The payments systems infrastructure at many traditional financial institutions — banks and credit unions — is showing its age at a time when new, nimble players are entering the space.
These lumbering systems, many of which were constructed 50 years ago for electronic funds transfers and card services, are being left behind entirely by fintechs, or they are being shored up with patchwork infrastructure additions and payments islands that can handle new authentication methods.
Whatever the case, it all adds up to an existential challenge for traditional financial institutions, one that was broken down in a conversation with PaymentsJournal by Jens Audenaert, Global Head of Payments Software at Diebold Nixdorf, and Tim Sloane, VP of Payments Innovation at Mercator Advisory Group.
In their discussion, Audenaert and Sloane advocated for a move away from dated legacy systems to a cloud-based infrastructure, focusing on these key points:
- The inherent risks of legacy systems.
- The primary drivers of modernization.
- How to make the transition from legacy systems.
- Key features financial institutions should seek in cloud-based infrastructure.
“The pace of changes in payments has been unbelievable in the last seven to ten years,” Sloane said. Meanwhile, he said, the traditional model “has poured concrete around [traditional FIs’] payments infrastructure.”
“It’s time for everyone to start to recognize that and think, ‘How are we going to be competitive?’”
The Inherent Risks of Legacy Systems
Traditional financial institutions derive 30% to 40% of their revenue from payments, Audenaert noted. Accordingly, the risks of maintaining legacy systems that he outlined all dovetail with banks’ need to continue generating those revenues.
The risks include:
- Costs, including the technical depth required to maintain legacy systems, the duplication of effort, and the software and hardware requirements compared with the cloud.
- Resilience issues, including outages of the systems. Audenaert noted that 24-hour (or longer) outages have been “a huge issue.”
- Talent acquisition and retention. Legacy systems are often constructed in COBOL, and COBOL-versed programmers are growing older and steadily retiring.
- The burden of meeting compliance requirements.
Audenaert also mentioned the difficulty in leveraging data on legacy systems, which affects such areas as fraud scoring and decisioning. Most important, he said, was the drag on innovation and time to market.
“In those siloed, legacy systems, introducing new technology is extremely difficult,” Sloane said. “If you can’t do it, you’re going to be challenged by your competitors.”
Sloane noted that with new and emerging payment schemes and authentication methods, many traditional financial institutions have had to build islands to handle them: one for the bank, one for the branch, one for card use, and one for the call center. The result, he warned, is attrition.
“The consumer will walk away,” he said. “They’ll just get so frustrated, they’ll leave.”
The Primary Drivers of Modernization
Staying competitive and relevant would be enough to make any institution take heed. Add to that the steady encroachment of fintechs and other nonbanks in the payments space and the acceleration of innovation prompted by the COVID-19 pandemic, and financial institutions face an imperative to keep up.
One relatively new system, real-time payments, offers instruction here. According to a Deloitte report, Economic Impact of Real-Time Payments, the scheme’s impacts include:
- Displacing a series of other payments methods.
- Financial savings garnered by the transition from legacy systems.
- A more inclusive environment for financial institutions, which can bring in more unbanked consumers with payments offerings that appeal to them.
Then there is the cost saving of in-cloud services as opposed to clunky, in-house legacy systems. Savings, Audenaert noted, are another form of lifting the bottom line.
“Customers that move to the cloud are cutting their costs by 50%, some well over that for a transaction,” Audenaert said, pointing again to banks’ deriving up to 40% of their revenue from payments. “It really adds up.”
How to Make the Transition From Legacy Systems
Recognizing the need to bring in a modern platform isn’t the issue for institutions, Audenaert noted. It’s deciding where to start and where to commit.
“Changing a payments platform for a bank is like open-heart surgery,” he said. “It’s really risky.”
Sloane described it this way: “I need to get to the cloud, but which applications do I move, how quickly can I move, [and] how do I manage security as I make that transition?”
As banks work through these questions — and they must because their merchant clients and rising generations of customers want modern payments — Audenaert noted that the flexibility of modern systems is on their side. New systems can be built in parallel with existing systems, allowing for the piecemeal migration of functions and services.
“It’s a very de-risked approach,” he said.
Key Features Financial Institutions Should Seek in Cloud-Based Architecture
Audenaert suggested an elevated view of the benefits of moving to the cloud. It’s less about individual features and more about remaining nimble, a quality that the legacy systems don’t empower.
“Really look at what’s the architecture, what’s the technology,” he said. “So it’s future-proof.”
Sloane noted that many traditional financial institutions start the process of installing new systems with an on-premises notion of housing the infrastructure. That tends to fall away as they see how the cloud-based structure works.
As with anything, he said, the transition involves risk. But not as much risk as continuing to patch together legacy systems amid rampant change in the payments space.
“Sit back and consider where the real risks are,” he concluded.