For years, tech and payments leaders have called for financial institutions to modernize their core banking systems. However, the meteoric rate at which payment technologies have evolved has caused many financial institutions to struggle to identify the optimal components of a modern payment stack.
In the Unpacking The Modern Payment Stack: What Matters Most for Banks report, Matthew Gaughan, Payments Analyst, and James Wester, Co-Head of Payments at Javelin Strategy & Research, examined the many layers that make up a payment stack and offered financial institutions insights for developing their modernization road map.
The Heartbeat of the New Paradigm
The elements of a modern payment stack are increasingly defined by the technologies that power them. This includes innovations like event-driven architecture and cloud-native infrastructure, but the heartbeat of the new paradigm is the application programming interface (API).
“A modern payment stack should provide the functionality to expose and consume customer-permissioned financial data via standardized restful APIs in a modern payment stack,” Gaughan said. “Banks and financial institutions will utilize these APIs to either build, modify, or launch new products, usually in a more streamlined manner.”
“They might be owned by the bank, or they might be provided by a core banking provider, but they let the bank be more nimble and more able to adjust pricing and use different routing logic and settlement depending on the type of payment rail. It takes a system that was static and makes it more dynamic and able to respond to the emerging payment rails that are on the top of customers’ minds.”
The layers of this modernized system can also be categorized by their function, the vendor ecosystem associated with them, and the value they bring in powering the next generation of payment solutions.
Some of the key characteristics of these technologies are that they are composable, open, and interoperable. This flexibility is critical for banks that are increasingly under pressure to provide instant settlement, and it is one of the elements propelling the emergence of event-driven architecture.
“Event-driven architecture allows banks to respond to real-time triggers and different data flows—as opposed to how it was done in the past, when payments were processed in batches, typically at a much slower pace,” Gaughan said. “It allows the system to asynchronously communicate with all these different systems.
“Batching payments will probably never go away, but this allows for assembling your payment stack in a way that allows for more efficient payments and allows you to respond to emerging types like real-time payments.”
Leading the Charge
Like APIs, cloud computing has been a revolutionary technology for organizations over the past few years, and it is also a critical component of a payment stack. Although many terms are used to describe how cloud technology is deployed, such as cloud-based or cloud-enabled, an optimized payments stack should be cloud-native.
“Cloud-native architecture is built entirely for the cloud, and it’s deployed on a scalable, containerized, and service-oriented infrastructure,” Gaughan said. “Similar to event-driven architecture, I think the through line to all this is to be more dynamic, but it allows banks to better respond to when there’s payment volume spikes across all their different systems.”
This need for adaptable technologies has been driven, in part, by the emergence of real-time payments. Consumers and businesses increasingly expect transactions to settle in real- or near-real-time, 24/7 and 365 days a year. Financial institutions must have technology that allows them to accommodate payments on a rolling basis and provide as seamless a process as possible.
Beyond being cloud-native, banks should also modularly structure their payment stacks, something many legacy core systems could not achieve. Many conventional systems were built using mainframes and monolithic architecture, which is effectively a single large code base for an entire application. This rigid system did not allow for asynchronous communication between disparate systems, even within the same company.
An optimized payment stack is oriented in a composable way that allows different components to be integrated, replaced, or scaled independently. This also makes the system flexible, interoperable, and open.
While creating this type of platform requires many technologies, one of the most important aspects of a modern payment stack is the people who implement it.
“Above all, none of this would be possible without the developers,” Gaughan said. “Banks are becoming more developer-oriented, but this still rings true with payments. Many of those next-generation payment solutions wouldn’t be possible without the developers leading the charge behind them. To create this system, all these layers must be undergirded by a developer-oriented culture.”
Signaling New Opportunities
With so much tech focus, many banking leaders may be inclined to leave payment modernization to their tech teams. However, the benefits of a modernized payments stack can reach much further than a systems upgrade.
“These aren’t just tech things happening in an IT vacuum. They’re directly related to the future business outcomes at these banks,” Gaughan said. “I think making that clear is important, so leaders and decision-makers recognize the benefits of these different parts of the payment technology stack. They’re part of a broader modernization strategy, but they could translate into real returns and help you increase operational efficiency.”
Modern payment stacks can lower costs for institutions because of their ability to scale based on volume. Additionally, they can work in concert with other systems to route payments more efficiently based on certain criteria.
Installing a composable modular core allows a financial institution to handle transactions based on the type of event that is triggered, in the most efficient manner. Once implemented, a streamlined tech stack can have dramatic impacts across the organization.
The operational efficiency gains can be significant, but there can also be key improvements in a bank’s risk and compliance operations. A modern payment stack makes it easier to link fraud, compliance, and risk systems with payments where these processes had previously been siloed.
“APIs can also signal potential growth or revenue opportunities within a business,” Gaughan said. “Banks will monitor the metrics associated, but developers can see which API is getting the most calls and how third-party developers are using them. Banks might be able to further monetize the APIs for other corporate clients or different banking services that are embedded directly into the ecosystems that their partners facilitate.”
Ultimately and Inevitably
Despite the benefits of a modernized payment stack, many financial services leaders have often elected to invest their funds into more customer-facing initiatives. However, an optimized payment stack can have a significant impact on customer retention and growth, especially as real-time payments raise consumer expectations.
“That level of speed and seamlessness in a transaction is becoming table stakes, and banks are going to need to be able to handle this,” Gaughan said. “The banks that modernize their payment stack set themselves up to offer the type of solution that their customers are looking for. It helps banks find their spot as a customer’s primary provider of banking or financial services.”
Many financial institutions have begun to feel the pressure to modernize and are unsure of the next step. However, the benefits of a modern payment stack make moving forward worthwhile.
“Modernization is not about a destination, it’s the journey—which sounds cliché—but these types of investments set you up for the next generation of payment technology, which ultimately and inevitably is going to be something that your customers are expecting of you,” Gaughan said.
