Long reads

Navigating core banking in Covid-19’s economic climate

Paige McNamee

Paige McNamee

Reporter , Finextra

 At first glance, the premise of attempting to satisfy ever-more demanding consumer expectations seems an obvious pursuit. Yet, delivery of these products in the timeframe and friction-free format that customers crave isn’t always possible, due to the incongruence of ill-equipped core banking architecture and the advanced capabilities required to launch new products and services.

This is an excerpt from Finextra Research’s recent report ‘The Future of Core Banking: The Catalysts Driving the Smart Finance Revolution.’

Party in the front, business in the back

Ezequiel Szafir, CEO, Openbank, believes that core banking does not need to be an obstacle nor an enabler of real time services per se. “Many legacy banks have put in place, for example, data lakes that allow some services to run real time. It is not necessarily efficient, but certainly does the trick.”

Rather, Szafir recommends that there needs to be a clear split between legacy banks and digital banks, given their fundamental differences. He compares the monolithic ‘do it all’ pieces of software of legacy banks with the technological architecture of digital banks, such as Openbank, which push the business logic to the front in the form of microservices. This has the effect of reducing the role of the core banking system to that of a ‘system of record’.

“In the new world, the core banking system is just one more system, albeit still a very an important one. I would argue that naming it ‘core’ is a reflection of a past way of thinking and technology paradigm. Today the core banking system is more like an enterprise resource planning (ERP) system of a large business: it is important, even ‘mission critical’, but it is not the ‘core’ of the business and its technology.”

Of more value these days is the bank’s front end. While historically the web and app were designed to enable clients to perform certain tasks or operations that would otherwise happen over the telephone or at a branch, Szafir believes this challenge of enabling face-to-face operations online is one of the past.

The challenge at present is to effectively digitise the business beyond branch operations because, as we know, these attempts of digitising branch operations fell well short of properly enabling the business to enact what tech companies are excelling at: attracting, engaging and retaining customers.

“For us at Openbank, the front end is the whole software layer that of course includes web and apps, but also the business logic with microservices mesh, and the data layer, that should act as the single source of truth. These elements are the new core because they are indeed core to the ability of a digital bank such as Openbank to attract, engage and retain customers without the need of an extensive branch network.”

Openbank’s approach appears to be paying off, experiencing significant growth during the first eight months of 2020 and now ranks among the fastest growing banks (by customers) in Spain and along with significant boosts in its brokerage accounts and loan book which Szafir argues proves that the model of structurally profitable digital banking is working.

Having their cake and eating it too

Despite a key mantra of meeting consumer expectation, Szafir believes that digital banks are not always able to meet their own goals and unfortunately suffer the limitations of a new industry. Most digital banks have fallen short of becoming official lending institutions, and therefore limit their offering to (mostly) free current accounts and cards. But is this enough?

“Banks, by definition, have to help customers to save, borrow and pay. Most digital banks have decided against or failed when attempting to enter the lending and saving businesses. This decision has deep implications in the business model, one that incumbent banks cannot and certainly do not want to replicate: that of a single product firm that offers its only product for free, as a loss leader, without other products in their portfolio to cross sell and provide profitability.”

A simple technology stack is a further implication of the single product stance that digital banks have taken, which while efficient and low-cost, may not have the ability to scale.

It’s like opening a small baguette store to sell (or give away for free) next to a big baguette store. Clients will abound, Szafir analogises, and the more baguettes you hand out free – all financed by venture capital partners with equity money – the more the customers will want. Customer satisfaction will be at an all-time high, but in order to meet growing overheads like refrigeration, a bigger shopfront, shelving, your costs will soar. This is where newcomers face a conundrum.

On the concept of this incongruence with consumer demand and tech delivery, Deep Varma, chief technology officer at Varo Bank agrees, noting the mismatch driven by how the tech has evolved over the last decade and how consumers are expecting their banks to adjust with their needs.

“There is always an issue with laggards as consumers’ expectations are pressuring banks to satisfy their individual needs. The mismatch is driven by the customer’s expectation, and we’ll see it continue like this for the foreseeable future. Banking is the focus for this at present, and that’s why there is so much investment going into core banking platforms.”

Speed, convenience or high-touch service?

Though it’s true that there is not one single formula or answer for all banks, Jack Jones, head of private clients at Investec, agrees with the premise that innovations in core banking, especially those in the retail space, have typically been in favour of supporting the industry’s movement toward more digital, branchless experiences to meet the demands of the modern, tech-savvy banking client.

However, his position diverges on the topics of private banking: “While advancements in core banking technology may help to improve digital capabilities and streamline back-office operations, there is still a real desire from private clients to speak with their private banker on a one-to-one basis. Prior to Covid-19 these interactions were taken for granted.

“Now, with an increasingly remote workforce at Investec, we have had to consider how our bankers can maintain the high-touch, relationship-driven experiences our clients require, and how any future investments in technology we make will support our new ways of working.”

Further East, Russian bank Sberbank argues that the realities of 2020 prove that offerings need to be available through digital channels which cater to the online lifestyles of customers. For instance, during the pandemic, the options of issuing and using bank cards without going to bank branches proved to be very popular among the bank’s customers.

Simplicity and convenience are driving up the number of customers using contactless payments, and the number of smartphone users making contactless payments more than doubled within a year. Sberbank boasts over 62 million users on their mobile app for retail consumers, while their online banking solution, SberBusiness, relays that its active users are in the realm of 2.3 million – a sizeable proportion of Russian businesses.

“Behaviour patterns are changing and so are customers’ tastes. We see that our clients require products within an ecosystem to be secure and convenient but would also help solve a whole range of day-to-day questions. The future is in the hands of ‘ecosystemic’ corporations, as the global technological transformation is irreversible.”

Alongside, or perhaps a result of, answering the expectations of clients across their retail and corporate offerings, another underlying factor for Sberbank’s unabashed success is speed to delivery. Popov argues that the “winner” will be the bank which generates and implements solutions quickly.

The architecture and computing power of the Christofari supercomputer launched last year by Sberbank for example, lets stakeholders train models based on deep neural networks in record time. The use of supercomputer resources like Sberbank’s is expected to improve the efficiency of problem solving in a wide range of areas, including natural language processing, computer vision, automated decisionmaking, risk assessment and management, fraud detection, predictive analytics, creating voice assistants and chatbots.

Currently the only company in Russia with a proprietary technological platform after launching last year, the bank is shifting its products to the new infrastructure piece by piece.

“The backbone of the ecosystem is the single technological platform that helps us shape the best offer based on open interface and code, artificial intelligence, cloud technologies and big data analysis. Within the ecosystem we can offer both our own products and the products of external providers. A client will navigate through it with his unique SBER ID.”

Sberbank’s strategy to enter new markets is either to develop its own proprietary service or partner with another company to gain the required expertise. Sber also conducts a number of accelerators and is a co-investor in Fort Ross Ventures that invests in IT startups in the US, Israel and Russia. This fund is actively looking into startups at various stages and would help them develop and put their products into the market, potentially even the Sberbank ecosystem itself.

Have incumbents brought knives to a gun fight?

2020 has been a challenging year on many fronts and a comprehensive reassessment of resource allocation has meant many existing projects have been re-prioritised. Justifying the significant expense of core banking transformation for traditional banks has arguably never been easier, yet the ramification of delays to cost-to-income has never been graver.

Some view the uphill battle of competing against newcomers such as Varo, a digital bank from day one, as bringing a knife to a gun fight. First and foremost, cost of delivery for digital firms is comparatively minute given the absence of brick and mortar overheads and legacy infrastructure drains.

Deep Varma, chief technology officer at Varo Bank, observes: “We’ve been able to continue delivering more value propositions to our customers because our cost of infrastructure is low. We didn’t see any spike up or down during Covid-19. In fact, Covid has proven our mission and purpose is working well with customers. We’re continuing with the launch of our new technology stack and we’re expecting the cost of our infrastructure to go down further.”

Varma explains that Varo’s overarching mindset is a fundamental differentiator between its digital cohort and incumbents. When designing for the future, Varo’s approach is to prioritise its mission and purpose of putting the customer first. Technology is considered the enabler for driving this core mission.

“The way we designed our architecture was by thinking about how to decouple the client side from the business logic from the database layer, all with a mindset of plugand-play because technology is going to keep evolving and we need to be able to keep up. If you have a strong foundation you can build two, three, five floors on top. If your foundation is weak, you’ll always have to find band-aid solutions in order to survive.” Varo also integrated other measures into its foundational layer including microservices architecture, the use of scaling technology and embedding security in the platform from the outset, all with a goal of innovating faster and improving delivery time to their consumers.

Pace of innovation may be attractive in theory, yet the challenge of transforming a bank’s legacy infrastructure is not achieved overnight. Despite the pressures of 2020, Openbank has been able to capitalise on its advanced core banking strength and presents a warning signal to other banks that this evolution is a long journey that should be measured years, not months. “For that reason, any bank getting the wake-up call only now with the Covid-19 pandemic is in trouble, because they are too late,” says Szafir.

“Banks that have not embraced emerging technologies are at a clear disadvantage in many ways beyond cost: they have to spend more time (they are slower to compete) and more capital to launch new products and to adapt to new regulations such as the Revised Payment Services Directive (PSD2), new products and services that require real-time capabilities are out of their reach, amongst others.”

Szafir theorises that perhaps the only way forward for legacy banks is to follow the likes of Santander or DBS, both of which started the digitisation journey years ago are now well advanced not only on frontend, but also have made important inroads in the process of core transformation. They have achieved this by increasing efficiency and reducing operating costs such as sizeable server virtualisation projects and the move of data to the cloud to enable real-time services.

You can download a full copy of the report ‘The Future of Core Banking: The Catalysts Driving the Smart Finance Revolution’ here.

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