Creating a Cool and Profitable Bank or Credit Union

In an American Banker article, Creating a Bank that's Both Cool and Fair, Chris Skinner poses a question, "What does 'cool' mean in banking?" The question I would ask is, “How do you create a ‘cool’ and ‘profitable’ bank?” Transaction fees, interchange fees and other non-interest income are often the difference between bank or credit union profitability and losing money. Regulators, neo-banks, new competitors and educated consumers are quickly forcing the end of traditional banking non-interest income.

Becoming "cool and profitable" in banking will involve a complete rethinking of how a bank or credit union operates and the business they are in.

Let’s Start with Profitability

Banking is no longer about money, it is about data and how that data is used. We hear the term “big data” and study after study has shown North American banks and credit unions have failed to realize or capture anything close to the potential that big data poses to offer. Why? Data is meaningless in its raw form. Instead of trying to capture all your data and then try to do something with it, try focusing on a specific goal that requires limited data. Start small and as you gain experience, understanding and positive results, expand the use of data.

For example, you could start by using data to help you identify profitable customers and more importantly, non-profitable customers, and what it will take to get them profitable. According to Bank Director 40% of retail bank customers and credit union members are not profitable. Optirate says, as many as 80 percent of customers at community banks or credit unions generate operating losses, with nearly all profits attributable to only 10 to 20 percent of customers.

Can your bank or credit union sustain subsidization of 40% to 80% of your customers or members? Regardless of what number is correct, there is no doubt subsidization is occurring, which will ultimately lead to your profitable customers and members being at risk. 

Simple data can be used to start a profitability analysis. Even if your bank or credit union chooses not to act on the information, CEOs, CFOs and board members should know the results of a profitability analysis so a conscious decision can be made.

What is Cool in Banking?

Banking generally operates according to systems and legacy technology that were developed in the 1970s to meet the needs of the market at that time. Is there any denying the market today is not the same as in the 1970s? Yet banking remains siloed, operates around products, account numbers and is internally focused for plenty of outdated reasons. That environment is slowly changing, but can it change fast enough to preserve the thousands of banks and credit unions that exist in the United States. Virtually every country in the world is dominated by a small number of large “too big to fail” national banks. The US financial services market is quickly moving in that direction.

North America’s national banks are investing tremendous resources into technology, Fintech startups, and technology incubator programs. Resources North American community banks and credit unions cannot compete with. So what is the alternative?

Create a “cool” bank or credit union. That means re-inventing how your bank or credit union does business. That means trying new ideas and recognizes they all will not work, but the organization learned something. It means positioning your bank or credit union to be able to adjust and move quickly. It means developing a niche that can be supported by your technology solutions. It means having agile technology.

Silos have to be eliminated, organizational structure must change and the focus must be “what is right for the profitable customer”. It means finding creative ways to deal with Know Your Customer and lending regulations. The banks and credit unions that can deliver frictionless, instant account opening, instant loan approvals and disbursement, and predictive analytics  will emerge as market leaders. It means leaving no rock unturned and allowing no sacred cows. It means “re-inventing” your bank or credit union to meet the changing expectations consumers demand in all other areas of their life in this digital age.

For example, why offer separate checking accounts, CDs, savings accounts, and credit cards? Why not let your customer or member build the products they want in real-time through a one-step instant approval process? As they add features and new services, pricing is adjusted based on real-time profitability analytics.

When I buy a car, I never buy the basic stripped down model. The low price may get me to the car dealership, but I do not end-up buying that model. Instead, I convince myself I need this "must have option" and "that must have option" to the point that pricing becomes less important to me and the dealer's profitability goes up. The same thing applies to new home buyers when they are purchasing a house from a new home builder.

If banks and credit unions take a similar approach by allowing customers to build products unique and customized to their situation, instead of offering a pre-defined menu of pre-built products my belief is customers and members would focus more on the customizable solutions that meet their exact needs, and less on the pricing that goes with it. Through relationship pricing and relationship analytics, banks and credit unions can improve product margins and provide pricing transparency.

Agile Technology for an Agile Bank and Credit Union

The problem bank and credit union executives face is that in most cases their legacy core banking systems are not capable of supporting this type of innovative thinking. Core banking systems are built around silos, products and account numbers. They are not built around customer relationships, and data analytics.  

Fortunately, there are options. The best part is that these options:

1. Come with far less enterprise risk than a core banking system conversion; and
2. Will add long-term functionality and architecture that will allow your credit union or bank to move into the world of real-time processing, transactions and data management, and personalization.

Components, APIs, standards, and the cloud offer banks and credit unions the opportunity to explore true alternatives to the zero-sum game of a core banking system conversion. Componentization, APIs – along with emerging standards such as BIAN (banks) and CUFX (credit unions) – and internal or external cloud environments allow banking systems to more effectively communicate with each other and allow banks and credit unions an opportunity to create their own service-orientated architecture (SOA). An SOA approach modernizes the technology environment by allowing credit unions and banks to “mix and match” technology solutions they need to adjust and drive their business model, as well as the ability to quickly adjust and implement new solutions.  

The most advanced banking technology environment is only as good as the vision, mission, and strategy it is designed to support.  This contrasts with the old days of banking IT when IT departments often unwittingly held the bank or credit union hostage by their antiquated systems, and were obstacles to innovation and change.

Banks and credit unions now have an opportunity to improve agility by becoming more invested in their technology strategy and its execution. The CIOs of today’s banks and credit unions needs to be savvy business leaders that are actively involved in shaping the direction of the bank or credit union, then putting in place the solutions necessary to achieve the corporate goals. They need to have a seat at the executive table and be like the orchestra conductor, pulling all the pieces together to create symphonic harmony.

Well-chronicled are the changes that have occurred in retail banking – and will continue to occur at an exponential pace – coupled with the increasing expectations of today’s retail financial service consumers. Some banks and credit unions have taken steps to adjust their business models and technology solutions to meet these opportunities. Other banks and credit unions want to change, but do not know how or even where to start. Others are sitting idly by and hoping that digital banking, omnichanel and bi-direction channel banking is a fad that will soon pass.  

Before your bank or credit union considers a core banking system change, formulate a technology strategy that supports the vision and mission of your bank or credit union. Evaluate alternatives and opportunities, which will likely be less expensive, have a lower enterprise risk profile, higher ROI, and can be operational much faster than a core banking system conversion. With these guiding principles in mind, you can position your bank or credit union as an agile player in the quickly evolving retail financial services market.  

Getting to the Core – Why a Core Banking System Conversion May Be the Wrong Approach

Ah, remember the old days……, the days when you had to get to your bank or credit union branch before 2:00 PM in order to get a deposit recorded as a transaction for that day. Fast forward to today. As Tom Groenfeldt, contributor to Forbes so eloquently writes, “When 40-year old legacy banking systems meet the two-month old iPhone 6, the results aren’t pretty.”  The same thing that happened 20 years ago when a customer visited a branch still happens to you and your iPhone 6 or tablet today. It encounters batch processing. We are in the era of real-time transactions, real-time processing, and instant access to data, yet banks and credit unions cannot consistently deliver that experience to their customers or members.  So much time has passed yet so little modernization progress has been made with North American core banking systems. The very systems that drive your credit union or bank. How can you compete against the up-starts, neo-banks, and fintech companies that seek to take piece by piece your most profitable business and leave you with the burden of regulation and no profit transactions when your core banking system is so far behind?

Core banking systems, also known as core data processing systems were architected and built 30 to 40 years ago. They were designed more than 20 years before anyone heard of the Internet and their basic architecture has not changed since then. They were built to handle internally generated transactions from tellers, loan officers, CSRs and back-office support staff. They most definitely were not designed and still are not designed to meet the needs of external users such as customers and members. As a former executive of a core banking system company, I have seen the inside of the belly of the beast and it is not pretty. They say that if you see how sausage is made most people wouldn’t eat it. At least the finished product generally tastes good. If you saw how core banking systems are architected, enhanced and maintained, the spaghetti code cobbled together, and the lack of documentation you would not want to rely on it to run your bank or credit union. The worst part is many banks and credit unions have a hate/hate relationship with their core banking system and their provider. Why, because the core banking systems in use today, simply were not designed to meet the needs of today’s credit union and banks. As much as your core banking system provider may want to give you what you want, they can’t. Their core banking system solution simply was not designed to meet the needs of modern banking and their customer’s expectations, real time processing, transactions and data management. They are built on outdated technology, they were built around batch processing, and they have enhanced using Band-Aids and patchwork. 

So what are banks and credit unions that do not have the resources of the major national and super-regional banks to do in this situation? Converting from one core data processing system to another core data processing system is like adding internet radio to your 300,000 mile 15 year old car. It may provide you with a feature you are missing, but what happens when the engine blows up?

Fortunately, there are options, and the best part is the options come with far less enterprise risk than a core banking system conversion and will add long-term functionality and architecture that will allow your credit union or bank to move into the world of real-time processing, transactions and data management, and personalization.

Components, APIs, standards and the cloud allow banks and credit unions the opportunity to explore true alternatives to the zero sum game of a core banking system conversion. Componentization, APIs along with emerging standards such as BAIN (banks) and CUFX (credit unions) and internal or external cloud  environments allow banking systems to more effectively communicate with each other and allow banks and credit unions an opportunity to create their own Services Orientated Architecture. An SOA will modernize the technology environment by allowing credit unions and banks to mix and match technology solutions they need to adjust and drive their business model and the ability to quickly adjust and implement new solutions. 

Combining a presentation platform on top of a security layer, an integration layer with business and workflow engines, data analytics tied to back-end and stripped down core banking legacy systems will provide credit unions and banks with the flexibility, agility and lower risk profile necessary to offer members and customers the solutions they demand in order to compete in the rapidly changing retail financial services market.

Before your bank or credit union considers a core banking system change evaluate the alternatives which will be less expensive, have a lower risk profile and can be operational much faster and positions your bank or credit you to be agile in the quickly evolving retail financial services market.  

Considering a Core Data Processing System Conversion - Think Twice

A Microsoft white paper in 2008 said the banking market is ripe for a massive conversion

of legacy core data processing systems (core banking system), most of which were architected and built in the 1970s and early 1980s. 

Earlier this year another prominent consulting group came out with a similar prediction. Close to ten years into the forecasted massive core conversion prediction, ..... it hasn't happened. Heck, even the local TV weatherman would have trouble keeping his job with a forecasting track record this off the mark. 

With all these predictions of banks and credit unions rushing to upgrade or replace their core banking systems, why hasn't it materialized? First we need to understand what is driving the desire to change core banking systems. Before we get there, we need to develop a common understanding of what comprises a core banking system. 

Even defining a core banking system isn't that simple. Just what is a core banking system? The answer depends on whom you ask. This seemingly simple question is complicated by a dizzying array of products and vendors in the market today. Many vendors describe their products almost entirely in terms of end-state benefits, dangling promises of real-time processing, service oriented architectures (SOA), and “bank in a box” solutions that offer end-to-end integration. As a result, the definition of core banking systems varies widely. 

Some credit unions and banks only seek to refresh an ageing MIF/CIF (Member/Customer Information File) or GL (General Ledger). Others believe a core banking system is much more comprehensive solution and is the  backbone of a credit union or bank. A core banking system that supports a wider range of systems, applications and databases as credit unions and banks wrestle with business, member/customer and regulatory demands. A core banking system may support member/customer relationship management (MRM/CRM), business process management (BPM), business intelligence (BI), business rules, risk and fraud management, anti-money laundering (AML), online and mobile banking, treasury, finance resource planning (FRP), asset liability management (ALM), general ledger (GL), regulatory compliance, transaction throughput, interest and fee calculation, parameterized product setup, transaction clearing and many other functions. The first thing a credit union or bank needs to do is define, "what is the executive team's definition of a core banking system".

Back to the first question, "what is driving the desire to change core banking systems"? 

The existing core banking systems are rigid and inflexible because of the complexity, age

of the design and multiple platforms, which makes it hard to understand, run and change. Changing the platforms to comply with regulatory requirements and to respond to round-the-clock digital banking needs is difficult. Driving the desire to change core banking systems are six common themes that can be easily identified:

1. Total cost of ownership: The cost of running core banking platforms is considered to be too high. Cost reduction is needed to restore the competitiveness of credit unions and banks.
2. Complexity: The complexity of core banking platforms and processes is seen as a very big challenge. This complexity has a significant impact on the ability of the IT team to track down issues. The cost of running, updating and changing the platform increases because of the complexity. The challenge is exacerbated in many organizations by the need to support and maintain multiple platforms, sometimes as a result of past renovation initiatives.
3. Age: Most organizations have aging systems that are forty years old or are even older. Keeping legacy platforms current requires ongoing investment in compliance, security, flexibility, functionality, and speed to market. Finding ways to retain skills and knowledge of the legacy technologies and the systems themselves is also a challenge.
4. Regulations and compliance: Regulations and compliance are consistently reported as a significant challenge. The pressure is exacerbated by the speed at which bad news travels because of instant social media communication. The cost and time of making compliance changes is also a major challenge.
5. Batch-focused systems: Most core banking platforms are basically batch systems. Adapting them to support the always-on channel solutions of mobile and internet banking and making the credit union/bank appear to be functional round the clock is a significant challenge.
6. Support for front office digital channel: According to the Microsoft white-paper, the majority of credit union and banking executives believe that core banking platforms will inhibit the development of front office solutions, rather than enable them. 

Many credit union and bank leaders plan to implement transformation strategies that specifically address front office digitization. Banking leaders who plan to transform the core banking platform for front office digitization expect to enable front office change by implementing enterprise middleware platforms and portals that use well-defined system interfaces.

So maybe the "big bang" is not going to happen after all. Their is growing consensus that

a migration plan is the best approach to deal with the deficiencies of core banking systems. In my opinion, as an past executive of a core banking system vendor, there has been very little progress made by North American core banking system providers towards architectural modernizing of their core banking systems. Oh sure, they have added new JAVA or .Net presentation layers, but the fact remains, the core architecture and application stack remains essentially that same as it was 30 to 40 years ago. How does that saying go, ............ "it is like putting lipstick on a pig".  With such a stunning lack of progress why would any credit union or bank what to upgrade its core banking system. In the year 2014 would you upgrade your 2000 Chevrolet for a 2005 Ford?

Is it surprising, then, that while the industry has been talking about legacy modernization and predicting growth in the numbers of banks and credit unions replacing their legacy core banking systems since the early 2000s, most banks and credit unions have hesitated and put off a core conversion? Despite all the media and consultant reports that core conversion are about to bust loose, it hasn't happen. Many credit union and bank leaders wish to evolve the architecture of their core banking platform as a strategy to achieve their objectives. The adoption of enterprise-wide enabling technologies such as business rules engines, master data management, analytics and business process management are seen as significant reasons for their wish to move to a more flexible architecture. Surrounding legacy systems with a multichannel and omnichannel architecture that has strong process and workflow capabilities; externalizing specific banking services such as MRM/CRM, payments, origination, document management and others, and ultimately migrating the remaining legacy system code to a different platform.

With the lack of modernizing progress that most North American core banking system

vendors have made, I believe it is smart business to evaluate middleware and portal solutions before making a core banking system change. In fact, I will go on record and suggest that "with the technology tools currently on the market, the smart money is investing in those solutions and solutions that can overcome most of the weaknesses of the legacy core banking system". This could make core banking system conversion obsolete, or at least, buy multiple years to allow existing or new core banking system vendors to prove their worth with open, modularized, and modern architected systems. 

In my opinion there are two obstacles that still need to be addressed with a migration instead of replacement strategy. The most difficult is batch focused systems. Batch processing is a legacy from the 1960s. In today's modern world, batch processing should be an obsolete term in core banking systems. I can assure you, despite what you may be told, all the core banking systems utilize some form of batch processing. In a 24/7 365 always on world, batch processing is the enemy of the desired member/customer experience. Members and customers want, expect and should get real-time access and transaction processing with up to the second accurate information. The core banking systems are not architected to support online, real-time processing 24/7, 365 access and processing. 

The second challenge of a migration strategy involves integrating all these systems, applications and channels and orchestrating banking processes from front to back – especially given multiple underlying operating systems and communication protocols. Even if you can get them to communicate, do the systems work together to provide a unified user experience. 

What does core banking systems have to do with omnichannel banking? It is the reason we are talking about omnichannel banking instead of already having implemented it. Omnichannel banking's implementation obstacle is the legacy and disparate technology solutions that are not able to support omnichannel banking.  Omnichannel banking is the seamless convergence of all credit union member and bank customer interaction channels delivering a consistent and uninterrupted experience, regardless of what or how many channels a member/customer uses to connect with the credit union or bank. Omnichannel banking is an “end goal”, not a product, service, or marketing campaign. Omnichannel is the breaking down of silos that exist with most traditional financial services providers. It is the entire member/customer experience. It is how credit unions and banks interact and reach out to their members/customers, both digitally and within the brick and mortar of their buildings. 

Almost all the core banking system platforms do not support an omnichannel banking strategy, therefore a core banking system change is not likely going to help you implement that strategy. But the good news is there are options that will work!