The White Paper Service

Making a Core Banking System

W www.esightgroup.com.au
E info@esightgroup.com.au
P 02 9430-6676
Decision
By Steve Pitt

Abstract
With the intense competition in the financial sector set to become even more so, your
financial institution is at a watershed moment whereby its long term future will be
determined by the actions of today and tomorrow.
White Paper

The industry is facing intense margin pressures, the need for more sophisticated
products and services that are demanded by time-poor consumers who want quick
decisions about their financial affairs and access at their fingertips. This is not to say
that the banks aren’t feeling the same pressures to improve their overall position,
however while your financial institution has customer satisfaction on its side, banks
have scale.

Recognising today’s competitive environment is destined to become even more

competitive in the future, your financial institution no doubt is clearly focused on
strategies to improve its competitive position. Some of these strategies would
revolve around reducing costs, increasing non-interest income and strengthening and
leveraging client relationships.

Most financial institutions identify these broad issues as necessary for the future in
addition to the need for access to new products, the ability to respond faster to
changing market conditions and more efficient methods to meet the changing
regulatory framework.

These are key issues driving the need to change. To meet these challenges requires
the right mix of business resources, products, processes and service standards to get
you to where they want to be - the main financial institution to your clients.

Notwithstanding the outcomes of these strategies, it is possible for your financial

institution to move towards achieving the benefits from these strategies now simply
through the introduction of a new core banking system.

With the product and transactional focus of a core system, coupled with its client
relationship focus, a new core system offers you the opportunity to leverage your
strong client relationships. It is a strategic imperative.

This document is intended to assist your financial institution to examine its

technology needs and provide some practical advice on making a core banking
system decision.

April 2010 For more information : Contact info@esightgroup.com.au

 What is a Core Banking System?
A core banking system provides a central database that holds all information about the client whether that
information originated from the core system or from other peripheral systems. Typically the core banking
system interacts with all service delivery channels and transaction points and incorporates a high degree of
integration with peripheral systems so the central database is always up-to-date.

The core banking system can be seen as the strategic heart of your financial institution and potentially can
leverage your current position to greater heights. Viewed graphically it might be seen as follows:

Project manage the web relocation project

Develop new position descriptions for the IT management team, based on CobiT

In simplified terms, a core banking system consists of essentially two elements: hardware and software.
Hardware is the physical machine you can see. Software is the programs that tell the hardware and peripherals
what to do, in what order and when. There are different types of software from PC based software like Microsoft
Word through operating systems to core banking systems software.

A good core banking system should be flexible enough to accommodate any and all of your business needs and as
such your business needs should drive your core banking system decision. Every technology vendor can provide
mountains of information on why their technology solution is the best, which in its place is valid, but that kind of
discussion should happen after the far more important aspects of assessing whether a system can deliver
according to your business needs has been done.

Obviously, with such an integral role in your financial institution and the complexities involved with the
integration of the other elements essential to your operations, care needs to be taken in the decision. A core
banking system decision will set the course for your financial institution for the next decade and beyond. The
cost and all encompassing nature of a change to a core banking system means that it is not a change you would
want to make regularly. Take the time for a long-term view to ensure the costs and upheaval associated with a
change in core banking system isn’t revisited again and again.

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Considerations
Good core banking decisions are typically made using an up-to-date business strategy as the starting point. The
strategic plan drives every other part of the business and should also drive the technological aspects as well. The
path from business strategy to core banking system decision is simply a series of logical steps, each building on
the outcomes of the previous.

Using the strategic plan, the first step is to determine the key areas for future growth in the next two, five and ten
years. With a market driven plan, your key areas might be in sectors that you have had no presence but are
profitable and would respond to your products and services or are emerging as a potential market. Likewise,
areas deemed “off-limits” due to technology or administration limitations should also be assessed without a
thought to how it might be done but with a mind-set of whether your financial institution would benefit from
participating in that area.

Take each of these key areas and break them down into critical factors that would be required to participate in
that area and achieve the goals set down in the plan. These basically become your business needs and could
revolve around reducing costs, improving access, improving processes, introducing new products or reducing the
time taken to complete certain tasks.

This list of business needs will drive every other process, discussion, demonstration or information gathering
session.

Making the Decision

The first step in the process should involve measuring the core banking systems on the market against your
business needs and seeing how they stack up. Some call this a business functionality fit and it can quickly provide
a prioritised list of those that have a high degree of fit and those without. Those options that do not have a high
degree of business functionality fit, no matter how well they rate in other areas, will always place limits on your
business and therefore you may choose to eliminate them from your decision making at this stage.

The second step is an assessment with its foundations in your long-term view. Those that rate highly on business
fit should now be examined in terms of the vendor. This is a long term decision and the vendor should also have a
long term view of your relationship, their product and also be financially viable for the long term.

At this point, assess the technology and architecture. The technology platform (hardware and software) should
be robust, sustainable, have an open architecture and be highly scalable.

Finally, a total value of ownership analysis should be done. Total value of ownership provides a more balanced
view of the new system, taking into account the value of business benefits with the hard costs.

At the end of this process there is normally a single, or maybe two options, that standout from the pack as better
options for your financial institution. Negotiation and business judgment will assist your decision making
however in most instances the final decision is one of trust – who do you trust with the future of your business?

A point of caution, this process can be quite involved and will require a reasonable amount of your time but the
results will deliver a decision that should provide a near perfect fit for your financial institution.

To provide some assistance the following pages provide further details and possible requirements that you could
use to start the five step process.

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Step 1 - Business Functionality: the driving force
While you will determine your own list from your own strategy plans, the following is an example of common
financial services business needs.

Flexibility
With the changes in the financial industry and the increase in competition from non-financial institutions,
flexibility to respond to market needs is mandatory. Look for flexibility in terms of being able to quickly change
product attributes such as rates, fees and terms without the cost and delay of programmers. Likewise, the ability
to introduce totally new products in response to an unfulfilled market niche quickly (in a matter of hours or days)
is also desirable.

A view of the person not just an account

Recent studies by the Meta Group indicate that it costs five times as much to acquire a new client than it does to
retain the business of an existing one. Given this, the ability of the system to support client retention activities
must be paramount. Key to this and client satisfaction is the ability to view the client in the core system as they
exist in real life with interpersonal relationships, multiple accounts and other foreign accounts and relationships.

The core system should be able to provide you, in a single view, an outline of each client as close to their real life
circumstances as possible. This means all involvement, or relationships, with their accounts, whether it is account
owner, joint owner, guarantor or maybe signatory, should be consolidated in a single view. This view should also
include other relationships found in the real world - husband and wife, father and daughter, employee and
employer. The final element in the single view is any third party accounts or policies. Items such as insurance
policies, retirement savings accounts and credit card accounts should be able to be seen in the same view as other
account details.

Just this ability – a single view – is a powerful tool that can enlighten your staff to offer better suited products and
services to each client and cross-selling opportunities become patently obvious. While it is true that this
information already exists in disparate systems, it is the intelligent combination that provides an accurate view of
each client in such a way that is useful.

Australia’s special needs

Each country has different government systems, requirements and regulations. Finding a new core system is not
simply a case of transplanting a core system from overseas. There are specific Australian regulations and
requirements that have to be incorporated into the core system before it is a viable option. This requires
concerted effort on the behalf of the vendor and is best done by those most familiar with the core system – the
vendor. Retrofitting these kind of core changes by another third party is fraught with hidden and obvious
dangers, as with most things a retrofit is never as good nor reliable as that done by those who originally produced
it.

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Reduction in costs
The current financial market environment demands cost reduction. Core systems that can automate mundane
but vitally important task like interest rate management and arrears management will relieve staff of these duties
and allow them to devote more time to other, more profitable, activities.

Transaction Processing
With the growth in electronic transaction and new distribution channels emerging, a core system with effective
transaction processing will streamline operations and increase staff productivity. A single centralised area for all
transaction exceptions coupled with intelligent distribution rules for processing direct credits will pay big
dividends to your financial institution.

Non interest income

The days of cross-subsidising unprofitable products and services with profitable ones unfortunately seem to have
mostly disappeared. In this margin squeezed market fees seem to have become a way of life. With the right core
system, your financial institution can again differentiate itself from the hard-hearted tactics of the banks. A core
system that enables your financial institution to diversify earnings into non-traditional areas, broadening the
product and services offering and allowing member reward and recognition programs provide essential
ingredients for this kind of business strategy.

Financial Management
With the focus on margins and profitability, a sophisticated financial management system that allows the
profitability of each product and region or department down to individual cost centres will provide great decision
making benefits to your financial institution. Detailed information that can be consolidated into major areas or
broken down into individual components is the kind of functionality that puts you in control of your financial
institution.

Improved communication with members

A core system that supports “one view” of a client can open a host of new opportunities to communicate relevant
and interesting information to your clients. Direct mail campaigns become more effective as targeting is more
precise. Statements as the main communication piece to each client could also be employed to communicate
appropriate messages to each client according to the account and relationship information in the core banking
system – the statement itself becomes a powerful selling tool.

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Step 3 - Technology: the delivery vehicle
Technology is another important component and is the vehicle to deliver the business functionality of the
software. It is not technology for technology’s sake. No matter how good you believe the technology to be,
without the business functionality of the software, you will not achieve your business objectives.

Any technology system will consist (more or less) of the following components which, within them, may include
hardware and software elements.

Take those core banking system options that rated highly in Business fit (step 1) and examine their technology
platform (or request your technical people to complete an evaluation).

Some core system providers require a specific technology platform for their systems and will provide you with
specific details of their requirements for all components while others leave finding the best components and
integrating them up to you and provide just a broad outline of their requirements. Each approach has its own
pros and cons which you need to examine relative to your financial institution.

Separate components from separate suppliers provides a large amount of choice but brings with it integration
and compatibility responsibilities, issues and costs. Remember to consider the hidden complications – for
example does a core system upgrade automatically work with the other components (if so, who will guarantee it
will?) or will you have to test all components in the whole platform for each upgrade; or if one component is
upgraded how does that effect the other components and will you need to test the whole system yet again.

Specific technology platforms where all components are integrated and coordinated by a single supplier remove
the integration and compatibility issues for your financial institution. If the technology platform supplier and core
system vendor have a close working relationship, the compatibility between core banking system and technology
platform as a whole (if one of the other upgrades) shouldn’t be an issue. On the downside, some regard a single
technology platform supplier as being too restrictive and prefer to coordinate multiple vendors, hardware and
software.

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Ultimately, look for a system that offers:

• Proven low cost of ownership

• Demonstrated price performance gains
• One that your core system vendor is strategically aligned to
• Simplified management and integration for your financial institution
• And a vendor that offers you a broad range of solutions rather than simple hardware provision

Step 4: Total value of ownership – the true effect

Clearly the components of the decision process have both a cost and benefit impact on your financial institution.
Therefore, it is important that your decision making balances the perceived costs with the perceived benefits.
Only this approach allows you to understand the true ownership value of the system to your financial institution.

Given that some of the costs and benefits are not easy to quantify, the process will have many subjective as well
as objective elements. This often makes it a more difficult process to adopt as it initially requires more work.

A starting point is to understand that this decision should be made like other business decisions: on the basis of
value. The value you attach to the decision can be determined using a combination of a traditional cost/benefit
methodology, the active participation of management and key staff, and mature business judgment.

There are three main categories for costs and benefits.

• In the first, direct costs and benefits can be identified and quantified. For example, the cost of new
hardware or the savings benefit in reduced personnel costs after a process has been automated.
• The second are indirect costs and benefits. These are not as easy to identify and often depend on
factors not entirely under your control, such as client response to a new product or service initiative.
• The third category is perceived costs and benefits and are not easy to quantify, perceived benefits
include improved competitive position or increased client satisfaction. Conversely, the reverse can
apply; this is the cost potential for missed market opportunities of doing nothing and not having the
systems capability to stay competitive in the market. In other words the impact of not moving forward,
the impact of not improving your competitive position, the impact of not increasing client satisfaction,
which all in turn will have an impact on your future flexibility.
Despite having a good planning process and a sound cost/benefit methodology, many business decisions cannot
be made by the numbers alone. For big decisions, such as entry into a new market or investment in a new
technology, it may be that no amount of analysis can remove the uncertainty. For small decisions, analysing to
the nth degree is simply a waste of management time. Analysis can undoubtedly reduce uncertainty and help
quantify it, but in the end there will be many decisions where unquantifiable factors are critical and cannot be
ignored. In such cases, executive management must fall back on their business judgment.

A final word, try not to get carried away with making it a technology decision for the sake of technology. Always
keep in mind your business objectives and work from the “big picture” down to determine your individual details.

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