Financial Services Growth: Legacy System Modernization vs. Future Tech

Economic data from 2020 will be marked as outliers with its impact expected to last many years. But while it put pressure on all sectors, the companies least prepared with digital alternatives suffered the most. The focus has shifted heavily toward technology solutions.

Like everyone else, the financial services sector had to adapt, however, the impact might have been offset by FinTech sector developments over the past few years. Digital alternatives were already in existence when restrictions were imposed.

So, did the global pandemic alert the world’s financial institutions of the problems with legacy systems, legacy software and apps? Probably not that critically. Nevertheless, they got to see some of the issues play out in real-time, which accelerated the necessary changes.

According to the research by AppDynamics, 66% of the globally surveyed IT professionals admit  the COVID-19 pandemic has exposed weaknesses in their digital strategy, driving an urgent need to push through initiatives that were once a part of multi-year digital transformation programs. 74% of technologists report that their digital transformation projects, that would typically take more than a year to be approved, were kicked off in a matter of weeks.

The lion’s share of the financial systems are dated in many ways, either mainframe based platforms with spaghetti connections, legacy software code or hardware, and yet they remain integral to core financial operations. The benefits of upgrading legacy applications or legacy software from product-based systems to current customer-based ones are obvious, but so are the difficulties in making this change.

2021 could be the year that sees the full impact of adopting new technologies. Some changes resulted from global pandemic restrictions, but continuing innovations from mobile banks and FinTech companies resonating with skyrocketing customer expectations have had their impact on the market as well

Downsides of legacy systems and why it isn’t easy to switch

The most obvious downside is the technology itself. Large financial services institutions still maintain systems developed in the 1980s; a complex proprietary legacy software that does not work well with modern third-party services. These legacy applications don’t respond adequately to the intricate demands of modern finance, including the staggering amount of data that’s being collected.

Custom integrations of leading-edge software with legacy financial apps and networks takes time. For example, these systems don’t have built-in data pipelines that can take advantage of the latest analytical tools. This drawback slows down the development of new digital products, with banks and insurers facing increased pressure from FinTech companies who are built on the latest tech.

One more urgent reason for legacy system modernization is the regulatory preassure. For example, the European Union’s payment services directive (PSD2) mandates that APIs must be freely available to aid open banking systems. Developing APIs for a legacy financial services software  is not as easy as it is for newer technologies. Moreover, financial institutions with a presence in multiple markets will have to adhere to a whole variety of regulations, which calls robust and everupdeted digital solutions throughout the whole financial services firm.

Maintaining obsolete tech isn’t cheap either. Apart from licensing costs, legacy  apps for the financial services providers need an additional layer of software in order to integrate with newer tech. It must be custom-built on top of a core system that was designed for a different era of finance management. Developing and building this layer is a substantial investment and when completed it still not guaranteed to work efficiently. However, modern software development service providers offer some actionable solutions that enable the financial firms to deliver modern user experiences while maintaining existing APIs thus accelerating digital transformation strategies.

According to a 2019 Ernst and Young report, customer demand for services created around real-time data has not been met because core banking systems are updated once a day instead of instantly. In contrast, FinTech companies, and what is more BigTechs , like Amazon, Apple,etc) operate on real-time data which is baked into their systems.

Finally, outdated tech also needs obsolete skills. Romi Stein, CEO of OpenLegacy, calls it the “single point of failure” for legacy systems in the financial services sector. An aging generation of developers is in charge of the legacy systems, with no one set up to take over in the near future. It often requires a lifetime of working with these complex and unique systems to gain the necessary expertise needed.

Despite all these drawbacks, what’s slowing the adoption of newer systems is mostly costs considerations. Ripping out a core financial system and replacing it is expensive and difficult. Legacy modernization might not be about the latest tech, but rather a stable platform representing billions in revenue for many financial services institutions.

Migrating to the latest platforms can get messy as well. Though legacy systems modernization is a vital need, they represent proprietary data management that is integral to businesses. Regulations require at least some of this data to be stored and available for a certain period while following privacy and cybersecurity laws.

→ Read about data privacy  Essentially, Data is good. It’s the use cases that can be problematic

A good answer would be performing legacy modernization bit by bit. This is only possible due to developing technology, especially cloud services. A substantial number of financial services companies opt for upgrading parts of their businesses or start offering new services using new tech. In fact, faster product development is a major business driver in modernizing legacy financial systems. JP Morgan states that 71% of traders believe that artificial intelligence (AI) and machine learning (ML) techniques provide deep data analytics and intelligence for their daily trading activity.

→ Dive deeper into Business Intelligence in Finance in the 2020s: A path to value

In any case, with technology proliferation coupled with macro-and microeconomic influencers, experts agree that financial services firms can no longer delay the transition. Established banks, investment managers, brokers and insurance providers face fierce competition from tech whales and FinTech companies, and they have to move fast in order to remain relevant and get a return on their IT investment.

APIs already offer an immediate solution to access better analytics. Take Citi’s example: in 2016, they launched the “Citi Developer Hub” for third-party programmers to test and share feedback on APIs.

New technology is gaining momentum

Whether banks, insurance companies, or investment management agencies, financial service providers have been applying a legacy modernization approach to update tech over the last few years, although 2020 has hastened the process.

For one, social distancing and lockdown restrictions have forced customers to use digital channels to manage transactions in many parts of the US and the EU. It’s even possible that they have a greater appreciation than others for digital services that rely on real-time data.

For example, a Deloitte report says that 35% of customers increased their online banking usage during COVID-19. The same report says that Visa saw about 13 million Latin American customers make their first online transaction in the first quarter of 2020.

To say the least, it’s challenging to manage real-time digital products on legacy software. However, since this difficulty was known well before the pandemic, thankfully there are solutions which financial systems can tap into.

One of the most vivid aspects is cloud services and cloud spending is soaring. For instance, the banking sector is predicted to spend over $12 billion on “public cloud infrastructure and data services” by 2021 which is a huge jump from just $4 billion in 2017.  Even though regulators have been expressing reservations about data security and dependence on a handful of large cloud providers, the financial services pacesetters are using the cloud to move data already. This means they don’t have to build the infrastructure needed to migrate data. Also, the cloud comes with the advantage of computing power.

→ Here is more on Cloud lift and shift – to migrate or to transformate?

The next step would be moving platforms and processes. Financial services companies see cloud solutions as part of the move from an aging core, by creating smaller cloud-based platforms that meet a new or existing business need. The cloud is considered an “evergreen system” and is without the worry of it becoming obsolete.

Experts call this the “greenfield” approach and it is perfect for creating new platforms in the cloud with the intention of modernizing legacy over time. These “greenfield” systems are built to deploy new solutions as the financial services firms require them, which is seen as less risky than complete core legacy system modernization.

Goldman Sachs’ 2016 product, Marcus, is a good example. It was a digital service that let them enter the consumer lending market.

→There is more on Artificial Intelligence & Machine Learning in Finance: the Whys, the Hows and the Use Cases

AI could be an equally important factor of digital transformation stgrategy, though it doesn’t directly help with the migration from legacy systems. However, upgrading old systems means better data management. Where data was once siloed, newer systems can allow better access. Banks or other financial services can then use AI to turn this data into customized services that increase revenue. Also, the latest open banking regulations give AI and data analytics even more power.

Customers are now more aware of the personal data value and are willing to hand it over for better services. Regulations are moving in that direction already, with open banking systems predicted to bring numerous innovations. For instance, insurers can price products based on individual factors or provide investment products that match life situations.

With modern CRM tools like Salesforce, legacy financial services won’t have to invest in developing data analytics. While it’s not impossible, API integration might be harder with outdated systems. However, upgrading to newer tech is the best way to make the most of the integration.

AI and automation serve another vital purpose that legacy systems struggle with. Let’s consider Salesforce again, which is a CRM (customer relationship management) tool. Lockdown restrictions kept customers out of bank branches and insurance offices, but customers still needed a way to interact with financial institutions. Enter Salesforce services. After this positive experience, it’s possible that people might never return, choosing digital alternatives instead.

With a tool like Salesforce, customer management processes can be automated and more efficient, while human intervention can be avoided until absolutely necessary. Legacy software can struggle to accomplish this as data needs to flow freely. Salesforce also has an app market that offers plug-and-play solutions to extend functionalities.

What fin techs have done right

Modern digital financial companies have done quite well in recent years. They’ve bridged a gap that large banks and insurers could not and they did it by using technology. Here are three basic things FinTech companies have done right:

• Redefined the customer experience: FinTech services put UI/UX and customer needs on the same level as core financial services, which set them apart from legacy companies.

→ More about Customer experience in the financial industry

• A mobile approach: FinTech companies did not think it was enough to just create digital services. Android and iOS app markets offered them the chance to build great services on mobile devices for the customers.
• Personalization: Customers were willing to share data, if the returns were worth it. FinTech companies built products that asked for data and used that data to offer all-around services.

Not surprisingly, these lessons were learned through the five ‘Big Tech’ companies: Google, Apple, Amazon, Facebook and Microsoft. FinTech isn’t really new either as its services have been gaining momentum over the years.

Ernst and Young’s survey on FinTechs showed 64% consumer adoption globally, up from 15% in 2015. In addition, 75% of global consumers use a fintech service for money transfers or payments and 48% of global consumers use an insurtech service. 68% of consumers said they would choose financial services over a non-financial services company. 

This shows how FinTech offerings, focused on customer needs, have gained their popularity.

There are some interesting takeaways from the stats of various renown resources. FinTechs have evolutionized from freshmen looking to ‘disrupt’ the financial services sector. They have simultaneously become mature global competitors and enabling partners to the traditional market players. So they are firmly here to stay. Also, large financial services providers, including insurers, are already betting on FinTechs’ propositions with services of their own, and most incumbents are looking in the direction of more advanced FinTechs as well as innovative ideas from new startups. Though the 2019 investment boom into FinTech has slowed down, mainly impacted by the global pandemic-induced crisis, Deloitte reports that there were 964 funding events that helped 722 FinTechs raise $34.4 billion through September 2020.

But, the FinTech growth story has a flipside. While people are more willing to trust its services, they’re not as tightly regulated. One difficulty in making laws is technology’s rapid development. Take cryptocurrencies, for example. FinTechs have been willing to support cryptocurrencies, even though there are no real rules in many markets.

Regulators have also expressed concern about data privacy in the cloud. Most consumers are aware that there’s some risk; 71% of FinTech users “worry about the security of personal data when dealing with companies online.”  But technology proliferation is making the future happen, which gives the digital economy a chance for sustainable growth.

What does the digital economy look like?

A digital economy takes a lot of work and legacy system modernization is a vital step, but there are stop-gap measures to make the transition possible. And in many markets, regulations need to catch up with the tech to ensure data privacy and consumer protection. Now, when all of this is finally done, what would it look like?

Estonia might have the answer. In Northern Europe, the Baltic state claims to be “a cashless society with over 99% of financial transactions occurring digitally.” Electronic IDs can be used to authorize almost anything in the country.

Their journey has lessons for FinTech growth globally. For example, in 2007, they had to deal with a cyber-attack that brought down part of its digital infrastructure. In response, Estonia set up the NATO Cyber Defense Centre of Excellence. They also backed up all their data at a “data embassy” in Luxembourg.

Despite having to deal with more cybersecurity attacks, Estonia remained digital. They pay taxes, vote and manage almost all their financial services digitally.

Financial institutions could consider Estonia as the probable future of global economies. While it is difficult to migrate from legacy financial systems that represent a stable way to do business, there’s no avoiding the fact that they should be left behind.

As a technology partner to financial services companies, BFSI (banking, financial services and insurance), our clients often wonder about the matrix of a successful journey towards digital excellence. We, at Avenga, clearly see the way forward by addressing technology as a benchmark for true digital transformation in the financial services industry. We reframe technology in a new inclusive economic context by combining capabilities and innovation. In order to deliver lasting change and business resilience in an increasingly competitive market, we clearly define the expected results. Avenga’s profound domain experience coupled with our dedication and professional approach, enables us to understand the complexities of the modern financial market and translate them into real business solutions.

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