#Core Banking

What is core banking?

Sep 23, 2022 - 10 min read
Also Available in : Français
Konstantin Lambrinov, Product Marketing Manager at Sopra Banking Software

As the financial services industry continues to change and evolve, the emphasis is on banks to keep up. Being able to meet the needs of today’s banking customers means being able to offer the latest in financial services and products. But without a strong core banking solution, banks struggle to compete with younger, more agile industry entrants.  

Indeed, over a third of banks (34%) say that problems with core banking systems are the greatest challenge they face with regards to developing a digital ecosystem of products and services, per our Digital Banking Experience (DBX) report.

Over a third of banks (34%) say that problems with core banking systems are the greatest challenge they face with regards to developing a digital ecosystem of products and services.

However, many people are still unclear about what core banking means exactly, and why it’s important. In this article, we reveal all, including key steps a bank can take to improve its core banking model.

Core banking: a definition

Core banking is a back-end IT solution set up by banking institutions to bring together all required and relevant components. The purpose is to manage customers’ financial operations. It’s something you don’t see, APIs built on top of a processing engine. For some banks, this can even involve advanced data processing and automation to calibrate operations for the best possible customer experience (CX).

In short, core banking is a back-end computer system that is used to support an array of the most common day-to-day banking transactions. These include:

  • Opening and managing accounts.
  • Managing deposits and savings.
  • Managing payments and cards.
  • Calculating interest.
  • Conducting customer relationship management (CRM) activities.
  • Setting criteria, such as minimum balance, interest rates, or a number of permitted withdrawals.
  • Lending, generating, and managing loans.
  • Managing the recording of all banking transactions and regulatory reporting, i.e., data processing.

The creation and evolution of core banking

We can trace the genesis of core banking to as far back as 1959, with the creation of the COBOL programming language.

COBOL played a key role in a period that would prove vital for the eventual development of core banking systems. During the 1980s, the widespread computerization and digitization of the global banking system really kicked off.

By the 1990s, core banking had become a mainstay of the global banking sector. The period from 1990 to 2005 saw the second generation of core banking systems become “product-centric”. This meant that core banking systems were much more product-oriented than they were in the 1980s, with banks often outsourcing the development of these systems in order to address specific products or groups of products.

From 2005, core banking became much more “customer-centric,” and there was a fundamental change in the core infrastructure to reflect this. Banks abandoned the traditional silo approach by developing new software based on model digital architectures, such as Service-Oriented Architecture (SOA) and Application Service Providers (ASPs). For customer experience, this third-generation development meant increased accessibility, especially via digital graphic interfaces on the internet.

The fourth generation of core banking is “process-centric,” which has an increased focus on the mobility needs of customers and banking institutions alike. This has led to an increased focus on cloud-based solutions and composability and therefore the development of efficient ecosystems that facilitate the day-to-day use of banking services.

The different types of core banking models

Many banks still rely on legacy systems developed back in the 1970s and ‘80s, during the computerization era of banking. These are mainframe-based platforms that support banks’ back-end operations across core functions, such as account opening, account setup, transaction processing, deposits processing and loan processing, just to name a few.

The problem with these legacy systems is that their archaic nature means they are often difficult to interface with other systems. In turn, this restricts banks from being able to offer state-of-the-art services to their customers.

As such, many banks are now shifting to SaaS and cloud-native models, which can facilitate innovation while at the same time removing obstacles to integration. But what are those different models, and how can they help banks to modernize?

SaaS model

The Software-as-a-Service (SaaS) core banking model was developed so that banks could move away from the requirement to use the hardware infrastructure of a traditional banking software suite. Unlike the legacy model mentioned above, SaaS platforms are operated by a third-party company, rather than the bank’s data center.

The SaaS model is a cost-effective solution to modern banking, as it allows banks to leverage cloud-based solutions and minimize the use of cumbersome legacy platforms. By leveraging the expertise of experienced partners, banks can more easily integrate with other players in the financial services industry, offering the latest banking products and services, while also being able to outsource their own banking infrastructure.

Cloud-native SaaS models

The cloud-native core banking model is essentially a suite of digital and processing banking solutions all stored on the cloud. It allows banks to store, categorize and analyze banking data and transactions using advanced technologies such as AI and machine learning

Like the SaaS model mentioned above, cloud-native platforms are operated by a third-party company. Notable providers include Amazon, Microsoft, IBM and Google.

Unlike non-cloud native SaaS models, cloud-native core banking provides a single version of its services to all its clients, meaning the provider takes care of the creation, deployment and maintenance.

Because of this, cloud-native models offer banks a number of advantages over legacy system and non-cloud native SaaS models, including:

  • Significant reduction in total cost of ownership (TCO).
  • Scalability.
  • Increased processing power.
  • Lower operational costs.
  • Seamless integration between APIs and back-end systems.
  • Enhanced flexibility and agility.
  • Reliable security and collaboration.

Criteria for choosing a core banking model

Choosing a core banking platform means taking into account a number of criteria. Modern core banking systems certainly offer more services and flexibility than outdated legacy systems. Banks today are starting to realize that their back-end systems are limiting their capabilities to provide a modern customer experience, with a decades-old focus on front-end solutions having been exposed by the rise of fintechs and cloud-native core banking solutions.

Moving from a legacy system to cloud-native SaaS core means evaluating the sustainability of the existing platform and carrying out a strategic reassessment of core infrastructure. According to a McKinsey survey of 37 banking executives in May 2019, 70% of traditional banks are reviewing their core infrastructure.

According to a McKinsey survey of 37 banking executives in May 2019, 70% of traditional banks are reviewing their core infrastructure.

Risk assessment is also crucial when it comes to transformation to a new core banking model, and banks must evaluate how much of it they can assume. This has always been a significant concern for both banks and regulators aiming to move away from legacy systems. Risks involve data fraud, which means banks must have a robust multi-channel, multi-layer auditing system in place.

It’s also important for banks to consider how they will adapt to regional General Data Protection Regulations (GDPR), strategizing security and confidentiality features, cloud infrastructure, and data monetization. This will allow banks to identify the key components of their core banking system in order to increase elasticity, agility, availability and remote collaboration, leading to a customer-oriented and future-proof design.

Current challenges of core banking

Banks seeking to modernize their core banking system are inevitably faced with some key challenges. Moving away from legacy systems to cloud and SaaS models that use open API-based architecture is key if legacy banks are not to be left behind. Much of the current core banking architecture, which has difficulty in real-time data processing, is outdated and will become obsolete in the near future.

For 28% of banks’ respondents in our DBX report, legacy systems that slow down development are the biggest challenge when it comes to digital banking. In short, without a modern core-banking solution, banks will fall behind.

It’s important for banks to understand the changing dynamics of customer expectations and the importance of user-friendly interfaces that offer flexibility and scalability, all the while minimizing security risks. This is key to building customer loyalty in an ever-changing sector, which is constantly seeing the arrival of innovations and new competitors from outside banking institutions, such as fintech companies, software developers, and firms aiming to tap into the BaaS and Platform-as-a-Service (PaaS) models.

It’s important for banks to understand the changing dynamics of customer expectations and the importance of user-friendly interfaces that offer flexibility and scalability, all the while minimizing security risks.

Of course, core banking transformation projects can cause time and cost issues, especially with strong regulatory and fiscal pressure. Moreover, cloud migration can be prone to project extensions. However, modern solutions do offer the possibility of a gradual, step-by-step migration, which lowers the risk involved.

In any case, core banking transformation will, in the long term, lead to the optimization and management of products and service cycles in a much more efficient way. This will, in turn, result in reduced operating costs, thanks to the effectiveness of AI-based solutions that manage data in the cloud, thus maintaining profitability.

Options for optimizing a core banking system

Many traditional banks are wary of the fact that transforming and digitizing a core banking system can have significant initial investments and potentially long payback periods before generating ROI. They therefore have several options for revolutionizing, upgrading, or enhancing their core banking systems. These include:

  • Sitting tight, keeping their current system going, and seeing how market leaders develop and evolve their systems.
  • Re-platforming to a PaaS model, which involves migrating the code with minor updates for a minimal charge.
  • Refactoring, i.e., modernizing the code base by adapting to the latest technologies, without changing its basic behavior.
  • Augmenting, i.e., deploying a parallel core, which addresses advanced needs not provided by the existing core.
  • Completely replace the existing core platform with new and modern solutions using a cloud-native SaaS model. This solution is adapted to ensure a better customer experience on the latest, high-tech cloud-native platforms that are designed to be scalable, flexible and agile.

Difficulties faced when deploying a new core-banking solution

Transforming a legacy core-banking system to a digital, cloud-native SaaS system can be a costly, time-consuming and difficult process, but the limitations of legacy systems become clear once the core-banking system has been fully modernized.

Moreover, developing reliable architecture with an executable code that takes into account the complexities of an older core system is complicated by the fact that extensive research and analysis are required in order to understand the modern customer’s needs. It is therefore important to be in a position to regularly adapt the solution to keep up with ever-changing customer expectations.

Of course, banks would need to leverage the know-how and expertise of a group of highly qualified experts to oversee the transformation, which is another area where the cost would have to be considered. The fear of failing in a replacement process so costly can lead some banks to remain wary. Sopra Banking Software’s composable core banking platform is a real advantage here because it allows a smooth, step-by-step transition.

How to implement a core banking system with Sopra Banking Software

Creating a core banking system for the digital age is no mean feat. The aforementioned challenges with regards to the transformation process have meant that many banks are yet to go all in on what will become the norm in the global banking system: cloud-native SaaS systems and a move away from outdated, legacy banking infrastructures.

Sopra Banking Software has developed an ultra-flexible solution, built according to each bank’s specific needs. This core banking solution is based on a composable platform with a plethora of APIs, launched step by step for a smooth transition, to a cloud-native SaaS system.

The solution offers a full range of banking functionalities in order to meet customers’ expectations in an era where functionality, accessibility, mobility, scalability, and flexibility are key. These range from basic state-of-the-art functions, such as account, deposit and savings management, to advanced security, fraud prevention, accounting, enterprise support and risk management.

Making changes or updating a core banking system could be the most important decision that a bank makes. And so, of course, it’s a decision that needs to be taken with due thought and consideration. By partnering with an experienced industry player like Sopra Banking Software, banks can be sure that they’re benefiting from a wealth of knowledge and expertise, for short, medium and long-term success.