Hollowing the Core: Challenges of Legacy Systems in Modern Banking
Recently, we have all heard of instances where the most prominent banks have been pulled up for tech outages - some even restricted from operating certain business lines. Central Banks the world over have been asking banks to invest in their tech infrastructure and have never been more involved in the tech of the banks they monitor.
This is not a great surprise, given we are usually talking about technology systems that were built two or three decades ago. While the digital revolution has swept through many industries, core banking systems that power operations at financial institutions are still outdated.
Some of the systems date back over 30 years or more! It is not just hard to update and future-proof technology stacks, but it can even be challenging to do even basic maintenance given the skills sets needed for these old stacks are not present in most markets. In this newsletter, we decode the challenges that legacy banking systems face and why financial institutions are warming up to the idea of a tech upgrade.
First let’s take a closer look at Core banking systems and how they came into being.
What is Core Banking and How It Came Into Picture
Core banking refers to the essential systems financing institutions use to manage their end to end operations. These operations can span transaction processing, account management, customer data handling & regulatory compliance.
For a very long time banks used handwritten ledgers for their operations. Early references suggest that Western Union pioneered e-money in the 1870s by transferring funds via telegram. After a lull, technology saw a revival post-World War II as banks began leveraging wartime tech. The first credit card, "Charge-it," was launched in the late 1940s, and banks started investing heavily in mainframe computers in the 1950s.
According to some reports, the earliest core banking systems emerged in the 1980's and automated the process to a large extent. These systems were revolutionary at the time, providing a significant boost in efficiency and accuracy. However, they were designed in an era when the banking environment was much simpler.
COBOL’s Enduring Role…
Another interesting fact. Some of these legacy systems were built on COBOL programming language that was developed in the 1950’s. Talk about tech that never got old but the people did!
It’s no joke when they say the COBOL programmers have since long retired but apparently over 43% of all global banks still use the same code today! In fact, according to a Reuters report in 2017, COBOL powered 95% of all ATM card-swipes and over 80% of credit card transactions! The skill set is no more available in the market which in turn makes it difficult for the systems to be efficient!
Enter Digital Banking & the Challenges in Legacy Systems
While banking technology evolved, the dot-com boom in the 1990’s and late 2000’s raised a lot of expectations from the customer. They wanted seamless, digital experiences offered by tech giants like Google & Apple for financial services as well. After the collapse of many traditional banks in the 2008 global financial crisis, the ones that survived had to enhance digital experience to restore customer trust. It was around the same time that the popularity of neobanks increased as they offered cutting edge technology for digital banking.
As Banking got more complex, the legacy systems tried to catch up by adding multiple features to the core banking systems. However it ended up making the systems more complex resulting in high costs and operational risks.
Here are the challenges financial institutions face due to legacy systems:
Complexity and Maintenance
One of the most significant challenges with legacy core banking systems is their complexity. Over the years, these systems have become a tangled web of interdependent applications. Someone has even referred to them as "spaghetti code." This rigidity stifles innovation and makes it challenging for banks to quickly roll out new products or services.
High Costs
Turns out, maintaining these outdated systems is also incredibly costly. Banks worldwide spend millions of dollars annually just to keep their core systems operational. These expenses cover everything from regular maintenance and updates to dealing with unexpected outages and issues. According to a report by Tech Mahindra, banks end up spending close to 40% of their “run the bank budget” on maintenance of these legacy systems.
Operational Risks
Legacy core banking systems are expected to handle high volumes of transactions with zero downtime. And, this need is only going to grow. We have seen instances of system failures and outages and they pose a massive operational risk.Prolonged system downtimes have attracted regulatory scrutiny, damaged customer trust, and resulted in substantial financial losses. Modern cyber threats have also become a cause of concern.
Customer Experience
In today's digital age, customers expect seamless, personalized, and instant banking experiences. Legacy systems have struggled to integrate with modern digital platforms like mobile banking solutions. This disconnect between what customers expect and what legacy systems can deliver leads to a poor customer experience, driving customers towards more agile and innovative fintech competitors
Time for a Tech Upgrade… Call for ‘Hollow the core’
Increasingly financial institutions are releasing that the solution is to embrace a "Hollow the core" strategy. “Hollow the core” means componentisation. By adopting microservices architecture, they can simplify complex features by breaking down monolithic applications into smaller manageable components.
For example the basic ledger, accounting modules can be part of the core, while specific product offerings like personal loans etc are built on top of it. Regulatory updates can be another external component built on top of the core. This component based architecture makes the core extremely lightweight allowing banks to launch multiple products/features effortlessly.
Why are Banks not making the switch then, you may ask. A Banker recently told me that while they struggle with their systems, the idea to make the shift is a scary and tedious one! ‘Think of it like a heart transplant’, he told me.
It is here new age companies building agile solutions can help. Banks can start off by using components to enhance their operations before they slowly transition. Not only are the legacy systems slowing them down, the cost of maintenance is not making sense as well!
Conclusion
It is becoming evident that financial institutions that don’t upgrade will miss the bus of innovation. They will not only find it difficult to compete with more agile and innovative players, the cost of maintaining the systems will only grow over time.
Ultimately, banks that prioritise upgrading their core systems will be better positioned to meet the demands of the future. They will be able to offer superior customer experiences and respond better to changing needs of the market. The time for a big upgrade is now, and banks that don't act risk being left behind.
