Sidecar Core Strategy 101

In this episode, we speak with SRM’s core expert, Jeff Ostheimer, to understand what he means when talking about sidecar core strategies and why this approach has become popular among banks and credit unions. Jeff will discuss how the emergence of fintech players, consolidation of core banking vendors, and more rapid digital transformation goals inside financial institutions have created the need for sidecar core investments and applications. This episode is a great starter for those interested in this topic, as Jeff provides valuable insights in his straightforward, casual style. Don’t miss this one!

Transcript

Sidecar Core Strategy 101

Welcome to Firmer Ground from SRM, where we explore trends and strategies impacting the current and future state of financial institutions in North America and across the globe. My name is Neil Dougherty, host of today's podcast and managing director of Global marketing at SRM. Every episode features experts from the world of banking and financial services, including thought leaders here at SRM, executives at future thinking financial institutions, and other experts from all corners of the industry. So let's get started. In this episode, I speak with SRM's core banking expert, Jeff Ostheimer on the novel topic of sidecar core strategy and why this approach has become an answer to a continuing challenge for banks and credit unions. Jeff discusses how the emergence of fintech players and the barriers of moving off of legacy systems has created an ideal environment for the sidecar approach. We hope you enjoyed this conversation with Jeff. My guest today in the SRM studio is Jeff Ostheimer. And Jeff is our director of Fintech Advisory Services here at SRM. Jeff joined us after 17 years at Finastra, where he was highly acquainted with core banking systems and various point solutions for banks and credit unions. And Jeff's been a great addition to our team. He works closely with our clients to help them think about the big picture for their tech stack and how to work with fintechs that are obviously moving at breakneck speeds. He's been our go to expert when it comes to core banking and digital platforms, and that's why I'm excited to have him on today. And we're going to talk about the core landscape, and I'm specifically hoping we get below the surface a bit on the idea of sidecar core strategy and what's driving the need for it, who the players are, and what are some of the more significant case studies where FIS have employed this approach. So welcome, Jeff. How are you doing today? 

Good, Neil. Thanks for having me. It's exciting to be here. 

Absolutely. Well, just to kick it off, Jeff, we were talking recently, and you said something that struck a chord with me. I believe the quote was that the system of engagement is now more important than the system of records. Did I get that one right? And can you help listeners better understand what you meant by 

Yeah, it's funny how that occurred, but everything hinges, especially in digital transformation around the Pandemic. Right. So before, it was always the system of record being the most important, the core platform being the brain of the bank, for lack of better terms. In every institution, bank or credit union had a digital strategy in their mind or a detailed kind of strategy laid out for five to seven years. But when the Pandemic hit, that fast tracked a lot of digital transformation and innovation, and it moved roadmaps two years up from where they typically were. And what we saw. Especially on the back half of the pandemic, was some significant investment in fintech and the featurization of products. And it turns out that a lot of the legacy providers are unable to accommodate their busy focus on compliance and other key areas when it comes related to core and digital banking. Providers, frankly, weren't doing that great yet with innovation and consumers were looking for more. And so that's why I mentioned today when I engage with banks and credit unions and that sentence always strikes a chord where the system of engagement is now more important than the system of record. The core is now coming a black box, it's commoditized and they're looking to either innovate next to the core or on top of it, but not be reliant on the core offering to provide innovation because. Those that during the Pandemic and during Coronavirus were more innovative. I use ITMS as a good example. They were able to weather the storm a lot better than some of the other ones that had to close their branches and still were relying on a branch delivery channel. So that's kind of the genesis of that quote. 

Yeah. No, that's super helpful. And it was something you had said, and it struck me as being so right on. Right. Because engagement and meeting the expectations of the consumer is so critical. So you mentioned the fact that some of the providers were challenged to kind of keep up. So help us just understand a little bit and kind of segue into how you feel the state of the core banking vendor landscape is looking today. Right. And kind of what's happening? Is consolidation still the move? Are there other challengers stepping up? Is there something that's happening that's kind of critical for our audience to know? 

Yeah, it's an interesting market. It's always changing. But what's interesting, the ABA came out with a survey  interviewing CEOs about their experience with their core provider and what their plans are for the future. But before I go there, it's always interesting to see just the area of where the market is heading in general. In 2022, there was 4081 banks. By 2045 I'm sorry, there's 4081 banks in 2022. But by 2042, they're expected to drop by half, which is really interesting because then you start surveying institutions, and that's primarily driven by these neo banks and challenger banks and fintechs really doing a lot in the market. I mean, look at what Apple just announced last week. I believe a new savings account that drew nearly a billion dollars in deposits in the first four days on the launch day alone. The savings account drew nearly $400 million in deposit. So that's a lot of data to throw at you, Neil. But it's just an example of kind of where I'm looking at the market and where I'm seeing and how that relates to the core. Because the question was asked, will your institution replace its core system as part of your digital transformation strategy? Overwhelmingly, almost three quarters said no, and only 14% of institutions said yes. And then there's quite a few that were not really sure. But it's really interesting because they're relying heavily on legacy core providers, legacy digital banking providers for innovation, but they're not willing to make the change. So what do we do now? What's next? Right? And not sure if I'm jumping ahead, Neil, to what the  market? Well, I think that's it, right. Yeah, that's what we're trying to get to, which is, okay, so if those are the numbers right, that's what the data is telling you. That's what the attitude looks like. And this is probably something that you've seen throughout your career in terms of that kind of challenge to make a change and all the pieces and kind of just the challenges that come with shifting to a new provider, then what's the alternative? Right? And I think I have to imagine that's where we get into this idea of kind of the sidecar core strategy and what's happening there and what that looks like, what that approach is all about. So I'm curious, is that the segue you think we can get into now? 

Yeah, absolutely. I think the sidecar core strategy and I'll just try to sum it up and paint the picture of what I mean by that, because it's not a really well-known term. It's something that I've stolen from different sources and just in my just personal experience, anecdotal experience in the core banking space. But because of the number of institutions that want innovation, they need innovation. They don't want to say, God forbid, another pandemic happens, and they don't want to be in the same situation again where they have to close brand. They can't do business. A digital system of engagement is more important than the system of records. So keeping that in mind, they want to do so how do they innovate? Well, they look at a strategy. And what we work on at SRM is making sure that we future proof the business. And that could be working with their legacy core provider to get the best structure, the best middleware providers, and leave that system in place. But they understand that they can't innovate through at scale and at speed that they want if they have to rely on legacy providers timelines. So what we're seeing is the growing need for Fintechs to come in. So there's some cloud native platforms that are making some significant investments. Interesting use cases in niche type product offerings. Instead of going in saying a full lift and ship of your core tech stack, move all that over to us, we can position a core like solution next to your FIS Jack Henry, Fiserv, or Finastra solution and help you with your cloud journey immediately. So time to market being months rather than years. And have a special type product. And like I said in the beginning, a lot of institutions are looking for more featurization of those products and that's where these legacy providers are really lacking in that featurization in financial services. So it presents a significant challenge. So it's inflexible outdated core systems that really inhibit the rapid and integrative product innovation that they're looking for that these neo core systems or challenger core systems that can do so they're left with only a couple of options, right? It's like let's wait on the core like I already mentioned. But that's typically innovation isn't the top priority of legacy core providers. They may say it is, but it's really not. Or the other option is replacing it to an alternative core which takes a lot of time. You'll get better pickups, you might get some better APIs and then at that point then you can start innovating and that you're years down the road. So I'm seeing that sidecar core strategy as a better and talking it's a good alternative to the legacy strategy to be able to offer. Modular banking or what's. In a good example, we're seeing card issuance products, real time capabilities, FX, just being able to sub accounts, being able to do some more interesting things 1s with these platforms that you can't do with the legacy provider. Buy now, pay later. And gone are the days where you move cores. If you have a specific core, you have the same type of products, your competition down the street will have the same checking account, right, the same CD or money market, and you're competing on interest or branch and online banking just overall scale. Well, now they're looking for more features and that's kind of where that sidecar core really comes into play. It's like we can launch a product, we can migrate maybe a subset of our legacy products to the new core or new product and offer our new membership, our new customers, the ability to onboard with a very slick UI experience. Kind of like that Apple experience that they could have within a matter of months rather than years and get started that way. And ultimately move and migrate your data from your legacy provider over time, so you're not really doing a full lift and ship or what the industry calls open heart surgery day one, migrating everything on a weekend. You could take years and greatly reduce your risk on customer impact. 

Well, sorry to interrupt you, Jeff, but that's an interesting point too, because you just mentioned this kind of idea of open-heart surgery. But you can still have a plan, right, to change if you want to, or if you see there's an advantage, but you also have this ability from some of these sidecar bolt ons, some of the other tech that's out there to do what you need to do in the year term while you're potentially making a bigger technology investment in the long term. Is that fair to say? 

 That's right? Absolutely all. 

And one other theme that we hear a lot about today is the idea of AI and integrating AI into everything from a business standpoint, right? And the kind of popularity and demand and also the challenges from kind of a responsibility standpoint and ethics and things of that nature in AI. But I have to imagine that AI is something that has to be taken into account now as it relates to these core banking systems and potentially these sidecar strategies. Is that fair to say? Is that something you're seeing kind of being built in or bolted on as well? 

It is. I think AI is definitely you hear Chat GPT all over the news. AI is being talked about all the time on everywhere you look, right? There's always a new use case coming out for it really interesting. It's scary, but it's also exciting at the same time on where AI can go. And if you're a bank or a credit union, you're not really thinking about a strategy on how to deal with this. One good example is Chat GPT. Right. Are there employees logging into Chat GPT asking for help? There's security risks with that. There's non personal information, customer information. They can't they've got to start thinking about, one, the strategy from their back-office perspective and just security, but also the customer experience. What are they going to do with it? Where I see AI really coming into play is this is where the legacy platforms could really benefit. Right? There's a lot of manual processes and processes that occur in a core or a back end digital solution. The consumer may see it as real time on the front end or on their experience, but on the back end, the nightly processing that occurs just the redundant compliance tasks that the staff have to do in the core every time something occurs. That's where I see AI and machine learning. Really picking up steam is creating unique workflows to drive Efficiencies in the back office and making their staff's lives easier so that they can spend more time not doing redundant compliance tasks. Like Reg II disputes as an example, right? There's always somebody who has a dispute on a card transaction, they got to call, they've got to talk to the staff. The staff has to fill out this form, and they have to go look at the transactions and do all this. AI can solve that and do it on its own and even get the form where it needs to go and notify for approvals internally. So I use it more in terms of running workflows and dynamic workflows and leveraging AI machine learning to learn a better process to get that done. That's one aspect of it, is the back office. And then, of course, we're seeing AI chat bots really driving some of the digital journeys and experiences for these banks and credit unions. So I'm talking to banks and credit unions every day that are really coming up with a strategy on like, what does this mean for our organization? Where do we want to implement AI first? I mean, it's not something you just launch and let it go. It's what are the use cases we're trying to solve? What are the KPIs that we're trying to measure? Where do we really want this going? You've got to have a good plan because. You know, sometimes if you if you think about Chat GPT as an example, you might think you're talking to a human being on the back end and they're just instant messaging back and forth. So large language processing, the customer may just be dumping on the institution with all their issues and they're getting terrible responses back. You've got to have a strategy for it and you've also got to have a human element to it as well. So humanizing AI, I think, is what banks and credit unions need to be focused on. Let it do a lot of the redundant tasks, a lot of the basic support questions what's my routing number? Where do I find this? How do I turn off my debit card? But then the complicated there needs to be a smooth handoff to what see as being the call center or the back office support to be able to drive a better engagement where AI can really be helpful. But if you just launch AI or you buy the next shiny object from an AI chat bot provider, it's not going to solve the problem. You've got to have a strategy. 

Yeah, I mean, that's a great point and thank you for covering that. I hope I didn't take us too far afield from our initial conversation, but we know that that's something that continues to come up and it's exactly that. How do we build a strategy and then have technology that aligns to that, right? So more and more I know that that's what we're talking about. I wanted to maybe take just a slight step back and ask you kind of your thoughts on certain profiles, financial institution standpoint that have kind of the hardest time adapting maybe to the movements or changes in the core. Market or are there particular profiles that are maybe struggling a little more than others in terms of whether it's again what we talked about, which is managing the legacy core and working with some sidecar core strategy? Are there other challenges that maybe financial institutions are facing that are keeping them from getting the most out of their core banking systems and generally their tech stack as it aligns to strategy? 

 Yeah, I think we're seeing most of the challenges comes along the lines of just support and service from these large legacy providers. Additionally, it's the back office having the resources to best optimize these platforms. And that's where you can leverage like an SRM or any other firm that can help optimize and help you with your vendor management and your tech stacks. And some of the challenges are the integration perspective. Right. They want to move quickly. They found a fintech provider that they want to work on or work with, but then they're stuck in a six month to one year  backlog with this. So.  And then additionally, that might be enough of a catalyst to say we need to do a conversion. And then always the question from the board comes up is, well, can we even do a conversion? Do we have the resources? Do we have the knowledge? Have we ever done this before? And a lot of institutions built today are one, running inhouse platforms where there's some pros and cons to that, but then they realize they need to go to a cloud offering or service bureau. It's just how do we do it? How do we get there? How do we get from point A to point B effectively and not disrupt everything that we're trying to do and let the customer feel or the member feel? And then we start talking about how do we go core agnostic with maybe some middleware providers that can bolt on top of the core. We can integrate through a middleware and then the core is really in the background as a black box and then that gives a little bit more flexibility over time. So really the challenges are resources.  There's just so many options to consider and it's just developing a sound strategy and working with a partner like us to be able to show them that path or help them on that journey to recognize the value much sooner than years. It should be rather months instead. Not sure if that answers your question directly, Neil, but no, I mean, it certainly does. I think it's the perspective that we're looking for, right, which is and oftentimes, I'm sure in the conversations you're having, every challenge and every kind of scenario is just slightly different. Right, but you mentioned the piece about the kind of middleware providers. Are there any specific providers that are standing out right now or that are coming kind of into a state of, shall we say, popularity in terms of what they offer and their kind of ease of integration? 

Yeah, I'm definitely keeping an eye on a few. I've talked to many community institutions just in the past couple of weeks on this exact topic, so it's very timely. But everybody's pretty familiar with a company called MuleSoft. Which is really an integration hub that you could do a lot of unique things with, but the barrier to entry is pretty heavy or pretty hard in there. Given that they work with some very large institutions, it's expensive to do. And then there are some others that like PORTX, which is very interesting company as well, that can cater to a different segment of the market. Those that want to kind of take control of their integrations and manage them better have a better API strategy to help with the burden of third party integration. So many of the legacy providers do point to point integrations, and that's not always efficient. You can wind up with a spider web of connections to do simple tasks such as account opening, whereas some of these middleware providers can have reusable APIs and it's an easier managed solution to do so. There's just so many out there that I think are doing a really good job that could help an institution realize that maybe you don't have to do a core conversion. You might think you do, but then it might just be maybe a digital strategy you're really looking for that we can assist with and help strategize on, and then also hold the cores accountable to access to the data. To be able to drive that and you're able to keep your current core or innovate on top of it. And all the whole time they probably thought they had to do a two-year conversion project when in fact they don't. 

And it sounds like having a strong API strategy and thinking about that kind of in a repeated pattern is going to be critical to that process as well. Yeah, we see. You and I have talked about this a few times, but banking as a service is kind of the gold rush right now, and a lot of institutions are looking at trying to dip their toes into it. And the number of banks out there in the market right now is only about 120. But the number of fintechs is definitely grown to about 562, according to Fed five sources, which is always interesting to think of. So they're looking at banks and credit unions are looking at those partnerships very closely on how do we embed our services or extend our services out to gather more deposits. I mean, post SBB and some of these bank closures, there's a lot of deposits to be had. And community banks and credit unions are in well positioned to be able to act on that and setting that strategy and partnering with us to kind of help with that strategy. That could be you need a new core system, or it could be, let's do a short term renewal, let's make sure you're on the latest and greatest APIs, and then work with a middleware provider. And then also a digital strategy, maturity assessments, things like that, to get to that goal to the market quicker. Yes, that makes sense. Okay, so let's just kind of tie this thing up a little bit. So, you're in a conversation with the bank or credit union, CXO, whoever that might be, that's really in the conversation, trying to make a decision, trying to think about their strategic next steps. Right. What's your big piece of advice these days? What do you really want them to have as a takeaway from a conversation with you based on kind of the things that you're often bringing to the table when it comes to core open banking, banking as a service? What should they really be taking away from that conversation? 

A holistic approach to the organization and the digital transformation they're looking to accomplish and what journey they want their customers or members to go on. Don't just buy the next shiny object and plug it in and expect that to save the day. Right. Great. I've got ITMS. Check. I bought four of them. That's digital transformation. You really got to have a strategy that if you're happy with your core relationship, that's great. Let's leverage it. And then how do we best structure an agreement with your core provider to give you the best flexibility and future proof your business? And what's the innovation approach that we're going to take and the strategy around that? Leveraging your existing core and your overall strategy and leveraging some middleware or other fintechs that might be able to fit into that just kind of coming back full circle. It comes back to the featurization of these products that I'm talking about that's really key, and that's kind of what we're leaving with. It's like we want to have a better journey and a better approach than our competition and. We want to be able to do more and offer niche type banking to maybe I'll just use an example of a credit union that caters to the military, right? So we want to have niche products for military banking, and there's numerous challenger, banks and fintechs that are jumping into the market and doing that level of engagement like Chi and Square and Greenlight is one that's really interesting too, where they're doing debit card management for children, for kids and their parents. So being able to feature these products and have a strategy on how to partner with your core and other fintech providers to be able to accomplish that digital strategy and journey would be a key thing to leave them with, I think would be the best way to address that now. That's great. So if I had to summarize that, I would say it's don't just buy the shiny object. Think through the journey first and make sure you have the multitude of things you'll need to make that happen. So that's awesome. That is so great. Well, I mean, I certainly appreciate your time today, Jeff, and I'd encourage anyone who's interested in this topic of sidecar core strategy to reach out to Jeff. And I hope you'll be able to join us again on this podcast. I know we've got a lot of different guests coming up in the weeks and months ahead, but I'm sure we'll have you back here when we can and certainly hope our listeners enjoy Jeff's insights today. Thanks for listening to firmer ground from SRM. Please stay tuned for our upcoming podcasts, including insights on AI chatbot use cases and the continuing trend of digital assets tokenization. Until then, you can visit srmcorp.com or on LinkedIn and Twitter.