By Sayon Deb
Tthe degree to which community banks can innovate is largely dependent on the state of their core banking platforms. Unfortunately, legacy architecture in most core platforms limits the ability to support innovation. Analysts estimate that more than two in five U.S. banks still run their core banking processes on legacy back-end systems designed nearly four decades ago.
Legacy architecture once built for stability and reliability now generates pain points for bankers: multiple disparate systems operating independently, hundreds of applications that rely on point-to-point integrations, and asynchronous front-office and back-office processes, among others. This arrangement results in nearly unscalable systems and operational inefficiencies. To make matters worse, these systems are expensive to maintain, with banks spending over 80 percent of their IT budgets simply to preserve their technological status quo.
In general, banks have three pragmatic options in core modernization: a greenfield transition, where a bank builds products from scratch on a new cloud-based core under a distinct brand; progressive migration, where a bank can migrate functions over one by one and run them in parallel with the legacy core until it is retired; and finally, surrounds the core with a middleware platform that allows enhanced external connectivity to third-party products and services.
Each of these options has its own set of benefits, risks, costs, complexities and outcomes. The optimum for a given bank is driven by the current state of its technology stack, business objectives, and the unique constraints on its operating model, including organizational risk tolerance.
What is middleware?
For institutions that do not want to replace or convert their core systems, but instead want to extend the functionality of their core systems, middleware solutions can help bridge legacy technologies with new applications. It is becoming increasingly popular among banks that have significant investments in legacy core infrastructure that want to reduce the risk of change. Adding a middleware layer can also better prepare a bank for an eventual migration away from the old core.
The API-led middleware acts as a translator between a financial institution’s core banking systems and the various customer-facing engagement systems that use business logic and data stored in the core banking platform, whether for internal business applications and dashboards, a fintech partner’s platform, or the bank’s own customer interfaces. The middleware path to core modernization is gaining attention from smaller institutions as it has a relatively lower price tag and risk potential, while limiting changes made to legacy core systems.
Using middleware in the banking technology stack can provide three main benefits:
- Reduces reliance on legacy core to deliver products faster and make future conversions easier
- Building a single source of truth for customer data, leading to a better customer experience
- Foster partnerships with fintech companies
The use cases supported by middleware are many, from deposit operations and contact center management to branch activities and back office operations. API-based middleware solutions are flexible and can be widely used across all banking functions that would benefit from quick access to customer data or internal data.
Reduces dependency on an older kernel
By integrating a bank’s core and other back-office systems into an API-based middleware platform, banks can quickly access their data—with less complexity and less staff time—and generate new opportunities for revenue growth. Banks looking to respond to increasing competition and customer expectations for on-demand digital self-service understand that speed to market is critical and that they cannot rely on their legacy systems for rapid product delivery.
Many institutions have found themselves with ROI-positive projects in the pipeline that are limited by a lack of clear access to internal business logic. Banks often face a long timeline when gaining approval from their core vendor for third-party fintech access. Without having to rely directly on the core to launch new apps, middleware equipped with business logic makes it faster for a third-party service to connect to the core data without waiting for a legacy core vendor to build the connection.
Adding a middleware layer can also better prepare a bank for an eventual migration away from the old core. By connecting applications through the middleware first, the bank reduces its dependency on the old core system. Finally, the legacy kernel can be replaced by plugging a new kernel into the middleware, without re-plugging each application into the new kernel. What’s more, the bank can do so without experiencing downtime across all other front-end systems integrated into the middleware—because they rely on the middleware layer, not the core.
Building a single source of truth for customer data
Banks can use middleware platforms to unify disparate sources of customer data and internal data into one platform that forms a single source of truth to build better products and customer experience. Despite the promise of being a centralized data repository, legacy core systems have been decentralized for a very long time, with multiple sets of customer data stored in different locations and in different formats. Banks can use APIs and the middleware integration layer to provide a 360-degree view of the customer across industries for a seamless, connected experience across channels, such as mobile apps, personal locations, contact centers, wealth and marketing.
Banks consistently identify integration as the main obstacle to meeting their customer experience needs. Ideally, customers should be able to easily shop online with real-time updates across all back office apps. But in reality, many bank customers have a different experience on digital banking channels; for example, because their credit and debit card data is stored in two different places and they have to log into two different apps. Another example could be if the customer changes their address, but this change is not reflected in real time across various back-office systems, including the core platform. As a result, the customer experience suffers from these back office inefficiencies.
Foster innovation and third-party partnerships
APIs are also gaining traction in financial services as an enabler of bank-fintech partnerships. In 2019, Capgemini found that a majority of banks globally use APIs to engage with fintech firms as part of their business strategy, and the pace of external API sharing is increasing, with two-thirds of banks saying they share APIs with partners and partners. more than a quarter plan to share APIs within a year.
Bank executives welcome a shift away from competition and towards collaboration with fintech companies. Survey data collected by Finextra in 2019 found that 81 percent of banks globally see collaboration with fintech partners as the best strategy for achieving digital transformation. Among US financial institutions, the sentiment is even stronger: 97 percent of banks surveyed for a 2019 Finastra study agree that collaboration with third-party entities and fintech firms will serve as a driver for corporate success.
By connecting with a variety of external players, including payment cards, investment and brokerage firms and fintech companies, banks can explore new revenue stream opportunities or offer personalized experiences to their customers. These types of connections are supported by partner APIs, which represent about 20 percent of banking APIs, according to the 2020 McKinsey survey, and are used externally to support integration with business partners. The survey also showed that the banks have plans to double the number of partner APIs by 2025.
In addition to supporting bank-fintech partnerships, middleware can enable external activities for banks, including banking-as-a-service, or BaaS, and third-party risk management.
BaaS models – the delivery of banking products and services through third-party distributors – are emerging as yet another use case for middleware-enabled third-party partnerships. In this scenario, banks act as modular platforms that deliver core banking functions that fintech firms source to build their own financial services. The role API-based middleware plays here is similar to how middleware platforms enable remote connectivity or partnership with fintech providers in general. The difference, however, is that the bank gives up some control over the customer journey and instead focuses on back office activities. Playing the role of sponsor bank for a fintech will not be suitable for all institutions, but may be a good strategic move for some institutions.
Middleware can also play a role in helping banks perform their third-party risk management. Historically, TPRM programs have focused on point-in-time assessments such as annual due diligence and review processes. However, as the financial services environment evolves and becomes more dynamic, real-time observability is critical to the business. Banks may contract with third-party companies to carry out activities on their behalf, but reputational, financial, regulatory and operational risks remain with the bank. Just as banks establish key performance or risk indicators, banks can establish triggers and metrics to monitor change in fintech conditions.
With middleware sitting in the data flow between the bank and its external partners, banks can build out risk management applications to actively monitor transactions. This approach places greater emphasis on information gathering at a regular cadence rather than an annual checklist exercise. A middleware-based TPRM application can help monitor risks as they emerge based on critical risk factors identified during the due diligence phase of onboarding a fintech partner.
Middleware is not a magic bullet. While banks can use middleware to temporarily extend the life of their legacy core systems, the reality for many banks is that eventual core replacement is likely inevitable, especially given the pace at which technology is evolving. The long-term solution for most banks will likely involve the implementation of cloud-based core banking platforms, but a middleware solution can buy time to make the critical investment.
Sayon Deb is a senior director in the ABA’s Office of Innovation. He is the author of “Exploring Banking Middleware Solutions,” a new report from the Office of Innovation, from which this article was adapted.
