Home Slider Is Outdated Core-Banking Technology Creating Material Exposures to Banks’ Revenues During Periods of Interest-Rate Volatility?

Is Outdated Core-Banking Technology Creating Material Exposures to Banks’ Revenues During Periods of Interest-Rate Volatility?

by internationalbanker

By Tom Schickler, Chief Revenue Officer, Zafin





After an extended period of interest-rate stability, central banks in developed markets from the first quarter (Q1) of 2022 onward have not only significantly tightened monetary policy but have also done so with a rate-change frequency that has created operational and liquidity risks to which many banks have struggled to respond. With most central banks having paused rate hikes in the fourth quarter (Q4) of 2023, rate curves in developed markets are anticipated to shift towards policy easing in the second half of this year.

This rising-rate environment has affected the behaviors of consumers and businesses alike, with significant outflows of deposits and greater dependence on funding into and from off-balance-sheet vehicles.

Coping with the liquidity implications of this rate environment and shifting client behavior has forced banks to revisit their product and pricing strategies and confront the operational limitations of their existing core-banking infrastructures. The reality is that banks have struggled to keep up with the pace and scale of change and have made compromises that have affected their net interest margins (NIMs) and operating expenses.

Interest rates and core-banking technology

Banks today are typically hobbled by legacy back-end core tech systems, many designed in the 1980s and 1990s. While these systems are scaled and resilient, their complexities, elevated costs and excessive time requirements to adapt and change are glaring drawbacks. In a financial industry dealing contemporaneously with shifts in macroeconomic, regulatory and client-behavioral dimensions, legacy systemic inflexibility can pose material risks to any financial institution.

Progressive core-banking modernization addresses today’s challenges while establishing a foundation for the future

Historically, a bank seeking to modernize its core infrastructure embarked on multiyear replacements with one of the leading core-banking providers. None of these replacement efforts achieved success and, in many instances, resulted in public and costly failures.

Recently, some banks began experimenting with lightweight neo-cores to modernize product by product while leveraging new state-of-the-art capabilities. Unfortunately, many neo-cores require significant effort to make them viable to operate within the complex banking ecosystem, and so, once again, these initiatives have not created the desired outcomes. According to McKinsey & Company’s research, 70 percent of digital-banking transformations have exceeded their original budgets, and 7 percent have cost more than double initial projections. Additional challenges, such as time to market, lack of employee buy-in, security risks and effectively coordinating the coexistence of a multi-core ecosystem, are major deterrents.

While replacing legacy cores and implementing neo-cores have not yielded the desired results, a new path has emerged that embraces the demands of delivering near-term paybacks in business agility and functionality while satisfying the need to modernize the infrastructure.

Progressive core modernization is the new path forward for many banks. It is underpinned by abstracting three legacy core components:

  1. Product management and pricing,
  2. Customer-arrangement master,
  3. Customer-information management.

Banks that have embarked on this journey recognize that through this process, their core systems can be reduced to operating as thin ledgers, which can continue to operate with lower operational risks or be replaced with new thin ledgers built on modern capabilities.

Why does this matter more during periods of frequent interest-rate changes?

Liquidity is the lifeblood of every financial institution, and with regulatory scrutiny and customers’ rate sensitivity elevated, banks need to be able to respond not only dynamically but also with surgical precision. The events in Q1 2023 in the United States were a key reminder to all banks of the potential existential implications of operating outside prudent balance-sheet best practices, with certain financial institutions failing and others needing to be acquired at heavy discounts to price-to-book (P/B) ratios.

Some banks were able to navigate this crisis because their deposit pricing and segmentation were fully aligned with their internal treasury and external regulatory guidelines. In addition, their product and pricing constructs could be modified at speed to respond both opportunistically and defensively when relevant. More importantly, by orienting their products and pricing around their clients’ businesses and life stages, they emerged from challenging circumstances into advantageous competitive situations with fortified balance sheets.

Consider a tier-one bank that operates globally in 50-plus countries and has more than 60 core-banking systems. Despite the US Federal Reserve System’s (the Fed’s) 11 rate rises between March 2022 and July 2023, this bank required no human intervention to update its rates for deposits and overdrafts across its entire geographic footprint. Instead, algorithms designed to reflect the bank’s liquidity values and clients’ rate sensitivities adjusted rates throughout this cycle. Before externalizing the deposit-pricing process, 150 bankers worldwide were charged with managing these rates daily. Equally importantly, NIMs were optimized, ensuring the forecasted net interest income (NII) increases were fully realized.

What options do banks have?

Core modernization and business transformation are no longer competing objectives. In fact, increasingly today, banks are choosing to reframe their deposit and lending pricing strategies as the first steps towards modernizing their core-banking systems. This approach creates an initiative that can uplift NIM and NII in the short term while simplifying the existing core infrastructure and increasing operational efficiency. The quick wins associated with this initiative build internal confidence across business, technology, compliance and risk stakeholders. Meanwhile, the core-banking system’s run efficiency and costs to the bank will show immediate improvements.

Banks attracted to this approach must consider whether to try to build the required capabilities or leverage an existing banking-technology provider. Increasingly, as banks have neither the internal skills nor the luxury of execution time, the latter may be the most viable option.

Uncertain times require something you can bank on

While the prospects of an economic soft landing have created pockets of positive sentiment, geopolitical risks, Basel III’s end-game-related impacts and potential long-term shifts in consumer and business rate sensitivities are creating anxieties in banks’ executive suites. While it may not seem like the best time to begin a core-modernization initiative, it could be the only time a bank will have to do so.



Tom Schickler joined Zafin as Chief Revenue Officer in 2019, prior to which he worked in financial services for 30-plus years in operational, technology and business leadership roles at Citibank, J.P. Morgan and HSBC. Tom also served as a founding board member of the National Payments Corporation of India. In his last role at HSBC, Tom was Managing Director and Global Head of Product Management for HSBC’s Payments and Cash Management business.


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