Insights from experience

Through our extensive experience in core banking modernization programs globally, we have observed that Tier 1 banks often opt for the co-existence strategy. This strategy is chosen because the bank is extensive and spans multiple products, services, and customers across various geographies and regulatory jurisdictions. Most of these banks have homegrown core banking systems, which are legacy, monoliths, and extremely complex systems heavily customized over a period of time. With the co-existence strategy the bank can retain its existing core and implement the new core to launch new and innovative products/services with a faster time to market. The bank gets enhanced product features or capabilities and significant time to market with the new core at a low risk, which they would have never achieved with their existing core system.

Over time, the bank can gradually migrate products from the old core to the new core as they embark on the journey of hollowing out the old core. This journey could take a few years, depending on the bank’s size and the legacy platform’s complexity. Though the co-existence strategy is a low-risk strategy of core transformation for large banks, there are significant overheads due to managing multiple core systems simultaneously. Hence, they need to be addressed and managed carefully to achieve success. The organization needs to be aligned internally on the goals, business priorities, timelines, cost, decision-making, delivery process, culture etc., across the business, technology, operations, and delivery to succeed. On the external front, aligning common goals and objectives with the product and SI vendors is critical.

Tier 2 banks opt for re-factoring or replacement strategy for core modernization. Most of these banks have out-of-the-box solutions from third-party product vendors, which can be replaced with an enhanced version of the same product or replaced with another vendor. In the replacement strategy, there will be an element of progressive replacement due to the complexity and the risk involved in replacement. The approach is less risky and cost-effective compared to the co-existence scenario. However, the alignment of stakeholders and the clear segregation of duties and responsibilities involving the product and SI vendors is crucial to achieving success.

Tier 3 banks opt for the replacement strategy. Since these banks are mainly local/regional, the complexity and risk are much less than Tier 1 and Tier 2 banks. The banks are highly risk-averse due to their size and limited budgets. However, the risks can be managed with effective processes, methodologies, and governance. It may not be a Big Bang replacement of the legacy core, and there will be an element of progressive replacement of products and services. Still, the intention is to replace the existing core with the new one within a fixed timeframe and reduce the cost of running two cores simultaneously. There are many benefits of a progressive replacement, such as it helps reduce business, technology, people, and regulatory risks.

Role of a SI partner

To achieve solid stakeholder alignment across the organization, an organization should find an implementation partner with a similar level of vested interest in the transformation. Choosing the right partner with significant past expertise and experience in core banking modernization is crucial. An experienced partner can guide the entire transformation journey, align various internal stakeholders, and leverage industry best practices to avoid common pitfalls. They can identify critical risks early, develop effective mitigation strategies, and define clear modernization goals. Additionally, the proper implementation partner can help banks streamline and accelerate their transformation process by utilizing proprietary tools and accelerators.

Buy vs build dilemma

The other key consideration in core banking modernization strategy is to decide what kind of core banking system the bank wants to choose. Does it want to opt for a build, buy, or hybrid solution? Each type of solution has advantages and disadvantages, and the bank must decide on the best option based on its business objectives, time to market, risk appetite and technology capability/maturity.

Many banks opt for a hybrid approach, implementing a "headless" core banking system. These cloud-native, API-driven systems offer an out-of-the-box core ledger functionality and building blocks in terms of vendor-provided libraries and workflows for configuring additional products and services. They provide the best of both worlds for time to market, flexibility, and control. Additionally, these systems integrate seamlessly with the existing ecosystem, ensuring continuity, interoperability, and scalability.

Successfully modernizing core banking systems requires a well-thought-out strategy, emphasizing thorough assessments during the planning phase and choosing the right technology and implementation partners. Transitioning from legacy systems is essential for innovation and competitiveness, but the process comes with challenges, such as integration complexities and risks of operational disruption.

To achieve their goals, banks must adopt flexible, agile, next-generation core banking systems built on modern architectures—cloud-native, API-based, and microservices-driven. Banks must adopt incremental approaches, like sidecar strategies or phased deployments, to reduce risk while enabling innovation. A dedicated focus on evaluating system needs, aligning with business objectives, and collaborating with reliable partners can ensure a smoother transition and long-term success in modernization efforts.

Notes: Raphael Friese, Harald Kube, Sebastian Schöbl, and Henning Soller, How to get a core banking transformation right: Eight mistakes to avoid, McKinsey Digital, February 17, 2022, How to get a core banking transformation right: Eight mistakes to avoid

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