Banking as a Platform

Published as part of ‘The Book on Open Banking’ — a collection of essays on the next evolution of money. Download your copy here: https://open-banking-book.paperform.co/?16mjt=Julian.cork@landbay.co.uk

Sitting at his desk on an ordinary day on Wall Street in 1993, a young Senior Vice President at hedge fund D.E Shaw & Co, was contemplating new investment ventures when he came across a startling statistic: World Wide Web usage was rocketing by 2,300% a month. As a former Computer Science student in Princeton and avid technology enthusiast, the 30-year old from New Mexico was already interested in the Internet as an expansive new digital platform. However, this growth was indicative of more than just another timid window of opportunity; it was explosive and pushed home the boundless possibilities of selling online — the world was in the midst of a major digital revolution.

From a potential cast of thousands of products, he settled on the sale of books. Like Barnes & Noble, bookstores were popular hangouts for all parts of society and sold thousands of titles under tens of genres. Nevertheless, this was but a mere fraction of the millions of titles which could be made available via a ‘virtual’ store. Making the decision to abandon his success at D.E Shaw & Co, and skip the promise of a significant company bonus, the young entrepreneur began setting the foundations for what would become known as the ‘largest online marketplace in the world,’ with his first investment coming from the life savings of his parents. Promising them only a 30% chance of success, Amazon.com was born out of a rented garage — an online marketplace founded by Jeff Bezos with the slogan, ‘Earth’s Biggest Bookstore’ and more than 1 million titles on sale to the world.

Over the first month of sales, Amazon made $20,000 per week and since then, the company has built a cult following, becoming one of the hottest contenders to become the world’s first trillion dollar company. Known as the ‘everything store’ that sells products ranging from clothing and garden furniture to movie rentals, its own devices (Kindle and Echo) and now groceries, Amazon has become synonymous with choice and consumer convenience — it’s no wonder the retail giant continues to have such a loyal customer base.

Through Amazon, Bezos demonstrated the value of an online marketplace, but also the importance of getting to know your customers.

“Even when they don’t know it, customers want something better, and your desire to delight your customers will drive you to invent on their behalf,” says Bezos. “No customer ever asked Amazon to create the Prime membership program, but it sure turns out they wanted it.”

With a broad range of products sold by thousands of sellers, control is firmly placed in the customers’ hands. It is the seller who is at the will of the customer, not the other way around, serving to create a fairer retail environment and build a degree of intimacy that has made Amazon indispensable. Alongside intuitive UX design, Bezos’ platform offered improved convenience and a fix for traditionally lengthy processes. It has not only made the overall retail experience more enjoyable and efficient, but has also given customers a better service in return for less effort and money. Beyond this though, Amazon’s success has had a broader impact. Through its near ubiquity in modern life, Amazon has normalised the kind of experiences it offers and has, in the process established a benchmark against which consumers can judge providers in other areas.

Today, the creation of online platforms has moved way beyond the retail sector. Technological innovation is delivering solutions and changing the way that people consume services in a wide spectrum of industries, from music to transport. The financial sector is no exception — however change here in the financial technology, “FinTech” space is really just beginning. New digital platforms are changing the way the industry works and facilitating a better service for consumers.

New business models have emerged as a result. One example is Marketplace Lending (MPL), otherwise known peer-to-peer (P2P) finance which involves the channelling of funds from investors to borrowers by means of an online platform. A unique feature of Marketplace Lending platforms is that they facilitate loans which are direct contracts between lenders and borrowers. This sector emerged in 2005 in the UK with the establishment of Zopa and has in recent years experienced significant levels of growth with platforms providing finance across the spectrum of personal loans, small business finance, property-related lending and invoice finance. Since 2010, more than £9 billion has been lent by Peer-to-Peer Finance Association members who collectively comprise around 80% of the total UK Peer-to-Peer lending market. Technology, in the form of online marketplaces, means that borrowers can access funding from multiple sources in one place and investors can directly invest into loans. This efficient structure provides benefit to both sides of the equation — lower rates and higher returns all through the elimination of the middle man — disintermediation.

Foreign Exchange is another area where platforms match supply and demand and thus provide efficient, disintermediated, currency exchange services outside of banking relationships. By linking together large groups, companies such as TransferWise complete foreign exchange transactions not by making expensive international transfers, but instead making multiple local transfers. Individuals wanting to send pounds to euros send pounds to a sterling account in the UK and the company then sends money out to the recipient euro account from their own euro account which means that the money hasn’t actually travelled internationally. As a marketplace exist where funds flow back and forth each local account receives credits and debits and thus can be maintained. This shift in model costs multiples less than banks charge and results in a more cost-efficient solution for the consumer.

Like Amazon, both innovations provide customers with a better service in return for less effort and money simply by matching supply and demand.

Similarly, Open Banking aims to introduce customers to a more flexible and customizable way of banking. The initiative provides the underlying mechanisms to draw together current banking and emerging financial innovations. It does this by using Application Programming Interfaces (APIs) standards — providing links between disparate systems — the ‘Babel Fish’ for financial communications. Open Banking is shifting the current financial landscape, it gives today’s banking institutions the ability to consolidate the variety of financial products and services used by their customers into one place. It also enables other non-banking companies to challenge the current status quo. Today’s financial business architecture was designed to work within the constraints of technology — this technology has now evolved and the business models need to adapt to take advantage of what this change brings. Like Amazon, Open Banking aims to create a fairer experience for customers by giving them greater control.

A Customer-Led Revolution

The conversation surrounding Fintech and its application in the banking environment has been growing over the last few years, as a rising number of startup disruptors are welcomed by a crowd of increasingly attentive potential customers.

These customers are simply expecting more from the finance sector. In other industries we see companies, such as Apple, delighting their target market with their innovative technology and designs by anticipating and in some cases actually creating new demand and expectations. In finance customers are asking why they cannot have the same type of innovation — disruption is being driven not by the underlying technology but from what it does to business models and as a result the changing expectations of customers.

This has been seen in other industries, as consumers demand shorter, simpler and more tailored experiences, so disruptor companies jump to meet this need, often ahead of traditional businesses that are hampered by legacy systems and require more time to adapt ingrained processes and traditional management mind-sets. The result is the birth of flexible platforms such as Airbnb and Netflix that have their foundations in a more personal approach and change the way we think about business by making products and services accessible on demand, meaning people can use these products and services wherever and whenever they need to.

Of course, the largest digital platform of them all is the Internet — a platform of platforms — which is responsible for the rise in disruptive activity. In itself, the Internet has always offered the convenience of free, perfect and instant; Internet storage is practically free, digital formats allow for perfect reproduction and, regardless of whether information is transferred next door or to the other side of the world, it is instant. This happy triangle of free, perfect and instant is the ideal foundation for companies looking to capitalize on customer convenience, and as they do so at ever increasing speed, consumers of all ages are turning to their services for all aspects of their lives. Of course the ‘free’ element of many online services comes at a price of your data, but that is another discussion entirely. Consider your average day, each one of us will turn online for news, shopping, directions, weather, communication, booking, research, entertainment and of course banking.

These business models are getting more innovative — they are not simply online replications of established businesses – Marketplace Lending is revolutionising lending and investment, online Foreign Exchange is reducing transaction costs. The adoption and success of vast platforms, such as Amazon have broadened horizons and encouraged consumers to be more curious and receptive to similar technological developments across other industries. This is starting to happen at pace in the financial services sector as people turn to Fintech solutions to meet their expectations of the industry.

Just like the retail industry in 1993, the financial services industry is ubiquitous; it is an industry that has many complex, administrative and time-consuming processes. Consequently, the opportunities to disrupt the landscape and provide customers with solutions that meet customers’ expectations of simple, faster, better and fairer are numerous; that’s where Fintech comes in.

Fintech has always been a part of financial services — it is nothing new. Banks have always embraced technological innovation from adding machines, through mainframes and the first ATMs to high speed algorithmic-trading capabilities. Recently however, public interest and awareness of Fintech has increased as the solutions and innovation moved out of the back-rooms of banks and started to deliver solutions that face customers directly and provide engaging services that match their needs and expectations.

Traditionally, bank customers have been limited to managing their financial needs by choosing products from the institution that they bank with. Banks bundled services and drew customers in with loss-leader current accounts. This resulted in stickier customers using other services offered by the brand such as mortgages, savings, credit cards and FX, which are all profitable. People simply didn’t move banks or look around for alternatives because it was difficult to get information about available products and a hassle to visit branches. The universal banking model where all services were provided in one branch, linked to one account meant that banks were able to retain customers and maximize revenue from add on services.

This is no longer the case. Today there are hosts of smaller firms which are offering products and services in specialist areas of financial services that not only directly compete with those offered by banks, but also step beyond the simple bank transaction to help people manage their financial needs. These innovative firms can reach customers directly without branch networks through online applications and network marketing and are eating bank’s margins. This means that it is commonplace for customers have multiple accounts, many relationships and an increasingly complex financial services environment to navigate — a modular banking environment.

The problem with this is that customers lose the joined up view of their financial positions as they engage with a multitude of specialist services. It simply gets more difficult to manage as customers use more services — and this is a price that people are willing to pay today. However Open Banking may be able to help address this. The technology to consolidate, aggregate and manage multiple financial services providers into one place is a reality today. We have seen banks start to embrace this and not only provide their customers access to different fintech solutions but also to other banks. The customer benefit of having a single consolidated view combined with intelligent marketplace capabilities that suggest appropriate products to them given their overall financial position will drive the next wave of customer loyalty for banks. Loyalty which disappeared when bank managers no longer knew the names of the customers visiting their branches.

Ultimately, Open Banking is bringing the marketplace choice of Amazon to the financial sector and giving the customer better control over their financial service needs. And for the consumer of today, it’s for this reason that Open Banking is a necessary evolution in the sector.

The Challenges

The move towards a modular financial sector means the universal banking model, as it currently exists, ceases to serve the market effectively. This presents many direct challenges to retail banks, largely in the forms commoditisation and disintermediation.

It is now no longer necessary to be a bank to provide customers with banking services. That means that in addition to the current pressure from challenger banks, retail banking institutions now face competition from smaller companies offering specialist products and nonfinancial services companies moving into the space.

Banks make money from a process called maturity transformation. Banks ‘borrow’ short-term account deposits (from the money you hold in your current account) and lend money out for longer-term periods. They manage the risk in liquidity and generate return from the income differential between what they borrow and what they lend — the Net Interest Income (NII). Banks require significant volumes of lending and deposits, coupled with higher margin add on services to be profitable.

Over the last 20 years, as growth in Fintech has accelerated and customers have become more tech-savvy, loyalty for banks has eroded. Customers are realising that they do not have to ‘stick’ to a single institution, as they once used to, but can pick and choose from a greater choice of specialist Fintech solutions that operate in a way which suits them. This modular approach to finance is serving to broaden the sector more than ever before.

As these specialist solutions and non-bank entities pick up business, banks market share is eroded. Banks face the real possibility of being reduced to a functional necessity — a commodity service to hold money — while newer innovations create the real value and take control of customer-facing business and importantly make the revenues. Of course, this will take time — personal financial management is often not at the top of an individual’s agenda — so while the legacy models continue to work today, people will not prioritize moving — however, as it gets easier the velocity will increase.

Technology has now made it easier for consumers to evaluate the finance market at a glance and with much greater accuracy and transparency than ever before. Simultaneously, consumers have become more tech savvy and receptive to online finance alternatives, meaning that they are not only better-informed, but also do not need to rely on information recommendations from specialist financial advisors. The direct access to specialist capabilities is taking layers of intermediation, and thus cost from the industry.

With so many consumers now conducting management of their finances online, the digital space has become a hotspot for fierce finance competition and it’s not necessarily the biggest brand that wins. The increased transparency of operating online is an advantage to smaller specialist Fintech companies, as it allows them to directly compete with banks and other larger financial firms.

Potential and Partnership

In 1942, political economist, Joseph Schumpeter famously said, ‘Economic progress, in capitalist society, means turmoil’.

It is true that disruption, in its fiercest form, has the power to shake industries in an instant. Kick-started in 2008, Airbnb experienced explosive growth, receiving one million bookings by January 2011, more than two million by July of the same year and 10 million in June 2012. From a listing perspective, by 2017, Airbnb had more than 3 million listings worldwide, far more than the largest hotel groups — Marriott International with approximately 1.1 million listings, followed by Hilton Worldwide with 774,000 listings — far more choice for the end consumer and a first call marketplace for bookings as a result. However, economic progress through technical innovation does not necessarily have to result in turmoil. While specialist Fintech solutions have the potential to disrupt the financial landscape on a grand scale, they can also promote progress through collaboration with traditional banks.

A Digital Playing Field

The effect of this kind of independent Fintech innovation is that retail banks, in their current format, are being pushed off the playing field. To counter this, some banks have already endeavored to acquire first-mover advantage with new mobile applications embracing some of the fintech competition ideas and competing head on. First Direct’s partnership with the curators of this book, Bud, is a good example. But it is one of many. On recognizing the inevitable shift towards online platforms, others are also investing in Open Banking initiatives and working to understand ways they can better-connect and serve their customers. However, this all requires an immense amount of time, energy and resources.

Established banking institutions all have a degree of legacy technology to manage. This hampers their ability to compete with fintech startups which operate with smaller scope, simple processes, fewer stakeholders and new technology. Adjusting requires serious dedication to re-train traditional management mind-sets, re-imagine business models, invest in systems and change approaches to delivery. This is no mean feat and something that a lot of management consultancies are making significant revenue from by helping banks implement ‘agile’, ‘cloud’ and ‘innovation’ programs.

Rather than trying to compete directly, banks have a real opportunity with Open Banking to embrace the emerging modular customer centered financial ecosystem. They can position themselves as the aggregation point to partner with and endorse the best-of-breed fintech providers of each service. This means that rather than pouring time and money into re-building their legacy systems to build functions to compete with specialist startups they should focus on building marketplaces and monetize these functions through partnerships. Investment in Open Banking — sharing data and creating a marketplace service architecture will pay dividends.

For banks, working with fintechs would not only allow them to identify with the changing demands and expectations of consumers more easily, it would also put them back on the map as modern, digital and consumer-centric institutions. Meanwhile, for newly launched fintechs, the association with retail banks is a prime source of credibility, while access to a broader customer demographic is, in addition, the ideal springboard for their business. Through working together, the investment in sharing expertise and capabilities would not only benefit both parties, but it would also mean that effort is combined and directed in a way that is useful for the consumer.

In my view this works for the big institutions who leverage their core capabilities and customer base. They monetise the functional areas where they have been losing ground without the need to invest and re-brand. This works for the specialist startup financial services providers who gain access to wider customer bases while focusing on the service offering and are incentivized to stay relevant and ahead of retail demand to remain in the partnership. And most importantly, this works for the customer who gets to access the best services in one single, simple environment using Open Banking technology to continue to access the right products to meet their requirements.

Better Together

To facilitate this vision, platforms are using the Open Banking APIs to connect retail banks with the innovation of Fintech SMEs and offer customers the joined-up experience of one fully customised and personalised banking app. Instead of logging into online banking to see a full list of transactions, with Bud, consumers are able to expand on this capability and link the myriad of additional products and services that they use today to their single account. It means that alongside their monthly expenditure, they can obtain personalised insights from a single source and review different aspects of their finances from their pension to the transfer of money abroad. HSBC and First Direct are two of the first UK banks to partner with a platform like this and address the change in customer needs by improving the relevancy of their services. The pilot allows the bank to integrate third-party providers quickly, providing a variety of product choice and convenience to their customers. The result is the ability for the customers to review and manage their finances via a single dashboard and wider, updated market insights for retail banks.

While it is clear that Fintech solutions do well at bringing banking processes up to scratch, the change in mindset that facilitates partnerships must come from the decision-makers in retail banks themselves. The rise in modular finance has increased the pace of change in the industry and if banks do not respond to take timely advantage of this opportunity, alternative solutions will develop and Fintechs will compete in strength, by partnering with themselves.

Revolut, the online current account provider is a good example of this in practice. By combining pure fintech services from other providers into their mobile application, they provide a far wider service offering and can, as a result, directly compete with the banking sector. However, it is important to recognise that while there is a widespread movement towards more modern and better Fintech services, trust remains in the established retail banks, demonstrated by the way that the majority of consumers are still anchored to UK retail bank accounts. Nearly everyone who has a challenger bank account also retains their ‘real’ bank account in a legacy institution. This is something that any new fintech challenger will need to spend a lot of time and effort to replace and supports Open Banking collaborations as a realistic next step in the industry and a fairer and better blend of the old and new.

Challenges to Partnership

Alongside the challenge posed by Fintech specialists that collaborate in disrupting the industry, other trials faced by this partnership model include, uncertainty surrounding third-party data-sharing and the attitude of banks themselves.

In Open Banking, innovative technology allows people to share their transactional information faster and easier; third parties can help people move money around their accounts and customers are able to experience a more transparent service guided by publicly available satisfaction scores and other service-level indicators. This sounds advantageous for consumers. However, while GDPR has done a lot to address this, the historical ambiguity of online terms and conditions clauses, has lead to any association with third parties becoming synonymous with privacy issues, spam emails and an increasing frequency of unwanted phone calls from unknown customer service centers — something that no customer wants. Moreover, some companies absolve themselves of third-party behaviour, leaving the consumer on their own with the worrying responsibility of dealing with any related third-party issues from services or investment that are made through Open Banking partnerships. As a result, and particularly as many are not directly familiar with the details of Open Banking, the conversation surrounding third parties could be enough to put many off the concept before they really know about it at all.

The real challenge is to bring consumers close enough to trying Open Banking for themselves to see the benefits rather than reject it outright. One way to do this is through re-education; it’s not enough to simply say that Open Banking is ‘safe.’ By creating short, jargon-free collateral, businesses can highlight the greater transparency of Open Banking and the ease with which people can manage their finances through a more integrated banking ecosystem.

The second challenge to partnership is the attitude of the banks themselves. While some banks, such as HSBC, have been quick to seize the opportunity offered by Open Banking technology, it is not clear how many others are interested in the partnership model as a means of expanding their consumer offering. For now, banks can generally rely on their large customer bases and the custom of those dubious about the value of Open Banking. However, as generations outgrow themselves and Open Banking platforms normalise, so legacy banking activity is threatened by an increasing level of competition, from specialist fintech alternatives and the banks that have already engaged in partnership.

Since Jeff Bezos first brought Amazon to the retail sector, the value of the online marketplace has soared to direct business operations across almost every industry in the modern day. For the finance sector, as consumers become more precise in their demands for a personalized service and more open to sampling the offering of innovative SMEs, so established institutions, such as retail banks, must work harder to compete with more agile Fintech alternatives that rise to take advantage of this unique business opportunity.

Challenges to traditional banks, such as disintermediation and commoditization mean that industry rules have changed; companies are no longer required to be a bank to offer banking services. Although the increasing modularization of the sector brings consumers a bigger choice of more efficient products and services, it also creates a more fragmented financial ecosystem, rendering banking services even more insignificant, in a crowd of more advanced and agile alternatives.

While there may not be room in society for banks to operate efficiently in their current form, they are still necessary pillars in the economy. Despite the attraction of Fintech alternatives, many people still have a bank account and there is no mass rush to change this. The only real difference between those who simply become money-storage spaces and competitive financial options is partnership.

Open Banking partnerships between innovative Fintech platforms and trusted retail banks is not only mutually beneficial, but also improves the sector for consumers plagued with the multiple accounts (and login details,) of an increasingly complex financial ecosystem. As well as saving banks time, a vast amount of money and resources, partnerships allow fintechs to access a wider customer base in a way which also brings more financial options to consumers looking for a better way to manage their money.

Marketplaces facilitated by technology have changed many industries so far and the Open Banking initiative is the catalyst for financial services. I am looking forward to seeing greater partnership between the incumbents and challengers as together they bring capabilities to the customers who have been expecting more in this space for a while.