implicit features, with no provision for the customer to decline them. Some trends are: 1. The development of a price-driven market is leading mortgage providers to make these features more explicit and optional for the customer. In return for fewer features (and less flexibility), the customer gets a lower rate. 2. A second trend in the mortgage market is the concentration in the intermediary distribution channel, with resulting complications for the banking systems. 3. The third major trend in consumer finance is a shiL in the pricing strategy towards risk-based pricing. The personal risk profile of a customer will be the main factor for the price of a product. 4. Finally, new legislation and regulation are having an impact on the products offered in the mortgage and consumer finance domain.

Changes Required for CBS to Support the Trends 1. More transparent and understandable products due to national and international legislation and regulation; 2. Break-up of the mortgage product into elements that can be included or excluded; 3. Straight-through processing to meet the demands of the concentrated buying power of intermediary organizations;

Changes Required for CBS to Support the Trends 4.Reintroduction of the personal loan. 5. Flexible credit lines have proved to be too risky for some customers and they want more controlled finance: the personal loan; 6.Introduction of risk-based pricing. Each customer is offered a price in line with his personal risk profile; 7. New products such as tax-friendly bank savings, which enable banks to compete with insurance companies in tax-friendly products.

4. Securities •  There are a number of drivers of change in the European securities market. •  Regulatory changes, for example, will come from multiple initiatives (market, local government and EU) towards an efficient cross-border securities clearing and settlement environment through the harmonization of: - Market rules and practices; - Regulatory, legal and tax differences.

B ANKING I NFORMATION S YSTEMS