Much has been written about the pervasiveness of legacy infrastructure. These systems have become entrenched in many firms through decades of growth and acquisitions.
Financial services firms could get by with these patchwork arrangements in headier times when technological growth was slow, if present at all. Now, as the pace of development accelerates and new companies unhindered by legacy stacks emerge, the old guard must respond.
Missing out on the future: The cost of falling behind
Banks like numbers, so here are a few for them. In North America, non-bank digital payments will soon overtake digital bank payments in growth, reaching $24.8 trillion by 2028. As they lose share, global banks will continue to spend on those ancient systems, with the costs of supporting them rising at 7.8% annually to reach $57 billion by 2028. That’s up from $36.7 billion in 2022.
As the slowpokes count their losses, the news gets worse. Those banks ready for the future could see a 42% boost in payment revenue while enjoying up to 21% savings in legacy costs.
Additional capabilities from nimbler technology drive the revenue boost, beginning with new product capabilities like deferred payments and digital wallet platforms (22%), banking- and payments-as-a-service (BaaS) (PaaS) (12%), and data monetization (8%). The savings come from punting redundant technology (8%), orchestration cost benefits (5%), reduced downtime (4%) and lower development costs (4%).
The 3 drivers behind the race for future-ready tech
The report finds three significant forces that are driving the banks’ searches for future-ready technology:
1. Consumer demand – The people want to choose how to pay. Next year, 70% of retailers will add at least two new payment methods.
2. Infrastructure – As existing solutions increase in technical complexity and number, half of global banks will adopt PaaS for at least some of their payment processing workloads by 2028. Cloud-based systems will be a focus
3. Business model innovation: Global BNPL should reach $500 billion by 2026. BNPL platforms will compete with legacy fiservs to provide working capital loans to SMBs.
Unique regional characteristics lead to some interesting trends. Europe’s PaaS market value could hit $59.7 billion by 2028. Some of that has been fuelled by PSD2 complexities that have fed a rise in specialist providers. Some European banks have partnered with specialists to handle payment processing; the trend should accelerate as more entrants join the market.
BaaS is dominant in Asia Pacific, fed by the tendency of smaller IT budgets. BaaS partner revenue could reach 30% of all banking revenue by 2028.
Episode Six CEO John Mitchell said Japan has a well-established system, with payment systems that work well. Change is slow. There is an appetite for newer products and services, including BNPL, real-time payments, split transactions and the shift to paperless.
The lack of established systems has allowed Southeast Asia to leapfrog generations of technology. Mobile phone users can start businesses, accept payments and move money with the help of super apps.
“Maintaining legacy payment technology systems creates a ‘lose-lose’ scenario for banks,” Mitchell said. “On the one hand, they’re spending more and more money to maintain outdated payment systems, constraining technology budgets urgently required to transform their businesses digitally. On the other, they’re missing out on substantial, long-term revenue opportunities for emerging competitors.
“But, given the business-critical role that paytech plays in banks, most will not be able to ‘rip-and-replace’ legacy systems. A progressive modernization approach defines a faster path to transform mature banks into truly digital banks. By progressively modernizing specific parts of their payments stack, banks benefit from the new capabilities of modern future-ready platforms, reduce costs and technical debt, while at the same time minimizing disruption from full switchovers to new platforms.”
Many banks have a legacy deficit
Mitchell said he wasn’t surprised by the report’s findings. It confirms what he observes in the industry. Most fiservs on the planet have older tech stacks. Those systems constrain budgets as a more significant share goes to maintaining the clunky systems.
With patchwork tech stacks developed over decades, many fiservs have dug themselves into infrastructure hols that are nearly impossible to escape. The time, resources and commitment required to deter them from doing it all at once. Add in vendor and process loyalty along with the “if it ain’t broke, don’t fix it” philosophy, and there’s your inertia.
“Adopting new technology can mean adopting new processes because the requirements that a lot of the tech was built around don’t exist anymore,” Mitchell explained. “The way technology works has changed dramatically since the inception of these systems.”
“Now newer technologies are widely available and provide the type of resiliency larger institutions require for their infrastructure.”
Before the pandemic, incumbents were worried about a fintech onslaught. While that has cooled somewhat due to investor recalibration, change is still on the menu. New virtual payment technologies reduce soaring maintenance and support costs. That helps fiservs to migrate to newer systems. That, in turn, frees up time and money for product development.
What’s holding the laggards back
Banks aren’t ignorant of the modernization trends happening. They know folks want real-time payments. They see the revenue opportunities with digital wallets.
Mitchell said one challenge the industry must overcome is the necessity of increased operability. Most systems aren’t designed for interoperability, meaning wholesale changes are needed. Luckily, there’s a path.
“We call it progressive modernization,” Mitchell said. “It’s a significant concept because it allows our prospects to move over programs to our platform at their pace. That allows them to adjust to market demands.”
Mitchell sees strong demand for embedded finance services. Brands are embedded financial capabilities into their customer experiences to offer end-to-end capability. The key is virtualization.
“Over time, every single bank on the planet will virtualize how they’re operating,” Mitchell said. “It might take longer in some parts of the world, but it’s happening. That’s not necessarily regarded as BaaS, but it uses some of the same concepts. They’re going to digitize in order to offer the products and services the markets are looking for.
The process begins with fiservs accepting that their internal technologies are not up to the task and must be, at a minimum, augmented and often replaced. That brings Mitchell back to Episode Six’s progressive modernization strategy, where the transition occurs gradually.
That change is slowly happening, and there’s much at stake.
“There is ongoing collaboration and some competition of various types between fintechs and banks, but the banks are taking back the pole position,” Mitchell concluded. “The banks that are adjusting are winning. Others are falling behind.”
Tony is a long-time contributor in the fintech and alt-fi spaces. A two-time LendIt Journalist of the Year nominee and winner in 2018, Tony has written more than 2,000 original articles on the blockchain, peer-to-peer lending, crowdfunding, and emerging technologies over the past seven years. He has hosted panels at LendIt, the CfPA Summit, and DECENT's Unchained, a blockchain exposition in Hong Kong. Email Tony here.