The core wars
In last decade, the big story in banking has been about the neobanks. Incumbent banks were still reeling from the financial crisis so had bigger problems to resolve than notice the likes of Fidor (2009), Simple (2009) or Moven (2010) starting new banks.
Whilst not a digital bank, Metro was the first new bank in 150 years to get a licence in the UK. Subsequently, the UK has issued over 20 new banking licences and over a hundred organisations are taking advantage of open banking to provide new services. There has been much talk about the disruption of banking, yet customer numbers indicate that they aren’t moving in droves. The majority are simply multi-banking more.
Meanwhile, another battle started.
This battle is for core banking software, challenging the likes of SAP, Finastra and Temenos. In this space too, there is a plethora of competition emerging in two forms. The first is simply the redevelopment of core banking software using modern technology and the second provides Banking-as-a-Service (BaaS) . Both these approaches rely on modern technology.
However, BaaS is typically offered by a bank or fintech. Again, it was Fidor that arguably was first to pioneer the BaaS concept. Fidor is a German bank that provides digital banking to its customers and BaaS to challengers that want to provide banking on Fidor’s platform. Fidor has a separate technology division to create and manage its platform that Sopra Steria acquired last year.
So, what exactly is “modern technology” and how are these new players different to incumbent core banking vendors? Firstly, they are cloud native. By this I mean they were developed and design to run in the cloud from inception. Incumbent providers have been selling cloud solutions for years. However, this has really been their monolithic solution packaged and run in the cloud for their banking customer.
A cloud native solution is typically developed as a set of services that can independently be developed, deployed and executed. The standards body BIAN defines over 300 service domains covering the breadth of banking and over 2300 services within those domains. Let us be clear, this covers all of the banking operations and not just core banking. Most incumbent solutions will be modularised, that is, broken down into smaller functions, the difference is that any updates require the whole solution to be deployed. In a modern architecture only the “services” that have been changed need to be redeployed after any changes have been made.
Another difference is that these individual services can be executed multiple times to handle increasing load for their services. This means instead of running the whole solution again or just relying on hardware scalability, a modern solution can better leverage software scalability also making it more cost effective to run than simply taking a monolithic solution and running that in the cloud. Increasingly, modern solutions also use smart contracts for product origination.
Creating a modern solution is not easy and developing something that is reasonably mature will take at least five years without any legacy. This is roughly the time it has taken the likes of ThoughtMachine and 10X in this space. This presents a challenge for incumbent core banking vendors, a full transformation could take five years and likely more, whilst competition is here today.
That being said, the new core banking players have their own challenges. Firstly, getting their first few clients will not be easy, but a few are already beyond this issue. Next their challenge is in two key areas: breadth and reach.
Firstly, the incumbents over many years and often with acquisition have amassed a product set to address a breadth of capability across banking segments: retail corporate, wealth and capital markets. Their capability will typically be broader than basic core banking, for example, portfolio management in wealth, corporate treasury, know your customer (KYC) and anti-money laundering (AML) to name a few.
Secondly, they have geographic reach in multiple countries, and this also addresses the variations in requirements for things like internationalisation, tax and regulatory reporting. This might not be important to domestic banks, but to banks that have geographic spread or provide international banking services this will be key.
So, in the core banking battle we have new banking platforms developed from the ground up utilising modern technology but lacking scale, breadth and reach at one end of the track. At the other end we have incumbents that have to recreate their solutions to utilise modern technology whilst still providing a migration path and support for customers on their legacy solutions.
However, this is really a three-horse race, and coming in at the left field are the banks that are looking to provide BaaS. These banks are not necessarily targeting just the existing banks, these banks are targeting the growing new space of embedded finance. This is where either the whole banking platform can be white labelled for new customer propositions or individual banking services can be used within a broader customer experience. For example, embedding KYC and AML checks into a property letting platform or turning rent payment history into credit history for renters that aspire to buy their own property.
We are not in the peak of this banking turbulence we see happening now, we are really at the beginning. On the horizon we have many new technologies that could further and more radically change the landscape for banking such as quantum computing, digital currencies, internet of things (IoT) and 5G to name but a few.
Platform business models and subscription pricing are also business models that could change banking, and we shouldn’t underestimate how much customer behaviour has changed, not least by the pandemic. I guess I’m saying that with all these changes, and not foregoing all the changes in customer behaviour, that making predictions about the future of banking beyond the next three-to-five years is almost futile.
About the author
Dharmesh Mistry has been in banking for 30 years and has been at the forefront of banking technology and innovation. From the very first internet and mobile banking apps to artificial intelligence (AI) and virtual reality (VR).
He has been on both sides of the fence and he’s not afraid to share his opinions.