Accelerated digital adaptation in banking

At the beginning of the year, I was invited by the IBM Institute for Business Value (IBV) to join 44 IBM global experts—members of IBM’s Industry Academy and Academy of Technology—to reflect on key trends driving investments and actions in 2021. We expect the following 8 trends to drive investment and push banking and financial markets leaders to move toward new cloud-based business architectures:

• Muted financial performance
• Accelerated digital adaptation
• New cloud-based business architectures
• Escalating competition
• Operational resilience challenges
• Increasing open and free data
• Security and fraud risks
• New ways of working

Let’s explore why accelerated digital adaptation is capturing a top spot on the joint agenda for business and IT.

In 2020, government-mandated actions in response to the pandemic required financial institutions to temporarily close many of their branches, operations offices, facilities, and call centers. Clients, employees, vendors, and other partners had to adapt to new ways to continue interacting.

Clients quickly adapted to digital channels, including web, mobile, and call centers. In the first months of the lockdown, some financial institutions reported a 30-40% increase in mobile and web volumes and a 300-400% increase in call center volumes. And it seems that increased digital activity is here to stay. In a recent BAI study, almost 90% of clients who increased their digital usage during the pandemic plan to maintain that use. (See “BAI Banking Outlook. COVID-19 Digital Banking Update”. Banking Administration Institute).

Working from anywhere   

Driven by social distancing and closures of physical locations, employees embraced remote working. The financial institutions not only had to deal with the upsurge in transaction volumes in digital channels that far exceeded their existing capacity. They also had to quickly enable their employees and vendor partners to work remotely without compromising security. A recent IBM study shows 83% of people want to work from home in some capacity after lockdown’s end. As working from home gains popularity, it's also redefining work-life balance. Yet, continued remote working can’t be sustained without digitization at virtually every level of an organization, and from front- to back-end. This will require banks to transform their processes, operations, systems, and culture—all at the same time.

Banks are simultaneously contending with muted financial performance that’s undermining their market evaluations when compared with payment providers and fintech that were capable of keeping and increasing client proximity through the periodic lockdowns. Compare the market capitalization, or private equity evaluation, of the top 500 global banks, payment providers, and fintech unicorns at the end of 2020, and you’ll see a clear trend implying a shift in power.

Downward trend of global banks: A shift in power

What’s different now with digital transformation?

For financial institutions, digital transformation isn’t new. They’ve been progressively transforming for several years, driven by a host of forces: changing customer expectations, pressures to reduce costs, threats from fintech and the neo-banks, emerging business models (online marketplaces and banking-as-a-service), and innovations enabled by technologies such as cloud, AI, and blockchain. So what’s different now?

3 things:

• The pandemic has drastically accelerated the need to change. Banks need to transform now.
• Transformation must lead to multiple outcomes. These include superior customer experience, higher efficiency, agility, and stability. To achieve these, transformation has to be end-to-end, including front-office, middle-office, and legacy core applications.
• However, such programs are typically long-drawn and require a level of investment that is not sustainable unless it is self-funded.  

Traditional approaches to transformation aren’t good enough to overcome the unexpected or unanticipated hurdles that could increasingly characterize a post-pandemic world. New approaches will be needed to mitigate challenges and still stay focused on the big picture.

Guiding principles for sustainable digital transformation

My experience indicates most banks have either started planning or have already embarked on a transformation journey. Some are looking at commercially available packages for replacing selective functions, some are attempting to refactor them, while a few are re-writing from scratch. In general, most banks are attempting to transform by domains and user journeys. Some are even exploring standing up a new digital bank with the hope that they’ll be able to migrate existing customers once it is up and running and the supporting software stack is stable.

While there’s no magic bullet for a successful transformation, here are some guiding principles for approaches that work.

Most banks have initiated multiple discrete projects to respond to specific challenges posed by the pandemic. Banks that adopt a sustainable transformation approach can go beyond tactical responses to the pandemic. IBM recently interviewed Piyush Gupta, CEO of DBS Bank in Singapore, to discuss how to thrive in a post-pandemic reality. He said, “If you can embrace agile setups, experiments, and constantly nurture a learning culture, then you become adaptive and nimble, which means you can respond a lot more quickly to opportunity and changes in the environment.” (See IBV report “Find your essential.”)

Banks that adopt a business outcome-driven transformation paradigm can shift from building business cases to justify a technology-driven transformation program to designing transformation programs that deliver business value, based on priorities driven by the business.

Banks that adopt an agile transformation approach can do so in waves of discovery and execution. Each wave results in demonstrable business value. In most cases, waves are designed around customer experience journeys.

Banks must have an architecture vision that acts as the North Star. While it is naïve to assume that the target-state architecture will remain static, it is important to have a foundation based on principles such as modularity; agility; portability across private and multiple public clouds; interoperability; and an intelligent, secure architecture that remains compliant to the core. Using a “design once” approach boosts performance with exponential technologies and unlocks business value across the ecosystem platforms.

Target state architecture vision

Attempting a transformation to replicate the old business architecture and processes based on new technologies is bound to fail. Good design for transformation liberates businesses to re-imagine processes and customer experience.

As banks think about the modernization and migration of back-end applications, many are considering a mixed fit-for-purpose approach of build, buy, and adapt. Build to differentiate. Buy when what’s needed is a commodity. Use an adapt-not-adopt approach for third-party applications.

For a given domain and customer experience journey, an end-to-end transformation delivers the highest benefit. Some banks may be able to wrap around their legacy core applications and expose APIs, but for most, these legacy applications can limit the ability to innovate on product features. Resilience and stability issues in core applications, combined with the erosion of the workforce that knows these applications, and difficulties in attracting new talent to work on these technologies pose operational risks. This has attracted the attention of regulators. Moreover, legacy core systems inhibit the ability to move to the cloud. Lift-and-shift strategies do not work with these hyper-integrated monoliths while maintenance and support of legacy core systems consume a significant portion of the IT budget.

At the same time, it’s true that core modernization efforts have not been very successful. IBM estimates 70% of the programs fail to deliver the intended outcomes. Combined with the cost of such programs (they could range from hundreds of millions to over a billion dollars in some cases), long duration (5-7 years or more), and long ROIs (often more than 4 years), it’s easy to understand the predicament of the CIOs. The approaches listed above help mitigate the risks.

Last, transformation programs require strong leadership, governance, and change management. These programs are complex, with far-reaching implications across business and technology. Underestimating the complexity of digital transformation can undermine a bank’s success—but a pragmatic approach can position it for the future and deliver value for customer, employee, and shareholder.

For more insights on a practical approach to de-risking your modernization program, I encourage you to download the latest IBV paper “Digital transformation in banking,” take a brief digital maturity evaluation, and see where you stand among your peers on your journey to the cloud.