The old banking system has been impacted, but reform is not easy

     Banks and many startups are looking for ways to “disrupt” the industry and change the way people interact with financial institutions and handle money.

     One way is to overhaul the banking system. The difficulty of updating systems is enormous and, in some cases, very dangerous given the potential for problems. However, with the old core systems running the industry, fintech players that use banks as partners have their own values ​​to find, which are complicated by the habits built into each bank. In that way, banks may inadvertently create a natural defense against the changes that fintech companies want to make.

     Can the banking industry be disrupted by innovative technologies from technologists and startups when many banks use programming languages ​​that are out of date behind the scenes?

     “What does the bank of the future look like when banks are still clinging to legacy systems?” asked Ghela Boskovich, director of global business development at Zafin, a banking software company. “Does it need to be replaced? Or can you redesign it? Can you redesign a hunting lodge into the Palace of Versailles?”

     No disruption is not a good thing because it makes banks stagnant in a dynamic environment. At the same time, it gives more opportunities to startups that think that the transformation will be better without the current banks.

“Disruptors want to work with incumbent banks. If you look at most customers, they don’t want to run around with multiple companies, they’d rather stay with one bank that has everything together,” said Chris Skinner, chairman of the Financial Services Club’s online division and author of the book Digital Bank.

     The banking industry knows about the problems of legacy systems, but it seems the best way to deal with them is to unbundle them. Massive conversions have been predicted but never materialized. Observers say they probably never will. Such ventures are expensive even if they save money in the long run. They also carry significant reputational risk, given the need to limit customers’ unfettered access and replace the core of a bank. For example, banks have seen their rankings in customer satisfaction surveys slip as core conversions have been tied to acquisitions. Customers are very sensitive to change.

     On the contrary, observers have a different view.

     Some say the best possible approach is to create a parallel bank to move customers methodically. This approach would allow the industry to transform its core systems on its own terms, in a way that is less likely to cause many customers to take to social media to complain about not being able to access online banking. But in the current environment, where banks are watching literally every penny they spend, running two banking cores seems like something that only happens in concept.

     As Boscovich describes, some might think they can build the bank of the future on top of the structures of the past. Of course, that’s what most banks are doing now. Through the use of middleware and other patches, banks have found ways to make older technology work with today’s needs.

     And, in a system like that, there is room for some innovation. For example, a bank might find it can move a portion of its business away from its core operations to test new processes. This could be done by using a distributed ledger, a technology that allows for lightning-fast settlements, transparent and global records in a cryptocurrency system like Bitcoin . At this point, most global banks are exploring ways to use cryptocurrency, distributed ledgers or blockchain.

     “Maybe it’s some internal banking activity where some version of a distributed ledger will be tested first,” said Pascal Bouvier, general partner at Route 66 Ventures, an investor focused on fintech. “There’s a lot of opportunity to innovate in the less frictionful parts of the banking system and things that are less used.”

     Each bank’s unique system overlay certainly brings its own problems. While some disruptive startups work around banks, many see their future intertwined with existing systems. They need banks to thrive, but building scale is difficult when every partner requires the company to build around the bank’s various infrastructures.

     Standard Treasury, a startup that tries to help banks open their APIs to developers, sold its intellectual property to Silicon Valley Bank in August. Its founders joined the bank to create an API channel for its customers to customize their interactions with the bank. At the time, Bruce Wallace, chief operating officer of Silicon Valley Bank, said Standard Treasury's founders began looking for a partnership after realizing that every bank needed a highly involved integration and planned to start their own bank because of funding failures.

     Bradley Leimer, head of innovation at Santander Bank, said Standard Treasury and Silicon Valley Bank's partnership is an example of what could happen because of the industry's varying reliance on legacy systems. Creating critical mass within the industry is difficult given the disparity between systems, so some startups are taking the path of partnering with or selling to tech-savvy banks.

     “Startups can’t go from bank to bank to bank if each bank is a year’s worth of work. How are you going to solve that?” Leimer said. “You’re going to see more and more startups that are really good at solving a problem and have an exit strategy when it comes to a bank.”

     But it doesn't have to be this way, said Hans Tesselaar, executive director of the Banking Architecture Network, an international group of banks and suppliers whose mission is to set a standard for flexible architectures in the global banking industry. It believes such a system will make innovation easier and technology costs much lower. So far, 24 banks around the world have joined the group, including U.S. bank members PNC Financial Services, First Niagara and Discover.

     Reliance on legacy systems is “a barrier to innovation rather than an enabler,” Tesselaar said.

     “Bank of America may think we are unique and special, but there are many aspects of our processes that are not that,” said Eric Donnell, chief enterprise architect at PNC. “There are certainly differences, but as proprietary things, many commodity functions have limited value,” he said. “There is value in standardization, and there is also very significant value in modernization. That’s the problem — the unfortunate side effect is that it limits the ability of banks to modernize.”

     Boskovich also said she would like to see U.S. banks move toward industry standards, and that software companies and other financial technology firms don’t treat every job as consulting work. The best fit is software that has 75% to 80% innovative features and the rest is custom features.

     “They’re always going to want some level of customization, and they’re looking for a leading edge wherever they can find it,” Boskovich said. “They’re looking for anything that will make them feel alive.”