Core systems at a crossroads

There are rumblings that community bankers—especially those in long-term relationships with their core banking providers—are feeling less than satisfied with the status quo.

Among the bankers’ list of complaints are a lack of transparency into pricing; contract terms that appear to protect the core banking providers’ interests at the banks’ expense; a lack of product innovation; and an increasing sense that banks—or more specifically, their data—are being held hostage.

Is this perception of unfavorable treatment from core banking providers spot-on?

Are core providers taking advantage of banks?

Or, has the industry changed so much and grown so complex that it’s natural that bankers’ relationships with their core providers will need to change as well?

Or, is the truth somewhere in between?

No simple answer

The answer, of course, depends on whom you ask.

Bankers are feeling increasing competitive and regulatory pressures, causing them to rethink their technology strategies. There’s a crop of consultants who specialize in core banking contract negotiations, and some have built their businesses, in part, on an adversarial relationship between core providers and banks.

In addition, as publicly held companies, the largest of the core providers obviously have a responsibility to return shareholder value. They are just doing what they need to do to satisfy their shareholders.

But the situation proves even more complicated than banks and core providers simply trying to get the best deal in an evolving business and regulatory environment, and consultants trying to drum up business.

Add in fintech and new web-based core banking and ancillary systems providers, such as Nimbus Banking and Mambu. These new systems boast the features and functions that bankers are clamoring for, such as real-time posting of transactions, cloud-hosted solutions, and open architectures that allow bankers to more easily use best-of-breed solutions from other third-party providers. They also offer attractive pricing schemes that are often less expensive.

Multiple add-ons under contract

Another reason for the increasing frustration is that the relationships between bankers and core banking providers have grown much more complex in the last ten years or so.

Banks used to rely on their core banking providers solely for transaction processing. It was, and still is, a mission-critical function for banks—and the core banking systems perform transaction processing and the associated functions admirably.

Today, many ancillary systems swirl around the core banking systems. Online and mobile banking and bill pay are just several systems that require close integration with the core banking systems. The core providers now offer these ancillary systems, and it’s not unusual for a bank to contract with a core banking vendor for 20, or even 30, add-on systems. As a result, the contracts have become exponentially more complicated, and the relationships more intertwined.

It’s little wonder that banker unease is reverberating throughout the industry.

“The relationship between core bank providers and banks has dramatically changed,” says Don Free, research vice-president with Gartner. “But vendors don’t seem to understand that.”

Although complaining can feel cathartic, it rarely changes the situation.

With that in mind, Banking Exchange spoke with consultants, bankers, core banking vendors—as well as interviewees who spoke off the record—to get a sense of the biggest gripes bankers have with their core banking providers. Instead of simply complaining about the state of the union, however, we also asked interviewees to share their recommendations for improving the banker/vendor relationship.

First, let’s walk through the gripes.

Gripe #1: lack
of innovation

It’s not the lack of core provider innovation that is frustrating, according to Christy Baker, chief operations officer of TS Banking Group, Treynor, Iowa, “It’s that the pace of innovation is slow.” The bank has used the Fiserv Provision core banking platform since 2004. Baker acknowledges that a large company like Fiserv is less likely to be as nimble as a smaller or startup company, adding, “It’s a big ship to turn.”

Brad Smith, managing director of technology solutions at Cornerstone Advisors, often hears bank CEOs express frustration that their core banking provider is unable to deliver products that the bank needs to compete.

“The big three core providers aren’t in the innovation business,” contends Smith. “They are in the business of maximizing their assets. Vendors continue to support legacy systems and upgrade them just to keep up with regulatory requirements, but won’t sunset them because they are cash cows. Bankers feel stuck.”

Smith’s colleague Bob Roth, managing director, agrees: “There are a few core banking products that have gotten very stale. Since these are not the vendor’s flagship product, they are not investing development dollars into them.”

Steve Powless, CEO of core provider CSI, concurs that there is a feeling among banks that vendors are not providing timely and substantive enhancements to their products. These community banks believe that their ability to compete is compromised by lagging technology, notes Powless.

All the vendors who spoke with us (all the top five were given the opportunity) acknowledged the tension, but said they try to work as partners with the banks.

But it is a juggling act for the core vendors, says Stephen Greer, analyst in Celent’s banking group. The biggest core banking vendors have been growing by acquisition, and are now having to expend internal resources to integrate their own products rather than focus on developing new systems that take advantage of technologies like open architecture and the cloud.

“The core banking vendors are upgrading the systems they currently have, but those systems will never be as modern as those provided by startup vendors,” says Greer.

Community bankers often feel that their requests for innovation also fall on deaf ears. Says Greer, “Due to their smaller size, community banks are less likely than large institutions to get attention from their core provider.”

In addition to systems that don’t provide community banks with features and functions that allow them to compete with large financial institutions, the age of these systems has bankers worried. “Regulators are expressing concern that community banks are at risk by running a system that is 30 years old,” says Greer.

Gripe #2: high cost of leaving

Some version of this story was often repeated by those interviewed for this article: A small community bank is acquired by a larger community bank. Each bank uses a different core system provider, so the decision is made to convert the smaller bank to the larger bank’s core banking system. The smaller bank is two years into a five-year core contract. The termination clause for the smaller bank to exit the contract is 100% of the contract value.

That’s absurd, according to Aaron Silva, CEO of Paladin fs, which negotiates with technology vendors on behalf of banks.

“There are big crimes in the contracts themselves,” says Silva. “The vendors are getting away with it because they can.” He notes that only 4% of banks switch core banking providers in any given year, but the statistic is misleading. “Banks don’t stay with their vendor because they are happy; they stay due to the financial penalties in their contracts.”

“Banks can’t afford to leave, and vendors know it,” continues Silva. “It’s an oligopoly.” He wants to change that. “Bankers should be able to leave if they are not satisfied,” says Silva. “This will give the vendors an incentive to provide competitive technology.”

Paladin fs, along with Pillsbury LLP, a law firm that is heavily involved in IT contract negotiations, launched the Golden Contract Coalition (GCC) earlier this year. Financial institutions pay a $5,000 membership fee for the right to license a standard contract, and according to Silva, the remaining fees are paid by vendors.

Silva’s vision is that “unionized” banks in the coalition will refuse to do business with vendors that don’t adhere to the golden contract standard. GCC then negotiates the pricing for each contract based on the economics of each bank.

So far, 165 banks—ranging in size from $200 million to $15 billion in assets—have signed on as members, representing $1.5 billion in total contract revenue, maintains Silva.

Dan Fisher, president and CEO of the Copper River Group and author of the Beyond the Bank blog on bankingexchange.com, is another contract negotiator who cautions bankers about termination clauses: “It’s dangerous not to read these contracts carefully. Banks that decide to leave their vendor early get a huge surprise on what de-conversion costs. Some vendors definitely gouge their departing customers.” 

“These contracts are always eye-opening and sometimes alarming,” Fisher adds. Before signing any contract—but particularly any contract for more than three years—Fisher warns bankers to ensure they have a favorable exit clause.

Gripe #3: not playing well with others

Those banks that would prefer to select best-of-breed solutions rather than purchase all the products they need from a single vendor often run into integration issues. Integration between the core banking system and an ancillary system, such as mobile remote deposit capture, is either nonexistent or available for a fee.

“Bankers are frustrated because they sometimes have to pay their core banking vendor to access their own data after they’ve just spent money on an ancillary system,” adds Smith. “Some of these core vendors say that they are open, but banks have to pay enormous fees to connect with other systems.”

The lack of integration is especially frustrating as banks work to improve the customer experience with digital interfaces. “Vendors can simply refuse to integrate,” says Stessa Cohen, Gartner research director. “It’s an old-fashioned way of doing business.”

In addition to integration woes, Fisher warns banks about exclusivity clauses for ancillary products that forbid the bank from even buying a third-party product.

5 ways to improve

The following recommendations can help banks improve their relationships with their core providers and take back some control over what many feel are unfair business practices.

Recommendation 1: Get more involved with the vendor

“We hear a lot of complaints, but we don’t see our bank clients getting very involved in the vendor user groups,” says Cornerstone’s Roth. That’s a mistake.

He notes that the large core banking vendors all do a good job of promoting their user groups as a way for bankers to provide feedback, but few bank executives take advantage of these opportunities.

But Roth acknowledges that sometimes the focus of the user group meetings becomes more of a “lovefest” or product showcase rather than an opportunity to have a serious discussion about what the vendor can do to improve or help the bank meet its strategic goals. Part of the problem is that the attendees at the user group meetings often lack the big-picture viewpoint.

“The vendor’s day-to-day contact at the bank is happy with the relationship because the core system is not broken, but the bank CEO and CFO are not happy,” maintains Roth. “There is a real disconnect.”

Pete Graves, CIO for Independent Bank, Ionia, Mich., believes in being involved. “We like to be front and center with our vendors, especially with FIS, our core provider.” He also participates in a peer group that talks about a variety of issues, including challenges with core providers.

TS Banking Group’s Christy Baker sits on several advisory board councils for Fiserv and will often raise her hand to be a beta for a new product or release.

Stacey Zengel, president of Jack Henry Banking, also believes that more communication is better for both the vendor and the banker. “Our industry is dependent on banks being in business. We are really joined at the hip. It’s helpful if a bank has a clear strategy that they can share with us,” says Zengel.

Eric Edwards, head of account management for D&H’s Enterprise Solutions Group, adds to that point: “Banks need to be open so we can help them execute on their strategy and get more value out of our products and services.”

Recommendation 2: Get better at negotiating

Even though the core banking contract is likely the largest dollar contract a bank will ever sign, “it’s surprising how few banks negotiate these contracts,” says Brad Smith.

However, it is not just price that is up for negotiation. Fisher advises bankers to keep their contracts as short term as possible. For example, he recommends only three years for renewals.

“I’ve seen banks sign eight-to-ten year deals without a way to get out of the contract. The longer the contract, the more termination options the community bank should have,” points out Fisher.

Bankers also should scrutinize the price increases written into the contract, according to Fisher, since some can result in double-digit increases. “Shame on the vendor, but community banks need to step up their diligence. Bankers should not assume that they will be getting a good deal from their vendor,” says Fisher.

Core banking vendors negotiate contracts every day, while bankers may negotiate a core banking contract once every five to seven years. Guess who has the upper hand based on experience? Hiring a consultant to negotiate a contract can be a good move, and there are very good consultants out there, says CSI’s Powless.

When negotiating contracts, Gartner’s Free points out that while training, implementation, and other resource-related costs are not candidates for negotiating since they are directly related to time and materials, maintenance fees as well as customization requirements that are regulation related are negotiable. For example, development efforts for regulation-related customization can often be shared by the vendor by up to 50%, according to Free.

Recommendation #3: Squeeze more out of the current core system

“Banks need to take responsibility for getting the most value out of their existing core systems,” says Cornerstone’s Smith. “This is not just a failure of the vendors. In 25 years, I’ve never seen a bank that has gotten the maximum value from their core system.”

For example, banks should take advantage of the training offered by vendors—even if that means paying for it. In addition, banks need to stay up to date on the vendors’ latest releases and system enhancements.

CSI’s Powless agrees with Smith. As the core systems have grown more complex, they often have tremendous capabilities that the bank is not leveraging. “Invest in the education to learn how to use the system. There may be features that you don’t even know about,” says Powless.

Recommendation #4: Understand what you need

Core banking systems are a key enabler of digital bank transformation—and should be treated as such.

“A flexible core banking system is a significant contributor to a bank’s ability to respond quickly to changing market conditions, including compliance and changing regulations,” says Gartner’s Free.

While functionality of the core system will always be important, many bankers are increasingly concerned about the architecture of the system and whether or not it’s open. Explains Free: “Banks recognize that a distributed approach is the desired end state.”

If a bank does decide to consider switching core providers, it’s important to look under the hood and scrutinize the core banking vendors’ integration partners.

“Vendor products with proprietary integration methods, absent a standards basis or alignment, are a high-risk choice for the long term, carrying much higher-than-average integration costs for future technology projects,” says Free.

Specifically, core banking solutions should provide flexibility that includes application connectivity and data integration, workflow, and component-based, service-oriented-architecture-compliant architectures, he notes, adding that there are differences in core banking SOA strategies.

According to Free, how the core vendor provides real-time enablement also is important. Look for systems that leverage database design and enable real-time posting of future-dated transactions.

Recommendation #5: Focus on vendor performance management

The regulators and examiners have been pushing the banks to improve their vendor management in the past several years. However, vendor management connotes a risk-based approach.

Smith, for example, would like to see banks shift to a vendor performance management focus. The difference is that while vendor management typically includes a yearly vendor assessment, a performance management approach is a continuous process that focuses on maximizing vendor relationships and return on investment of technology spend.

“Vendor performance management requires ongoing discussions between the bank and the vendor,” explains Smith. It also requires accountability on both sides. “Build contracts that hold the vendor and yourself accountable,” he advises. “Commit to staying up to date on releases and training. Employ processes and discipline to make the relationship with your core banking provider more productive.”

Will bankers vote with their wallets?

Jack Henry & Associates, FIS, and Fiserv dominate the core banking provider market. Silva says that the big three have 85% of the under $1 billion market, and 93% of the above $1 billion market.

However, by the end of 2019, 25% of retail banks will use startup providers to replace legacy online and mobile banking systems, predicts Gartner’s Cohen in the Market Guide for Open Unified Digital Banking Platforms. “Vendors should be thinking about whether or not they want to be relevant in a few years,” cautions Cohen. 

Don Free agrees that a change is the air—although it won’t happen overnight.

“There will be alternatives to the big three core vendors. It’s only a matter of time until vendors’ solid base of long-term customers starts crumbling.”

He points to Mambu, which is installed in 30 countries and runs on Amazon web services, an increasingly attractive approach.

While there are several core banking providers new to the market, including Mambu, that are getting attention, these vendors have an uphill climb to gain momentum and market share.

“The sales and implementation cycle for core systems is long, so it will take a long time before these new entrants gain critical mass,” says Smith.

The other challenge for new entrants is passing regulatory muster. “With all the regulatory focus on vendor management, the bar has been set high for banks choosing to go with an upstart vendor,” adds Smith.

Cohen agrees that the risk of an untested vendor—perhaps one headquartered internationally, without hundreds of bank customers—is a regulatory risk, although she points out that smaller bankers are increasingly willing to take on that risk.

Copper River Group’s Fisher says he sees more banks willing to ditch their long-time core providers.

“I’ve seen more banks willing to convert in the past 18 months than I’ve seen in the past 18 years,” he contends. “I see interest in banks with younger management teams who aren’t intimidated by technology and who recognize the need for technology to stay competitive.”

Another reason that bankers may be willing to switch is a lack of trust, especially if, in a competitive bid process, the bank discovers it may have been paying too much.

“The last thing a core vendor wants a customer to do is to go through a competitive bid process,” explains Fisher. “If they feel taken advantage of, they lose trust in the vendor and may decide to leave.”

In other words, it’s true that ignorance can be bliss, but it all depends on which side of the contract negotiation table you are sitting on.

Some signs that your core system is at risk

For bankers concerned that their core banking systems may not be getting the development dollars they should, here are some telltale signs that their vendors may not be prioritizing upgrades or enhancements:

• Lower sales: Year-over-year sales of the core system your bank uses are trending downward over a multi-year period, especially important when the product is marketed to Tier 2 to Tier 4 banks.

• Poor design or architecture: Use of proprietary integration, and the product has no discernible or credible road map to adopt service-orientated architecture.

• Operating system, hardware, and database dependency: The core banking market is moving to operating system, hardware, and database neutral systems.

• Decreased customer satisfaction: Product support is lagging, resulting in lower customer retention.

Source: Core Banking Renewal: Criteria That Matter For Successful Selection, Gartner