The False Security of Legacy Systems: Why Fintech May Not Be Your Biggest Threat

May 24, 2016

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Fintech innovators are at your door, vying for your customers and business, but your real threat lies within your own walls. Legacy systems are increasingly irrelevant, costly, and difficult to use.

In 2012, Bruno Iskil, a trader known as the London Whale, lost $6.2 billion for JP Morgan. While the underlying reasons why are complicated, one of the primary causes was that the bank’s Value at Risk was being manually calculated through spreadsheets.

It’s a familiar story, like The Royal Bank of Scotland’s system crash in 2012, locking customers out of their accounts and costing millions in fines, or MF Global’s collapse as a result of its dependence on outdated IT systems.

 

“If it ain’t broke, don’t fix it.”

 

It’s one of those clichés that, unfortunately, people still listen to. It’s still the attitude towards IT from many banks and financial institutions when it comes to their legacy systems. Some are still running on systems that were put in place during the Cold War.

 

With fintech flooding the market with innovation and showing no signs of slowing down, and with new technologies like blockchain spreading like wildfire, it’s irresponsible for financial institutions to carry on maintaining the status quo when doing so makes them more irrelevant and inefficient with every passing day. Innovative payments companies like Square, and Robo-Advisors like Wealthfront are using Software as a Service (SaaS) to deliver digital, cloud based alternatives to outdated systems and companies. This leaves them free to make instant updates at any time, and free to completely change systems in days/weeks, rather than months/years.

 

Even though Dave McKay, chief executive of Royal Bank of Canada, is concerned about staying up to date with the latest technology and potential innovations – like blockchain – he realizes that the threat isn’t only from without, but from within: “the biggest barrier to adapting is…legacy systems.”

 

How Bad Can Legacy Systems Really Be?

 

Most of these outdated systems were modeled for a bygone era when institutions only had to deal with a fraction of the data they have now. Millions of people around the world are being affected by software that doesn’t update properly, or small bits of embedded code that creates self perpetuating errors within the system. The Defense Department, the Pentagon agency responsible for paying almost 3 million American soldiers, relies on a hodgepodge of over 2200 different systems rigged together, costing $17.3 billion per year. Accordingly, there are a plethora of errors in payroll. Peter Schoomaker came out of retirement at the onset of the Iraq War to return as the Chief of Staff of the Army in 2003, but wasn’t paid for months because the computers weren’t capable of restarting pay for a retired solider returning to active duty. And he’s just one of thousands of soldiers who have been lost in the system. The Defence Finance and Accounting Service still runs on Cobol, one of the first computer languages, and has millions of lines of code that haven’t been updated in a decade. Their system is such a mess that they haven’t been able to conduct an audit for twenty years. Their situation wasn’t inevitable; it was just too little, too late. But as the fintech sector grows, SaaS is solidifying as the solution to old computing technology, providing an alternative to every variety of core business function in a more accessible, less expensive manner than on-site software.

 

Keeping legacy systems may have once seemed like a good idea when new technology was still experimental and seemed risky, but it’s becoming more and more apparent that these old systems are little more than massive Rube Goldberg machines, adding unnecessary steps and work while placing a stranglehold on IT departments and generating even more errors down the line. Cloud computing tech and SaaS are becoming increasingly sophisticated and easier to integrate, making it well worth the cost.

 

Craig Focardi, a principal executive adviser at CEB TowerGroup, notes that “The biggest threat is a bank’s unwillingness or inability to consistently fund a high cost project over many years while facing the pressure to meet quarterly earnings targets. However, inefficient legacy systems hold back the very thing that shareholders value most: a lower cost-to-income ratio, organic growth and higher return on equity.” Banks are forgetting that in this day and age, IT is a core part of the business, not just a peripheral utility. The Bank of England’s chief economist Andy Haldane, estimates that 70-80% of IT costs are embedded in keeping legacy systems alive and running. It’s the equivalent of driving around an old car, thinking you’re saving money by not buying a newer model, when your repairs and maintenance over the years are just as expensive as new car payments.

 

Is There A Solution?

 

So why is it so difficult to pull the trigger and get change started? The primary reason is the risk of the unknown. Again, “if it ain’t broke, why fix it?” And sometimes change can have disastrous results. Aggressive innovation isn’t always the answer, especially when you’re trying to overhaul a massive system. The Defense Department had previously tried to build up a new system, spending billions over a decade before realizing that it didn’t work. Accordingly, they become mired down in their old, error-riddled system even more. Big, grand gestures of innovation are exciting and can seem like the right solution to fight disruptive innovation, but in reality, they are often unrealistic, expensive, and outdated before they’re fully implemented. Creating a new expensive and unwieldy on-site software system is a short term solution that will do little but devolve into tomorrow’s legacy system.

 

Fortunately, the choice isn’t between outdated legacy systems and a massive overhaul. That’s a false dichotomy. Updating or replacing legacy systems doesn’t have to be a major risk.

 

Instead of clinging to the safety blanket of old technology or grasping at new and untested innovation, you can take a slow (but steady), methodical approach to updating your legacy systems. In the short term, it may be difficult to see how the time, money, and complexity of doing so is worthwhile, but it can ultimately save the institution from itself.

 

Transitioning from legacy systems to SaaS will cut IT costs, simplify data integration, and, most importantly, bring your institution back from the brink of extinction. It’s natural to be wary of adapting to the same technology used by your fintech competitors, but it’s necessary to start anticipating your future needs rather than staying mired in the past. It’s a brave new world, and you can’t afford (literally) to keep thinking of the past.