The Bank of the Future Will Be a Technology Company

A Different Banking Experience is Desired

Right now, customers want a new banking experience. While reading a review of Simple Bank on Reddit last night, one poster stated:

“I “applied” on their website and waited on pins and needles for a few days (ok, I may be exaggerating but it was the first time I was excited to join a flipping bank).”

Tandem Bank currently has a waitlist of 18,487 people for their product release, and Monzo has a waitlist for their current account, although the length is unknown.[1]

While consumers have evident pain points with their banking experience, legacy banks have started to remove themselves from the consumer banking sector. An article by Bloomberg stated that these banks are shifting their focus to high-net-worth individuals, large corporations, and institutional investors because they are more profitable than consumer banking customers.[2]

The illustration below shows significant changes in HSBC’s and Citigroup’s profit mix between 2006 and 2015.

Figure 1: https://www.bloomberg.com/graphics/2016-global-banks/

Room for Startups

In 2009, Chris Skinner, a financial technology visionary, published an article describing his thesis called Banking-as-a-Service (BAAS). He believes that the bank of the future will be a platform that aggregates other companies’ services via open API’s. Banks used to control the entire banking process, from user experience to product offering. This journey will now be broken up as customers use a platform that connects them to product offerings from other companies.

Given the current state of consumer banking, I believe that a startup is better positioned to establish itself as a platform bank than a legacy bank. To successfully build a platform bank, I believe that the company must act like a technology company, not a bank. This platform must provide valuable insights into a user’s financial health and be easy to use.

I believe that this platform bank will have a revenue model based off of service fees from the third party integrations it offers, not financial products that it develops. I.e. the platform receives a fee for every customer that enters into a loan agreement. Banks such as Wells Fargo or Bank of America will continue to offer loans or mortgages, but people won’t purchase them directly from the bank, they’ll purchase them from this centralized platform.

I believe that a startup is well positioned to become this platform bank for two reasons:

1) In order to develop this platform, the company must have a culture of being customer focused. This means two things:

a. They understand the customer’s pain points. They understand how their customer uses their mobile phone and computer. They understand their customer’s goals, etc. Legacy banks don’t seem to be very great at doing this.

b. The service must be willing to suggest financial products that are best for the consumer, not themselves. They must be willing to give their competitors business and act in a way that is customer focused. I believe that it will be easier for companies that don’t offer their own financial products to develop this culture because they won’t have any incentive to push users towards their own products.

2) I imagine that this banking platform will make the majority of its revenue from services fees. These fees will probably not have as large of a profit margin as traditional financial products, and companies’ management must be willing to pursue these business opportunities. A new company in this space will not have many of the costs that traditional banks have i.e. Oliver Wyman has reported that legacy banks spend 15% of their total expenses on branches, a cost digital banks can entirely forgo.[3]

Problems to Overcome

While I believe that there is a need in the customer’s journey for a new banking experience, previous attempts at solving this issue have not been very successful. BBVA, who bought Simple Bank in 2014, has issued an $89.5 million goodwill impairment charges on their acquisition, and Moven Bank decided to pivot its business and sell front-end technology to traditional banks.[4] Both of these banks had cards and corresponding apps that allowed users to easily track their expenses, very similar to what many of the UK Challenger Banks have today. But what I believe these banks missed, and no challenger bank has developed yet, is a platform that provides a network effect. I believe that a platform bank can develop network effects via their financial insights. By gaining more data into the transactions of users and the ways they manage their financial health, the platform will be able to provide more meaningful insights to all its users. Acquiring more customers will help this company develop their two-sided marketplace with third party financial service providers.

Currently, I believe that the expense tracking features and low fee structures bring enough value to customers in the beta phase of these release i.e. Monzo, Mint, or Wealthfront. But in order for a startup to develop a platform functionality, it must bring other value to customers via third party integrations and financial insight.

Following Banks

Some Challenger Banks such as Atom have started to offer their own financial products such as savings accounts and mortgages. But Atom has already had to lower the interest rate they provide on their savings account. Their reasoning was as follows; “We’re now reducing our rates for a while to ensure we’re taking a balanced approach to managing our business.”[5] They also ended their mortgages that had the lowest interest rate ever in Britain after nine days.[6] While Atom has seen total savings deposits of £538 million as of March 31, 2017, offering one of the highest interest rates on savings accounts and lowest interest rates on mortgages is a difficult business model to make profitable.[7]

Conclusion

In order to develop a successful platform bank, I believe that these startups need to develop a business model that does not include providing the same products as legacy banks but with better user interfaces. As Paul Graham tweeted, “Don’t attack incumbents head on, grow in the margins of their business.”

Please comment with your ideas and thoughts. This is just my hypothesis, and I would love to hear counterarguments.

[1] https://www.tandem.co.uk/features/

[2] Onaran, Y. (2016, July 26). Citigroup, HSBC Jettison Customers as Era of Global Empires Ends. from https://www.bloomberg.com/graphics/2016-global-banks/

[3] Low, S. (n.d.). Perspectives on the UK Retail Banking Market. from http://www.oliverwyman.com/our-expertise/insights/2012/nov/perspectives-on-the-uk-retail-banking-market.html

[4] Greer, S. (2017, May 09). For all the hype, challenger banks have challenges of their own. from https://www.americanbanker.com/news/for-all-the-hype-challenger-banks-still-face-enormous-challenges

[5] Williams, A. (2017, March 15). Atom Bank to cut top interest rates tonight — act now to grab the best deal. Retrieved August 04, 2017, from https://www.moneywise.co.uk/news/2017-03-15/atom-bank-to-cut-top-interest-rates-tonight-act-now-to-grab-the-best-deal

[6] Murray, A. (2017, April 20). Best-ever mortgage offer pulled after nine days. Retrieved August 04, 2017, from http://www.telegraph.co.uk/personal-banking/mortgages/best-ever-mortgage-offer-pulled-nine-days/

[7] Atom Bank. (n.d.). Atom Annual Report 2016–2017(Rep.). Retrieved from https://www.atombank.co.uk/investor-information