The Reasons for Replacing Bank Core Systems Are Changing

The CEOs of the Big 8 core apps companies could write this blog better than I could. But they don't write stories; they make them. So this is an account of a trend change based on my experience.Background

In the late '07s, a significant tech trend started among community banks to replace their core systems. The reasons were quite clear:

• The largest service bureau providers (major correspondent banks) were getting out of the DP (data processing) service business.

• When a provider exits any business, the deterioration is noticed a couple of years ahead of the sunset date, and by those who count the most-customers.

• What had been a "you-scratch-my-back-I'll-scratch-yours" relationship in the correspondent bank business turned into a feud. For you newbies who don't understand that quid pro quo, in bank parlance, it meant you give us your balances and we'll give you our left-over DP capacity. Community bankers were forced to look for alternatives.

• Whether it was vision or coincidence is unclear to me, but Ken Kirchman (Florida Software Services, now Metavante Bankway), Don Dillon (ITI, now Fiserv Premier) and Jack Henry (still Jack Henry & Associates, Inc.) invented the packaged software business for banks. Ken did it in 1968 and built software originally for mainframe users, going after larger banks. Don and Jack catered to the new discovery of mini computers in 1976 and built hermetically sealed turnkey systems for community banks that, in my words, a chimpanzee could operate. The key was "turnkey." The inventors built it their way and they had the wisdom as well as the chutzpah to tell bankers to run it as delivered. In 1976, community bankers were DP deficient, so they welcomed vendor leadership. As a result, Fiserv Premier and Jack Henry SilverLake and CIF 20/20 account for 47 percent of what drives commercial banks and S&Ls in the U.S. today.

• In 1985 and 1986, the ICBA hired Art Gillis to conduct seminars to show community bankers how to deal with in-house computers. Even the BAI jumped in offering their series of Art Gillis seminars.

• Given all of the above, 1,200 banks converted to a new core system in that two-year period, a number never to be seen again. In 2008, only 371 banks and credit unions converted to a new core system.

• A major contribution during this period of change was that competition (in-house systems) provoked a wake-up call to the commercial service bureaus (not bank-owned) to get their act together and improve their offerings and support. They did.

• During the past 22 years, the improvement process also resulted in the consolidation of vendors from 113 to 28.

Today, there are eight major core providers and 20 small ones. A very high percent of the financial institution population is now comfortable with their core system and they are not in the market for a new one. In 2008, only 2.27 percent (371 banks, credit unions and de novos) acquired a new system. The number that switched for cause was 263. De novos (108) were first-time buyers. So why did 263 financial institutions switch? I didn't ask them but I have some opinions. I invite others to post their opinions.

Here are the new reasons that banks are switching within the Big 8:

• A very high percentage of the switches occurred among the Big 8, and that's a new thing.

• There are 57 core products among the Big 8. They have been characterized as commodities by some pundits. However, there are enough differences among the 57 that would push a fussy buyer to switch. I emphasize "fussy."

• 108 credit unions switched, and their reasons are different from the reasons banks switch now. Credit unions were slower to jump from their old system because their needs were simple.

• As legislation provided more business opportunities for credit unions, and as six of the Big 8 enhanced their credit union offerings, credit unions switched from weak systems to stronger systems. Call them stragglers.

• That leaves 155 banks and thrifts that, in theory, had strong enough reasons to switch to a new core system, and they were willing to suffer the pain of a conversion.

• Keeping up with the likes of modern architecture that some legacy systems provide, even though they were created 35 years ago.

• Reaching a higher level of integration with ancillary offerings that are also best-of-breed.

• Changes in a bank's strategy that outgrew the system it had when its needs were pedestrian.

• Vendor culture. I'm not a psychologist. "Analyst" is what I am and I use science (36 tools) to develop my recommendations. But at the end of the day, after the science and the heart meet, my clients say, "We like these guys." There are eight hugely different cultures in the Big 8.

• Equitable pricing. I use a model that can measure any bank's IT cost within 2 percent of its actual. I don't have a crystal ball that shows what happens during vendor/bank negotiations. If a Big 8 vendor tries to pull a fast one, he's out the door. Bankers don't have a choice when setting their pricing to their customers; others like the Fed and activists do it for them. Note how BofA and Chase caved to activists on OD fees last week. So how emotional do you think a banker can get when an IT vendor squeezes his earnings? Frothing at the mouth comes to mind.

• One step ahead of the "Dear John" letter. There's still a chance that a couple of vendors will throw in the towel. Not bankruptcy, but selling out to a vendor that is unacceptable to a bank. When a bank "inherits" a vendor it did not choose, and in fact, rejected that vendor that is now the inherited vendor, it opens the door for a new search.

• If the Big 8's 57 core systems were a coin-toss, then I cheated 321 banks out of some fees. My clients are still using the core system that was recommended to them. I didn't need 57 products to satisfy the needs of my clients and the results of the 36 tools. I needed 11. Those 11 are still at the top of the list for current buyers.

• Outsourcing vs. In-House. If it fits, choose it. The method depends on the bank. I was happy to read in a Sept. 25, 2009 press release that my respected colleague, Mike Young, at Fiserv said, "Financial institutions are certainly not alike, and they select the processing option that best fits their particular business model. The fact is we continue to see clients move from outsourcing to in-house processing, but these days in particular, more seem to be moving the other direction."

• When Jack Henry won the deal at Whitney National Bank, I wasn't surprised. One of my clients did the same thing 12 years ago. When I read on Sept. 14, 2009 that BS&T sister brand InformationWeek named Whitney as #91 in the IW 500 Innovators, it provided another dose of respect for the SilverLake product.

• On Sept. 9, 2009, New York Community Bancorp, the 42nd largest U.S. bank, announced the successful implementation of the FIS MISER system. In my opinion, this press release is an eye catcher because I haven't seen a core conversion within the 142 largest banks in decades.

There will always be a market for core systems sales. But the stats show it is a dwindling market. And ironically, that's a tribute to the current core vendors who keep their systems up to date with three releases per year, thus removing a significant reason for their customers to switch. On October 1, this market will be led by a really Big 3 (FIS, Fiserv and Jack Henry) followed by four not so big. Now for students of this movement, the next question will be, "How much influence will the eight offshore core banking companies have on the U.S. market?" Based on the past 10 years, the answer so far is "not much."