How banks can achieve next-generation legacy modernization (2024)

April 28, 2021by Pawel Kot, Sebastian Schöbl, and Henning Soller

Even before the onset of the COVID-19 pandemic, persistently low interest rates had increased pressure on banks to reduce their IT costs. The pandemic exacerbated this issue, as banks scrambled to deliver new digital IT solutions faster and at lower cost.

The combination of these two trends has led financial institutions to explore new and more creative ways to modernize their legacy IT architecture. Even functional areas that had previously been sacrosanct—risk, finance, and regulatory compliance—are under consideration.

Now, banks are taking a new approach to modernization to reduce complexity and accelerate project delivery, which can be defined by six principles (exhibit). A comprehensive effort encompasses the data stack (principle 1), the core systems (principles 2 and 3), as well as the surrounding systems (principles 4 and 5) in line with a global approach (principle 6). Companies that have fully adopted this approach have been able to cut typical transformation timelines in half and costs by 70 percent while achieving the same benefits.

Six principles of successful legacy modernization

We analyzed more than 50 transformations to identify six principles that address the different layers of legacy IT and outline a path forward for banks.

1. Leave data at the edge, and build a flexible data platform over time rather than starting from scratch

In the past, banks have embarked on the centralization of all data in a large data warehouse. Today, banks can move more quickly by retaining their existing data assets in their current location and focus instead on building better interface layers—for example, through streaming databases and a data mesh. One major bank launched a large-scale program to invest in the modernization of its data architecture but had little improvement to show for it. Managers decided to focus the program on the more modest goal of ensuring access to golden sources of data—the defined single sources for a specific data element. Doing so not only reduced the program price tag by two-thirds but decreased the total implementation time from five years to three.

Impact: Typical reductions in cost and in time of 10 percent

2. Hollow out the core, and migrate customization to microservices

Banks can seek to move toward a complete reduction of the core. This approach will allow them to focus all new development in the surrounding systems and microservices. If major parts of an application’s functionality are noncore, IT can transition core functionality to microservices and then decommission the rest. For instance, one bank modernized its account-management system by migrating functionalities, such as how accounts were named and interest-rate calculations, out of the core one by one. Afterward, modernization of the remaining functions was a lot easier.

In line with this principle, banks can start by prioritizing capabilities to support newly designed customer journeys. For example, a major digital attacker had an outdated core banking system that was more than 20 years old but used a full application-programming-interface (API) layer to enable its future technology. This approach enabled the bank to pursue the digital journey without going into a two-year implementation program.

Impact: Typical reductions in cost of 15 percent and in time of 10 percent

3. Do not perform an arbitrary system modernization, but clearly categorize and modernize capabilities required for customer journeys

Many institutions build new capabilities with no clear view on how they can better support a customer journey, which results in wasted resources. Leading banks invest in new capabilities only when designing a customer journey that specifically requires them. By combining this approach with a focus on front ends, including the implementation of micro front ends, banks can achieve end-to-end enablement much faster.

One large bank started to modernize its platforms. Only when leaders identified the capabilities required to implement the customer journey did they recognize that overall costs would be reduced by reusing front ends. This realization enabled the IT function to significantly decrease the time needed to implement new journeys.

Impact: Typical reduction in cost and in time of 10 percent

4. Prioritize integration over simplifying systems

In most legacy-modernization efforts, the typical approach is to reduce complexity by rationalizing systems and applications first. Instead, leading banks focus first on integration and then on simplification. Only with the proper APIs in place can banks better see what applications and structures are redundant and begin restructuring and decommissioning them.

For example, a global bank embarked on a major IT cost-reduction journey. By implementing an API layer, the IT function was able to significantly reduce cost without decreasing the number of applications.

Impact: Typical reductions in cost of 15 percent and in time of 10 percent

5. Move all non-differentiating functions to SaaS

Most successful organizations have a good sense of the functions they can combine to create a competitive advantage. For all other capabilities, IT can move enterprise applications to software as a service (SaaS) or at least to platform as a service (PaaS); doing so ensures standardization and eases upgrades. Organizations that complete this migration could also experiment with cloud add-ons and new functionality to boost productivity.

One major banking group moved its HR system to the cloud. This deployment reduced its cost by 50 percent and enabled IT to significantly decrease the back-office team managing the system.

Impact: Typical reductions in cost and in time of 10 percent

6. Build global platforms, but allow local customization

Many institutions have allowed choices on platforms to be made at the regional or national level, an approach that creates unnecessary complexity. Leading banks have moved toward global platforms for channels, core banking, and data. They then permit countries to implement specific parametrizations. For example, a major banking group has standardized core banking and channels across seven geographies.

Particularly in the market process chain (that is, front to back to risk, including treasury and finance), banks have used standardized off-the-shelf solutions. These platforms do not just serve one country but are used across all branches. One global bank, for instance, is setting up a global retail platform with local adaptations of the product parametrizations and customized front ends, reducing IT operating expenditures in retail by 20 percent.

Impact: Typical reductions in cost of 10 percent

The new cost paradigm

Using these six principles, banks can not only achieve massive cost and time reductions but also ensure better quality and reliability of the result: the enablement of a better interface layer is the key lever to ensure the architecture’s resiliency and future readiness.

However, to get the most from this new modernization approach, banks will also need to overhaul their operating model to focus on productivity. Such a transformation cannot be achieved through pure technology changes alone; it requires a different approach to the “how” of delivery. Banks can introduce key enablers to support new ways of working that should naturally also drive the adoption of the six principles described in this post. Specifically, these include:

• Engineering excellence with the proper mix of talent. Create smaller teams of better people to ensure the drive toward the more simple and standardized architecture.
• A true platform-oriented operation model of all teams. Provide all services to the respective teams via APIs.
• Cloud-native architecture with automated infrastructure and public cloud at scale. Automate the deployment pipeline as much as possible to supercharge productivity.

A commitment to change management and the continual evolution of the IT architecture across the organization are critical elements that support this new way of working. Banks that can make changes to both technology and the operating model will be on their way to achieving modern IT architecture at lower cost.

Pawel Kot is a digital expert in McKinsey’s Warsaw office, Sebastian Schöbl is a consultant in the Berlin office, and Henning Soller is a partner in the Frankfurt office.