In the face of an ever-evolving financial landscape, banks are encountering a turning point, driven by an escalating demand for real-time, easily accessible, and primarily digital payment experiences. These experiences must dovetail smoothly with the business and lifestyle needs of today’s tech-savvy customers. This pivot in consumer expectation necessitates the implementation of a robust payments system modernization, capable of offering secure and trusted transactions to the vast swaths of businesses migrating towards digital-centric operational models.
A growing challenge for traditional banks is the intricate regulatory environment, compounded by the arrival of ISO20022, an increased need to control compliance costs, and the advent of cryptocurrencies, like Central Bank Digital Currencies (CBDCs), and digital assets with both transactional and speculative functions. Addressing these pressing concerns necessitates a wholesale rejuvenation of the bank’s capabilities, and most critically, their payment network.
With an increasing emphasis on innovation and strategic maneuvering, banks are looking for ways to extract greater value from their payment systems. One approach involves adding supplementary layers to their core systems to expedite product launches. However, this strategy could potentially increase technical debt, complicated operations, and negatively impact competitive positioning.
Ultimately, it may necessitate system updates down the line. A more holistic approach suggests developing a future-facing vision for their payment systems. This approach emphasizes internal alignment between business and tech teams to smoothly navigate the transformative journey, enabling a mutually beneficial sequence and pace.
While selecting this route, banks must address numerous questions such as the optimal sequence and approach to modernization, selection of superior technology components, and the formulation of a data and IT infrastructure roadmap that fully exploits the benefits of cloud technology. This article delves into the shifting market drivers and modernization strategies within the payments industry and elucidates the challenges and best practices for small and medium banks.
Payments system modernization to develop next-gen products and enriched experiences
Banks have a cornucopia of innovation options, from enabling Buy Now Pay Later (BNPL) services, to cryptocurrency-based payments, to launching Real-Time Payment (RTP) offerings, and exploring Alternative Payment Methods (APMs). However, amidst this plethora of choices and limited investment budgets, banks need to prioritize their payment product investments. They should base this on customer adoption trends, growth potential, and devise a strategic playbook for each product in their portfolio.
Defining the roadmap
Products promising high growth potential over the next three to five years warrant investments geared towards fostering awareness and adoption, influencing consumer behavior, responding nimbly to market dynamics, and meticulously defining the product strategy roadmap.
Emerging alternative payment methods, like cryptocurrencies, digital tokens, IoT-based payments or payments in the metaverse, lack regulatory clarity and industry standards. Banks should, therefore, create a roadmap to quickly scale adoption and influence consumer behavior. However, these digital-first payment products necessitate the integration of advanced digital technologies like AI, AR/VR, blockchain, and IoT, highlighting the need for IT systems modernization.
Aggressive pursuit
In the aggressive pursuit quadrant, banks should continuously invest in enhancing the user experience and channel innovation, as adoption is skyrocketing and competition for market share is intense. Fintechs offer interest-free credit through partnerships with leading e-commerce platforms, making BNPL services readily accessible to customers. A real-time credit decision engine, making financing decisions based on historical transaction data and credit ratings, supports these offerings.
Banks are now customizing payment experiences for each industry segment, a strategy necessitating an in-depth understanding of the specific needs of businesses and owners. Critical to their success is access to relevant data to design unique experiences.
Furthermore, facilitating Real Time Payments (RTP), a method witnessing vast adoption, should be a key focus for banks. The success of RTP lies in defining end-to-end payment experiences through the customer-preferred network in a cost-effective, compliant, and secure manner.
Adding value
To differentiate their payments experience, banks need to invest in value-add services tailored to specific regions and customer segments. These services need continuous innovation as they tend to transition from being unique to must-have features over time.
Optimizing investment
High-adoption payment products with moderate future potential will likely see consolidation. Economies of scale will help banks manage profitability pressures. As an example, banks could consider adopting wire processing as a service on the cloud, moving to a platform approach, and leveraging APIs for enhanced connectivity. This will ensure resiliency and future proof the wire transfers business.
Future journey of payments system modernization
Navigating legacy systems: Unraveling the challenges
The path to modernization of payment systems within banking institutions is strewn with formidable challenges that revolve around the entrapment of legacy technology and the silos of isolated data. The grip of these challenges restrains banks, stifling their agility to respond to the fluid dynamics of market demands and regulatory shifts. This translates to protracted time-to-market, complexities in workflow development, and limited access to data for the purposes of product development, testing, and analytical decision-making for enhancing operational efficiencies.
Transaction monitoring within these legacy environments often presents a fragmented and inconsistent landscape, hampering the ability to observe transactions in real time, which may subsequently lead to compliance pitfalls. The repercussions of such lapses can tarnish the reputation of banks, undermine the trust of customers, and potentially lead to punitive measures.
Historically, a significant proportion of penalties stemmed from deficiencies in risk and compliance systems, inability to deter fraudulent transactions, and inadequate or delayed incident reporting. Therefore, it is critical for banks to identify and address emergent risks that may slip through the cracks of existing regulatory frameworks and legacy systems.
On the flip side of these technological constraints, banks are grappling with the escalating financial and human resource commitment necessary to maintain these legacy systems. The fading skill sets required to manage and operate traditional core systems imply substantial IT expenditure to keep these antiquated technology stacks operational.
Meanwhile, the burgeoning presence of BigTechs and FinTechs in the payments landscape poses a looming threat to incumbent banks. These new-age players, equipped with open architecture, API capabilities, advanced analytics, data management, and cybersecurity features, operate on cloud-first principles.
This modern system infrastructure provides them with the ability to adapt offerings based on customer needs, expedite time-to-market, swiftly accommodate new regulations, reduce operating costs, and seamlessly offer value-added services. This endows them with operational efficiency levels far exceeding those of traditional banks.
Given this backdrop, the essentiality of modernizing the core payments system for sustainable growth is apparent. However, the complexities involved in such a transformation can incite fear of operational disruptions among CIOs. To mitigate these concerns, banks can contemplate two viable options: a comprehensive overhaul of the core system in a single stroke (the ‘big-bang’ approach) or an incremental approach of gradually integrating modern systems.
Big-bang approach: Revamping the core system
The ‘big-bang’ approach aims to uproot and replace the legacy system with a novel end-to-end platform conceived from scratch. Banks operating on outdated applications with negligible improvements typically consider this strategy, as they necessitate the wholesale replacement of their systems. However, this approach carries substantial risks and drawbacks – it tends to be resource-intensive, time-consuming, and disruptive to business operations.
Embracing payments system modernization
Under this paradigm, banks identify specific areas that warrant modernization and formulate a roadmap to progressively modernize systems based on priority. The success of this approach hinges on the adoption of a composable architecture based on microservices, integration of advanced technologies, and nurturing a cloud-native mindset.
Over the past five years, various organizations ranging from central banks and scheme operators to retail banks have embarked on modernization efforts, each adopting a unique approach. While the ‘big-bang’ approach involves higher risk and investment, it amplifies the system’s capabilities to be adaptable and swift on a larger scale compared to the incremental approach.
On the other hand, the incremental approach offers flexibility, fosters partnerships with multiple vendors, reduces the risk of organization-wide failure, and allows banks to retain greater control over their modernization journeys. It enables the delivery of value to stakeholders from the get-go by targeting quick wins, allowing banks to launch new payment products within months and continually augment features and functionalities.
Given their scale, the incremental transformation approach is generally more suited for small and mid-sized banks. This strategy diminishes reliance on the legacy core platform and facilitates the integration of modular digital components into the core system.
By building extensions of the core to expose APIs, this iterative procedure aids in transforming monolithic architecture into a microservices-based one. Deploying on the cloud bestows flexibility to scale capacity based on transaction volume.
Charting the path forward!
Entrapped in legacy systems, layered with multiple capabilities, and constrained by limited budgets for upgrades, small and mid-sized banks have largely refrained from migrating to modern payment systems, bearing the brunt of this inertia. Trapped between large banks with hefty technology budgets and FinTechs built on agile cloud systems disrupting traditional markets, these smaller institutions grapple to compete.
As these small and mid-sized banks explore the incremental modernization approach, they should consider revamping front-office systems to enhance stakeholder experiences, explore ready-to-deploy payment technologies, and evaluate the cloud-readiness of technology providers.
Harnessing next-generation digital technologies to streamline payment processes and make data-driven decisions has become indispensable for operational resilience. AI/ML and big-data analytics have emerged as clear investment choices to curb spending, fortify security, and reap additional benefits.
