Today’s core banking conundrum: Is your system ready for instant payments?

The adoption of instant payments is on the rise among U.S. businesses and consumers, according to Federal Reserve surveys.

By one Fed measure, 86% of businesses and 74% of consumers said they used faster or instant payments in 2023, and most (74% of businesses and 79% of consumers) reported looking to their financial institution to provide these services.

Banks know this. In fact, according to Jack Henry’s recent survey, 96% of financial institutions plan to add payment services within the next two years, with the FedNow offering a top priority for financial institutions.

However, as core banking platforms become increasingly overloaded, many banks are struggling to keep up. With mass adoption around the corner, the big question is – are banks’ existing technology cores ready?

Appetite for faster payments grows

As customer expectations evolve, financial institutions are quickly acting. Since the launch of FedNow, more than 700 financial institutions have signed on – a dramatic increase from just 35 last year.

Not surprisingly, younger consumers, particularly Gen Z (18-25) and Millennials (26-41), are driving mass adoption. According to the Fed’s surveys, one-quarter of consumers express frustration by slow payments as a primary factor for adopting faster payments.

Among businesses, nearly half (48%) are adopting faster payments to reduce costs. And 39% cite flexibility in payments, while 35% point to 24/7 availability as key benefits. Additionally, instant payments are driving significant value for business-to-business payments, cited by 92% of respondents. Business-to-person payments were also called out as a tremendous value by 71% of those asked.

Still, the U.S lags other nations for real-time payments. For instance, countries like Brazil process over two billion Pix payments per month compared to just 76 million U.S. RTP transactions for the entire first quarter of 2024. Created by the Central Bank of Brazil in 2020, Pix is Brazil’s system for instant payments.

Looking ahead, transactions in the U.S. will continue to grow and banks will likely experience infrastructure challenges, as was the case for many banks in Brazil. Faced with the challenge of processing billions of Pix instant payments each month, banks grappled with overloaded core banking platforms, hindering customers’ ability to make payments due to the real-time settlement nature of instant payments compared to the batched settlement of credit card transactions.

The same challenges are mirrored by U.S. banks contending with an ongoing surge in digital transactions and so a solid technology roadmap for payments modernization is critical.

Outdated legacy cores are a barrier to digital transformation

To enable real-time posting and 24/7/365 transaction availability, the adoption of modernized payments systems also requires modernizing a bank’s core and partner systems. However, updating a bank’s legacy batch systems is a massive undertaking and requires overcoming significant hurdles to achieve long-term change and innovation.

This dilemma was experienced in Brazil. With a meteoric rise in instant payment volumes came unforeseen strains on Brazil’s legacy core banking systems. As consumers switched to paying merchants and each other by Pix instead of cash or credit, the transactions hitting the core banking systems accelerated. Core banking systems had to authorize each of these growing Pix consumer payments and post the receipt of merchant payments instantly.

Additionally, large merchants who accept Pix, for example, saw 10 times or more transactions hitting their bank account per day. Meanwhile, credit card transactions are bundled and only posted to these merchant accounts once per day. When large merchants accept Pix payments, some banks were required to deliver account statements on thumb drives because the statements reflected so many transactions. In response, having a core system able to process thousands of transactions per second became imperative.

While this is Brazil’s experience, banks in the U.S. are already struggling to keep up and instant payments transactions are still relatively low in comparison. Just keeping up with digital transactions generated by Apple Pay, Google Pay, Venmo, PayPal, Zelle and others is challenging.

Many U.S. banks are looking for ways to modernize their core, but replacing legacy platforms is expensive, distracting and requires a lengthy process. Afterall, no bank wants to replace their core, despite how outdated it may be.

Preserving existing core investments

The good news is that they may not have to. There are solutions that work alongside legacy core banking platforms to process these instant payments and other digital transactions in real-time and bundle them to share with the core at a designated point in time, saving core processing time and costs.

Instead of completely replacing a core, banks can preserve their core investment, replicate data on the core rather than start from scratch, avoid huge transformation projects that can occasionally go awry, and test in a cost effective and low risk way.

Additionally, banks can perform simple, but critical, functions necessary to support “always on” experiences for customers, and authorizing transactions and updating balances can be performed in real-time. Ultimately, replacing core banking systems becomes less urgent if modern software is introduced to relieve the core from real-time demands.

This was exactly the case for Brazil. In response to this need, banks were able to leverage a high-performance ledger to extract balances from the core so it can perform the simple function of authorizing transactions 24X7 in real-time.

By leveraging cloud technology, banks can also scale up or down as needed and respond to digital demands even when the core is down during non-business hours. In fact, according to The Clearing House, 50% of RTP volume is processed outside of traditional banking hours. When given the ability to make payments at any time, it turns out that consumers make a lot of payments before 9 a.m. and after 5 p.m.

Future of U.S. banking hinges on core system modernization

While FedNow and RTP instant payments are being adopted at a slower rate in the U.S., data on current usage are a harbinger of things to come. As volume grows, which it inevitably will, having a core system able to process thousands of transactions per second will be critical. There will also be an increasing demand to authorize transactions 24X7 when branches are closed and when the core is down.

To accommodate these expectations and remain competitive, modernizing core banking systems will ultimately determine which banks survive. Even today, U.S. financial institutions are losing share to digital-first, nonbanks built for speed and convenience. Creating real-time digital user experiences will be challenging if constrained by an inflexible legacy infrastructure.

A nimbler operating model is paramount to support innovative digital products and services and can be achieved simply with software that can enhance a core banking system rather than replace it.

Carlos Netto is CEO of Matera.