The digitalization of financial services—driven by the exploding popularity of smart phones and tablets and also by aggressive competitors from outside the industry—is forcing banks to embrace technology innovation. Of course, banks have relied on technology to process their transactions and manage their enterprise for years, but online and mobile apps are now becoming key differentiators in the war for market share as consumers shift more of those transactions to their digital devices. Banks used to be financial companies that viewed technology as a utility, but are rapidly becoming technology companies that sell financial products.
Sitting at the very center of this huge shift toward digitalization is the bank’s core technology, which makes everything work. There are four companies that control the lion’s share of the core technology market and they, too, are under great pressure to keep pace with innovations that are occurring in the market. The relationship between a bank and its core technology provider is not unlike a marriage. It can work well—or poorly—and the pressure to keep pace with a rapidly changing marketplace is becoming a crucial stress point in that relationship. In Bank Director’s 2016 Technology Survey (see “Drowning in a Sea of Data,” page 48), 54 percent of the 199 respondents (a group that includes CEOs, independent directors and senior technology executives) say that a slow response to innovation in the marketplace is the most challenging aspect of their relationship with their core processor, and 48 percent complain that their core provider is unable to customize solutions for their bank.
“Our business is in a tremendous period of change,” says Randy Woodson, executive vice president and chief banking officer at First South Bancorp, a $961 million asset bank headquartered in Washington, North Carolina. “It’s just unbelievable how different the world is today and how different we envision the world to be three or four years from now.”
First South switched five years ago to Monett, Missouri-based Jack Henry & Associates, the industry’s second largest core technology provider, and like most community banks it relies heavily on that relationship to stay competitive in a fast-changing market. Woodson says that a bank of First South’s size lacks “the resources and infrastructure to keep up with the tech or digital world 100 percent on our own,” and it relies on its core provider to give it “competitive parity” with larger, better-funded companies in the market. “As a community bank, we rely on them to bring it together, to hopefully form partnerships [with third-party solution developers], to hopefully do the things that can allow us to focus on the customer the way we want,” he says. “At the end of the day, we’re really a small business competing with behemoth companies.”
Four companies control 70 percent of the core technology market (including both banks and credit unions) in the United States, according to a July 2016 research report by the Aite Group. The market leader is Brookfield, Wisconsin-based Fiserv at 37 percent, followed by Jack Henry at 16 percent, FIS in Jacksonville, Florida, at 11 percent and D+H in Toronto at 6 percent. The remaining market share is held by a wide cross section of regional players, some new companies and several international companies that are trying to get traction in the U.S. market.
Without question, the core technology provider is every bank’s most important vendor relationship. The contracts extend on average for five years, although longer agreements are not uncommon, and because only a small percentage of banks leave their core provider when their contracts expire, the relationship can last much longer. “I tell banks that it’s a 10- to 20-year decision,” says Paul Schaus, chief executive officer at CCG Catalyst, a Phoenix, Arizona-based consulting firm.
In recent years there has been a marked change in what is generally considered to be “core” technology. Traditionally it has referred to the data processing capability that keeps track of tens of thousands, and for larger banks, tens of millions of transactions that occur every day. But in recent years the definition of core has been expanded to include digital channels like online and mobile banking, which have become necessary capabilities for every bank today. In Bank Director’s Technology Survey, anywhere from half to three-quarters of the respondents also rely on their core provider for additional products like remote deposit capture, bill pay, mobile banking, payment processing and storage and archival services. Forty-two percent also use their core provider’s peer-to-peer payments product.
There has also been a growing trend toward cloud-based hosted solutions rather than licensing arrangements where the bank uses the core provider’s software but owns and manages the required hardware itself. Two motivating factors are cost and resource allocation. Relying on an outside party to manage most of the bank’s core technology functions saves money and allows the senior management team to spend a greater proportion of its resources on revenue production. “Many clients view that there are opportunities around controlling costs to hosting or outsourcing these services,” says Teri Carstensen, president of bank solutions at Fiserv. “It’s not a headache they have to worry about if they don’t have to invest the capital in it. It becomes a more predictable expense for them to manage.”
There are approximately 6,000 banks in the United States, and based on his firm’s survey data Schaus estimates that every year about 130 to 140 banks switch to another core provider when their contracts expire. Those numbers are roughly in line with an estimate offered by Stacey Zengel, president of Jack Henry’s banking division. “The published industry numbers that I see [indicate that] about 2 percent of the banks are looking at core transactions every year and that equates to about 200 to 250 in the market,” Zengel says. “I would say that about half of those [end up not leaving] their core vendor.”
This is just a small percentage of the contracts that expire every year. Most banks—especially small institutions—are reluctant to take on the challenge of moving to another core provider unless really pressed. Core conversions can take anywhere from six months to a year, depending on the size of the bank, and can place an inordinate amount of stress on the bank’s entire management team. “It’s not a lot of fun,” says James McDonough, CEO at Randolph Bancorp, a $456 million asset bank headquartered in Stoughton, Massachusetts. McDonough says he went through that process a few years ago at another bank. “It takes an incredible amount of energy, and the business disruption that occurs is pretty significant,” he says.
When banks do leave their core provider, it’s often because of an irreparably damaged relationship. “When they make a switch, the number one reason is they have lost confidence in their current provider to get them where they promised to take them,” says Scott Hodgins, senior director at Scottsdale, Arizona-based Cornerstone Advisors. “People will try to get better pricing, [although they] almost never change because of pricing. They’ve just lost confidence in the management team at the vendor, whether it’s [because of] broken promises or an unwillingness to give them face time.”
Much of the tension nowadays between core providers and their bank clients centers on the growing imperative to keep pace with changes in the digital marketplace, which strains the ability of providers and banks alike. As consumers embrace digital finance in increasing numbers, community banks like Randolph Savings and First South are feeling the heat of competition from aggressive nonbank fintech companies in the lending, investment management and payments spaces, as well as very large institutions that can afford to invest in innovation and have the personnel resources to pull it off. Schaus at CCG Catalyst takes aim at the conventional thinking at many community banks that personalized service is their competitive advantage. “I’m sorry, but we’ve done a great job of moving our clients to self-service,” he says. “We all have great service because the majority of our clients are doing it themselves.”
Instead, banks need to find other ways of differentiating themselves in the marketplace, and technology can be one way of doing that. It can also redefine what providing good service means in today’s marketplace. Richard Olson, senior vice president for retail banking at Randolph Bancorp, says that learning how to deliver their products at the speed and efficiency of many of their fintech competitors is an “imperative” for the bank, and something the management team and board have discussed during their strategic planning process. “Community banks have to learn how to compete effectively and deliver products and services at the speed at which customers want them today,” he says. “Customers are demanding it.”
For example, Olson cites the complaints of many community bankers that small business lending dried up during the last recession. “In reality, small business lending grew over that time, but where it grew was in the credit card space [with] larger banks,” he says. “Why? Because a business customer could get access to that credit easily, without a lot of hassle, without a seven-day waiting period, without two months of underwriting [and] all of those things. Community banks have to learn to manage the risk while being able to leverage those technology tools that exist to put those services that customers are demanding in their hands quicker and faster.”
Because they lack the financial resources and know-how to innovate in response to a changing marketplace, most community banks rely on their core provider to innovate on their behalf. James O’Neill, senior analyst at consulting firm Celent, says that while the core providers could have been described in the past as “fast followers” that didn’t want to be on the cutting edge of change, now they are making more of an effort to keep pace with changes in the digital space. “They’re actually trying to be proactive in examining new technologies and pushing forward state of the art technologies,” he says. “They’re being much more aggressive in terms of pursuing innovation rather than following innovation.”
Nigel Prince, head of enterprise solutions and product management at D+H, says there is a changed mindset at his company when it comes to innovation compared to, say, 10 years ago. Back then, if its software developers were building a general ledger system, they would have said “This is how loans work, and this is the accrual process, and yes, it’s going to take 10 minutes [for someone at the bank] to do this, but so what?” Prince explains. “That’s the way it works. That’s the process.”
“Well, in today’s world that doesn’t fly,” Prince continues. “What we’re seeing now is the reverse. It’s a whole shift, where consumers are actually dictating how things work. It’s an outside-in approach.”
But are the core providers really leading the field when it comes to innovation? Each of the four largest core providers was interviewed for this article—and they all said they take the innovation imperative very seriously—but not everyone is convinced they walk the talk, especially in the mobile space. “I just had a discussion like this with a client yesterday,” says Hodgins at Cornerstone. “Our message to them was ‘If you’re looking for innovation out of your core provider, you’re probably going to be disappointed.’ I think they’re wasting their time trying to get it from a core vendor. I think the specialty players are where the vast [majority of] innovation is going on.”
However, banks that go outside to third-party developers for specific applications face the task of getting it integrated into their core system, which can be a challenge since it requires the cooperation of the core provider. While it is in the financial interest of the core provider to have an exclusive relationship with their bank clients, all four of the companies insist that they are willing to work with their clients if they wish to use the product of an independent fintech firm. “More than anything, our view is to work with our clients and help them be successful,” says Anthony Jabbour, chief operating officer for banking and payments at FIS. “But integration is a lot more complex than most people think. It’s complex for us. Ultimately I have responsibility for it all, and can bring everyone into a room and dictate what I want everyone to do, but it’s still hard at times.”
Clearly there is a lot of dynamic tension around this issue of integration. In Bank Director’s Technology Survey, 19 percent of the respondents say their core processor has been unwilling or unable to integrate a third-party product into their core system, while another 11 percent say they received “negative pushback” from their core provider when they decided to work with an outside company. Aaron Silva, president and CEO of Paladin fs, an Austin, Texas-based consulting firm that helps banks negotiate their IT contracts, says that a standard exclusivity clause in every contract gives the core provider the power to say no to integration requests. And even if the core provider does agree to integrate a third-party solution into its core system, it will charge the bank a hefty fee to do so. “Of course, all the core systems tend to say they’ll work with their customers and they stand for choice and that’s the political answer, but I can tell you the truth in the trenches is that’s not how it works,” he says.
Both Randolph Bancorp, whose core provider is Fiserv, and First South, which is a Jack Henry client, have gone to outside vendors for solutions, and their core vendors have successfully integrated those products. But First South’s Woodson says that a community bank with finite resources would be hard pressed to pursue a best of breed strategy where it chooses what it deems to be the best available solution without regard for its origin. “There [are] a lot of fintech providers out there, but they’re startups,” says Woodson. “How does a community bank ferret through those options and manage those relationships? We tend to rely on our core.”