Three Paths to Modernization: Which Is Your FI Taking?
- Mid-sized banks have about three years to modernize cores
- Incremental fixes will not meet efficiency or AI demands
- Modernization must align with payments, deposits, and fraud workflows so analytics and AI can scale
Over the past decade, the banking industry has seen a dramatic shift in how consumers and commercial clients perform their banking. This has lead to each financial institution embarking on a modernization journey to replace legacy systems such as OCR for check processing and even their core platform.
On top of customer demand, financial institutions have faced a wave of fintechs and neobanks entering the market space, leading to increased pressure to speed up modernizing their technologies and infrastructure to keep up with these digital-first, technology-driven new competitors.
In a post from The Financial Brand, Jody Bhagat, president of Engine by Starling North America, notes that any serious AI and digital roadmap must sit on top of a modern, cloud-first architecture rather than aging mainframes. Bhagat’s argues the industry is splintering into three camps:
- Progressive modernizers
- Born-digital trailblazers
- Legacy institutions that are only now addressing their core tech constraints
According to Bhagat’s “need to know” thesis, modernization is inevitable, and mid-sized U.S. banks must secure at least a 5% efficiency gain in roughly three years just to remain relevant, which translates into about $40 million in annual earnings for a $25 billion-asset bank.
Three Modernization Paths
On top of customer demand, financial institutions have faced a wave of fintechs and neobanks entering the market space, leading to increased pressure to speed up modernizing their technologies and infrastructure to keep up with these digital-first, technology-driven new competitors.
1. Progressive Modernization
On top of customer demand, financial institutions have faced a wave of fintechs and neobanks entering the market space, leading to increased pressure to speed up modernizing their technologies and infrastructure to keep up with these digital-first, technology-driven new competitors.
The bottom line is steady ROI with lower failure risk: banks can de-risk transformation by upgrading specific product lines without destabilizing the institution. The roadmap: plan migration by domain starting with high-impact/low-complexity areas, stand up an integration gateway to route traffic between old and new systems, and enforce hard decommission dates to avoid perpetual dual-core cost drag.
2. Hollowing Out the Core
“Hollowing out the core” keeps the legacy system in place but strips away the complex business rules—loan approvals, fee calculations, and product logic—into a modern, flexible middle layer. This is positioned as the fastest realistic path for large (Tier 1) banks that cannot risk a full rip-and-replace but need to launch new digital features in weeks, not years.
Efficiency gains come from three levers: moving rules into a modern layer to accelerate product launches, using a digital bridge to connect old data to new software, and relegating the core to a simpler, record-keeping role that is cheaper and less risky to maintain. In effect, the legacy mainframe becomes a system of record, while innovation and experimentation move to the middle tier.
3. Digital-led Expansion
Digital-led expansion means building a new digital entity alongside the legacy bank, using a clean, cloud-native stack to experiment at low cost and high speed. This model removes legacy constraints entirely for the new business line, which can later become the main bank once customer data is migrated. The roadmap: launch the “sidecar” offering to test fast deployment cycles without risking the core bank, design its architecture with eventual full-bank migration in mind, and use the high margins of the digital entity to fund sunset of the legacy infrastructure.
Integrating AI Technologies to Your Modernization Path
For bank and credit union leaders, Bhagat’s message is that choosing a modernization path is now a strategic urgency, not a back-office IT project. Modern, cloud-native infrastructure is what enables low operating expenses, rapid product iteration, and most importantly practical AI deployment, advantages that born-digital players already enjoy and legacy institutions must now actively pursue.
As we've noted previously, 85% of financial firms are increasing their AI budget in the next 12 months. Many financial institutions are looking to benefit from technologies in all areas, including automating check processing and reducing check fraud losses. Additionally, these technologies enable financial institutions to harness the power of their data to make smarter decisions.
However, without updating their legacy core systems, any efforts to make gains in efficiency, interoperability, and competitiveness will be all for naught.
So, which modernization path is your FI choosing?