The Banking Railroad of Innovation: Follow the River

I'm a big fan of the old movie classics. The TMC channel was a loyal companion during my graduate school days at the University of Illinois, offering a comforting black and white backdrop to frequent all-day programming sessions, and today I frequently call on TMC to get me through my daily hour-long treadmill sessions.

This weekend TMC offered up Jimmy Stewart as railroad detective Grant McLaine in 1957's Night Passage. A classic Western, McLaine was fired in disgrace over a railroad robbery carried out by his estranged brother, only to be offered a second chance to prove his loyalty to the railroad by being the courier for a large cash payroll being sent to the workers at the rail head.

Night Passage Poster

Grant's companion during the critical train ride to the rail head was young Joey.  Riding with Grant on a flatbed car as the train twisted and turned through the Rocky Mountains, Joey asked Grant how the railroad builders knew the best route through the harsh terrain.  This question gives Jimmy Stewart the rare opportunity to showcase his singing and accordion-playing skills as he responds by singing a song called "Follow The River".  The song ends with the chorus:

"Follow the river,
Wherever you may be,
Follow the river back to me."

Just as the railroad builders used the river to guide the design and layout of the early railroads, bankers have used technology to guide how banking services are designed and built.  In an interesting bit of historical irony, the first use of machine-based bank processing was being rolled out by the Bank of America just as Night Passage was hitting the movie theaters.

The system was called ERMA (Electronic Recording Method of Accounting), a machine-driven approach to electronically reading checks and processing the bank's accounts.  ERMA was co-developed by Bank of America and the Stanford Research Institute, launched in 1958, and was able to process 50,000 accounts per day.  While ERMA's initial capacity was small by today's standards, in those days, it represented an outlandish number in comparison with 10,000 accounts per month that BOA estimated it could process using existing paper-based manual methods.

ERMA ushered in the era of Big Iron in banking (a term also used to describe railroad locomotives), as improvements in the speed and capacity of what we today call the mainframe computer facilitated the rapid growth of the large banks during the 1960s and 70s.  Mainframe computers running programs powered by Rear Admiral Grace Hopper's newly developed Common Business Oriented Language (COBOL) became the river that banks followed when planning and building new banking systems like Electronic Payments (EFT), Electronic Tellers (ATM), and others to meet emerging customer demands.

Mainframe computers are interesting from operational processing perspective in that data (specifically customer accounts and daily transaction data) takes a while to load, but once loaded accounts can be processed at a lightning-fast rate.  While ERMA could process only 50,000 accounts in a day, modern mainframes can process millions of accounts in a matter of a few hours.  COBOL itself as a programming language was scorned nearly from Day One by the computer science cognoscenti as a crude and unstructured way to build an enterprise system. 

In 1975, a respected Dutch computer scientist named Edsger Dijkstra made the famous comment that: "With respect to COBOL you can really do only one of two things: fight the disease or pretend that it does not exist, " before concluding, "the use of COBOL cripples the mind; its teaching should therefore be regarded as a criminal offense."  Despite the withering criticism from academia, mainframe vendors and banks moved forward on the basis that the systems simply workedThroughput is the key to understanding how high-volume banking systems and today's railroad system works. 

A case in point is the Canadian National railroad's purchase in 2007 of the Elgin, Joliet & Eastern Line (EJE) to facilitate its rail connection of parts east and west through Chicago.  While the distrance from Gary, Indiana to Waukegan, Illinois is only 70 miles by car, CN now connects these points using EJE's 198 miles of track.  This makes no apparent sense until you consider that CN is now able to route cross-country trains around the busy hub of Chicago, where previously CN endured a variety of operational restrictions and traffic jams arising from the many at-grade crossings through the congested urban core.  To CN, routing traffic around Chicago rather than through Chicago resulted in more throughput and fewer train delays, more than compensating for the additional mileage.

And so it has gone for the banking processing. The use of oft-criticized COBOL and the unique operating characteristics of mainframe computers was tolerated as there were no other alternatives for banks requiring reliable processing at very high scale. That is, until recently.

Just as the river in Night Passage twisted and turned through the Rockies, the path of technological progress has twisted in an unexpected way to many bankers, as cloud services are now challenging the hegemony of mainframe-based banking systems. While a top of the line mainframe computer can be purchased with more than a 100 lightning fast processors, a bank can "rent" thousands, even tens of thousands, processors for 10 minutes, 10 days, or 10 years. Using software that is tuned to manage the distributed processing of bank accounts across thousands of virtual machines, banks can now meet and exceed the enormous throughput of their mainframe computers at a fraction of the cost.

The king of mainframe computing, IBM, clearly understands and has responded to the changing role of the mainframe in banking.  During the 50th Anniversary celebration of the mainframe in 2014, IBM rolled out its new vision of the mainframe as an uber-sized cloud server, allowing for the hosting of several thousand virtual machines at one time.  Last summer, IBM upped the ante with the annoucement of IBM LinuxONE Emperor, a z13-based server allowing for up to 8,000 virtual machines to be hosted on a single machine.

While banks have experimented with cloud services to varying degrees, most of the innovation has taken place at the channel services level, with new online and (particularly) mobile banking applications getting a technology refresh through the unique benefits of cloud services.  While each bank will need to build its own business case for the gradual porting of COBOL-based account processing systems to modern programming languges that are "cloud-ready", it is clear that cloud-based account processing will allow the level of agility in product development that is increasingly called for as channel and payment systems continue to evolve.

Cloud-backed innovation in back office systems has been slow to develop, with many banks citing security and the fear of regulatory issues as inhibitors to adoption.  As the recent two-part Celent report Banking in the Cloud:  Between Rogues and Regulators establishes, regulators in fact do not have any objections to banks hosting their banking services in the cloud, provided that banks follow the same standard of care (including encryption, access controls, data masking, etc.) that they manage for in their own data center.

In time, I expect that the banking railroad will continue to follow the river of innovation that is now leading us directly into the age of cloud services. The proven yet inflexible COBOL-based systems that have served the industry reliably for 50 years will be replaced with agile and cloud ready account processing platforms that will over time both reduce costs and the drive service quality improvements that banks will need to compete and survive in the increasingly competitive world of financial services.

And then there were four…Fiserv acquires Open Solutions

On January 14 Fiserv announced that it closed the acquisition of the equity of Open Solutions for $55 million.  At this size the deal was not subject to regulatory review.  The result: there are now only four major U.S. based Core Solutions providers: Fiserv, FIS, Jack Henry and Harland. Fiserv touted three key strategic benefits to the transaction:
  1. An expanded base of account processing clients,
  2. The “high quality and innovative technology” of Open Solutions’ DNA platform, and
  3. The wise use of Fiserv’s capital.
Overall, Celent views this as a win-win transaction for the firms. Celent  sees two key benefits for Open Solutions customers, existing and potential.  First, questions about the company’s staying power are moot: under Fiserv’s umbrella, Open Solutions is now financially viable. Second, Open Solutions, at least theoretically, gains access to Fiserv’s proprietary  complementary products such as Corillian and Mobiliti.  If Fiserv executes to its historical standards, the implementation will go well. As for Fiserv, it gets access to a real-time relational database structured to be charter- and geography- agnostic, together with multi-currency capability.  This gives the company technology to accelerate its international expansion, particularly with smaller community-based banks (Fiserv estimates there to be 40,000 such institutions globally). Questions that we’re interested in:
  1. How much did defense factor into Fiserv’s strategic calculus – that is, did it pursue this acquisition to prevent a foreign entity from purchasing Open Solutions?
  2. How well will Fiserv be able to integrate DNA into its current Acumen offering, and will it meet its 24-month target?
  3. Fiserv spent a lot of time discussing the implications for Credit Unions; what should banks currently running on DNA expect to come out of this?
  4. What will happen with DNA vis a vis Fiserv Premier, Precision and Cleartouch?  Might DNA customers be encouraged to move to Premier or Precision?  And might Cleartouch users be migrated to DNA?
  5. What must Jack Henry and Harland be thinking?
Overall, this lifts a potential cloud for any potential Open Solutions customers worried about the firm’s long-term viability and creates new international opportunities for Fiserv.

Misys and Temenos together

The press has reported that Misys and Temenos are likely to merge. I think these two companies make a very good couple with significant overlap in geography, and complementary product sets. Misys customers on Midas, Bankmaster, and Equation have been waiting for a path forward and were recently given BankFusion as a way forward. It is not fully built out, but now T24 presents another attractive option with a much larger customer base than BankFusion. Temenos had T24 model bank (a preconfigured T24 designed for certain target markets) designed for Misys clients. As a single company, it will be much easier for Misys to present viable paths forward in retail and commercial core banking.

Theory versus practice

In the theoretical world of the analyst, we think about the perfect world and the perfect solutions. Regrettably, that isn’t the world that most of our clients live in. There are legacy systems, limited budgets, time to market issues, project risk, reputational risk, etc. This helps explain why established legacy systems are continuing to sell in the US market and those more perfect (modern) solutions aren’t. This helps explain why systems designed 30 years ago are continuing to sell in the US market. They are proven; they work. Some data points…. Celent wrote a case study on Webster Bank which moved from a real time system (Miser) to a batch system (Systematics). Isn’t this backwards? In theory it is; in practice it’s not. My theoretical thinking was, why move from real time to batch, when your business is becoming more and more real time with debit, internet, mobile, etc. In practice Webster needed deep business functionality and didn’t particularly care whether the system was batch or real time so long as it could meet the needs of the bank. Foreign vendors are trying to enter the US market, and failing up to this point. Oracle (formerly iflex Solutions) FLEXCUBE came into People’s Bank in Connecticut. The implementation wasn’t proceeding as planned and management ended the project. People’s United now runs FIS (formerly Metavante) IBS. Union Bank (formerly of California) selected Infosys Finacle. Implementation is not proceeding as planned. Citi announced they were moving their domestic deposits to FIS Systematics. Again, I asked myself, why go through all the trouble of moving to a new core system, and not move to a real time system? Citi viewed the operational and project risk much greater. They were already using Systematics in other parts of the bank, so they had familiarity with it. They also didn’t want to move item processing from a batch environment to a real time environment. Changing core systems was quite enough change, thank you. Restructuring operations on top of that added more risk to the project. The latest announcement is BBVA Compass moving to Accenture’s Alnova platform, a real time platform developed in Spain and deployed across the globe. I see opportunities for success here. Accenture brings a broad and deep base of US banking experience from their US consulting arm. Assuming they work in a non-arm’s length manner with their Spanish colleagues, meaning the Alnova team, things will hopefully come to a successful end. Many have underestimated the difficulties of a core banking migration.

Celent Banking Innovation and Insight Day Recap

Last Thursday, we hosted our annual Banking Innovation and Insight Day at the Westin Times Square in NYC. Celent Senior Analyst Bob Meara opened up to a packed house with his presentation on top tech trends. This set the stage for the day as we moved into more specific subjects including, social media, risk management, core banking, mobile payments, and more. We had a good number of journalists in attendance to cover the event. Bank Systems & Technology was first out of the gate with a story, and wrote up a detailed piece on the social media panel that I moderated (Citi, USAA Execs Share Social Media Best Practices). I also had the honor of presenting awards to the 18 banks that were selected for our 2010 Model Bank initiative (group photo below). If you would like to obtain a copy of the 2010 Model Bank report please click here. If you are interested in submitting a nomination for our 2011 Model Bank report, or for more information on Model Bank, please visit www.celentmodelbank.com.

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All presentations from the event are available for Celent clients to download on our web site. We invite you to review what folks had to say about the event on Twitter If you would like to see a few photos from the event please visit our Flickr photostream.
www.flickr.com
Feedback on the event has been extremely positive. I would like to thank all of our attendees, distinguished panelists, and dynamic presenters for contributing to a successful event!