The Open Banking Strategy for Australian Small/Medium (SME) sized Banks
By Raja Venkateswar on The Capital
Actively embracing Open Banking will enable SME banks to remain competitive and increase customer wallet share in a transforming but highly concentrated Australian financial services market.
Why Read This Brief
Open Banking is a reality in Australia and will disrupt the financial services ecosystems. The Big 4 Banks [The Big 4 banks refer to Commonwealth Bank of Australia, Westpac, ANZ Bank, and National Australia Bank] and new entrants; often from other sectors like Big Tech or Retail, will increase competition for the SME banks as Open Banking progressively takes root. CIOs of such banks need to transform their technology platforms urgently to meet their obligations under the Open Banking Initiative and importantly; utilize the opportunity to gain customer and wallet share. They are at heightened risk of losing relevance in an Australian financial services ecosystem where they together own less than 7% of the market [Endnote 1]
Key Takeaways
The time to transform is now
All Australian banks, including the SME sector ones, need to comply with the onerous Open Banking regulations by July 2021 which gives them a one-year advantage over the Big 4 banks. Systems, processes, and culture need rethinking in an Open Banking model. The SME members will need to consider the demands of a transforming customer base of a younger generation - digital savvy and expecting seamless online and offline experience. Mere evolution of existing core platforms will be insufficient to win in the Open Banking world and CIOs will need to urgently review their existing legacy core platforms and migrate to more suitable platforms.
Develop a cloud-native architecture model supporting an application ecosystem.
Building an open ecosystem leveraging platform-as-a-service (PaaS) models has been a key to success for banks in markets like EU zone and UK. Globally, evolved banks are transforming their technology architecture to utilize third-party cloud-native applications to significantly decrease the risk of complex transformation programs and minimize cost of change. Some UK based banks are increasingly developing ecosystem models where consumers can view and transact across different financial or non-financial entities and their unique products or services from a single financial services institution. [This Forrester research on the future of Banking in 2023 is an interesting read]
Don’t merely focus on the digital presence, leverage existing physical locations by deploying emerging technologies.
The existing physical presence at key locations especially in smaller towns is a key advantage and SME banks need to utilize emerging technologies like face recognition to gain valuable customer insights into their behavior patterns. This is especially critical in an Open Banking world where competition will often be a Fintech or a large tech company or even a retailer with customer service at the core of their technology. It is worth considering how the UK based digital only banks fared in the past 3 years. Atom Bank’s loss before tax totaled £53m for the year 2017–2018, higher than the £42m loss in the previous year. Monzo’s overall losses jumped to £33.1million from £7.9million (2017–2018 annual report). The loss for the year 2018–2019 further grew, after taxation, to £47.2m. The above are only two examples in an increasingly crowded landscape but the digital only banks will probably need more runway before they commence making significant money, Starling is the one true exception to this. However, the digital subsidiaries of the main street banks seem to be doing well — consider Metro Bank. Whilst Metro Bank in the UK, a Digital and Physical Bank with over 60 stores and continuing to open more, has delivered profits over the last 2 years. According to their last Annual Report “Our impact is greatest where we have established stores.” That is indeed food for thought and perhaps the Australian incumbents with branch networks can learn from Metro Bank on how to make the best use of their physical presence
Open Banking is disrupting established business models
Open Banking is ‘one of the biggest changes in financial services in a generation’ [Endnote 2]
In the countries where they have been implemented, Open Banking and associated initiatives have created an environment of data reciprocity; challengers are constantly innovating using a combination of data, AI/ML (Artificial Intelligence / Machine Learning) algorithms all deployed on increasingly ubiquitous cloud computing power. In Australia, ACCC (Australian Consumer and Competition Commission) is endeavoring to increase competition in the financial services sector and Open Banking is one key lever.
· Open Banking has enabled the rise of digital banks More than 100 digital attacker banks have launched in the last few years globally — including N26, Monzo and Revolut in Europe, WeBank, Digibank, Jenius in Asia, SoFi, Marcus, Moven in the US, Nubank in South America, all fuelled by the promise of easier access to consumer data through an Open Banking ecosystem. In the UK, banks like Starling are already profitable; firms like Noble Oak are targeting extremely profitable components of the financial services ecosystem. PaaS platforms mean the time to stand up a vanilla bank is smaller than ever. [Endnote 3]
· Open Banking has been implemented in several global economies. Open Banking, in various forms, has been mandated by respective regulatory bodies and deployed in several countries, notably UK (July 2017), EU Zone (Dec 2015 — January 2018), India (March 2016), etc. [Endnote 4]. There has been a significant impact in the financial services sector in each of these countries which the Australian firms can learn from. [Endnote 5]
· Open Banking is creating increased choice and personalization for customers. Today most banks develop similar products and services and release in bulk to all customers through a series of pre-selected, existing channels. This approach does not account for a customer’s individual preferences which are sub-optimal for customer satisfaction or adoption rates. Open Banking is enabling improved choices for the customer. Products or services are tailored to their individual needs, over the channel or selection of channels most suitable for them [Endnote 6]
· Open Banking is an opportunity for existing banks to capture wallet share. Most banks in Australia are considering Open Banking a threat and have demonstrated a marked reluctance to part with their data. However, visionary banks think it is an opportunity to capture customer mind share and wallet share. Incumbent banks in the UK and EU Zone are enhancing consumer and business offerings by creating new service propositions combining predictive analytics, artificial intelligence, machine learning, leveraging existing tech platforms and access to financing. [Endnote 7]
Technology changes required are complex and expensive
Banks have traditionally considered customer data to be their right. With Open Banking, customers become the rightful owners of their data, they can now direct a bank to share their details with a trusted firm, delivered safely and securely through an Application Programming Interface (API) at no additional cost to them. Fundamental changes to technology platforms will be needed to build these APIs and share data securely. This will increase the Cost to Income ratio gap [Cost to Income ratios for the Big 4 average 46.6% while for SME banks varies from 72% (for the larger ones) to 83% for smaller ones giving them limited financial strength for significant transformative changes] between the Big 4 banks and SME banks as SME banks primarily utilize on-premise; legacy core systems from Australian core banking platforms or older versions of Global platform providers.
· Open Banking gives customers their rightful ownership of their data. In Australia, the Open Banking regime is part of the development of a national Customer Data Right (CDR) announced by the Federal Government in November 2017 as a partial response to the Productivity Commission’s Inquiry into Data Availability and Use. A key feature of the right is that access must be provided in a timely manner in a useful, secure digital format which complies with the applicable standards. [Endnote 8]
· The data expectations are significant and complex. The table under gives an overview of the data requirements under the Open Banking initiative in Australia — The access to such data on existing on-premise legacy core systems will require ‘opening’ them up using APIs and / or using complex middleware platforms.
· The privacy and security expectations are complex and needs significant strategic vision to implement. Standards are being defined by CSIRO (data 61) summarised as under:
A) Privacy standards include Right to erasure, block solicitation & profiling, establishment of a data protection office and pseudo-anonymization
B) Security standards mandate adherence to a Strong CustAuth (SCA), OAuth2 & APRA CPG 234/5
For CIOs, this will require encapsulating data in secure APIs after extracting them from existing legacy platforms.
Time is limited for banks in Australia; CIOs need to lead the transformation
Banks in Australia have a finite window to meet the Open Banking guidelines. In UK and EU zone, banks are leveraging PaaS with built-in distributed storage, per second database roll back, encryption at rest and transmission, multi-zone redundancy, auto-scaling baked into architecture and delivered as a fully managed service. CIOs need to transform their technology assets, sweating core 2 or 3 tier architecture technology assets by using SOA (Service Oriented Architecture) or ESB (Enterprise Service Bus) will not give them returns due to inability to consume and extract intelligence from real-time data transfers. [Endnote 9]
· The opportunity window is small: Open Banking in Australia is being deployed in phases with the Big 4 Banks deploying their assets (Feb 2020) prior to the other banks (July 2021). This leaves the SME banks with limited time to act decisively to get their technology platforms ready and take advantage of the opportunities Open Banking will create. [Endnote 10]
· First mover advantage will be critical. In Australia, there will be significant benefits for the first movers who are agile and tech-savvy to take advantage of increase in the availability of context-defined data to develop enhanced customer offerings. An example is the intuitive interface, mobile-first from Monzo enhancing the customer value proposition by additional services like budgeting, expense categorization, etc. The “trusted agent” status that incumbents currently enjoy will remain a competitive advantage for some time, but it must be exploited now to halt the loss of business to new entrants. [Endnote 11]
· EU and UK banks are leveraging cloud-native platforms. A WEF report published in 2015 found that innovators have the greatest impact where they deploy business models that are platform-based, data-intensive, and capital light. The common factor in most of the challenger banks or digital subsidiaries of financial services firms is their use of ubiquitous cloud computing, leveraging data (first-party sources and procure third party data to maximize risk — benefit models) and focus on customer experience.
· Keep the core simple, extend as needed. The key to getting a bank up and running rapidly is simplifying the core technology platform and extend as needed using specific apps with internal and external access delivered through an API library. CIO needs to identify suitable core platform(s) and extend the core transaction engine(s) as necessary to enable key services like credit risk scoring, personal finance management and end-to-end processes like Loans Origination. it is quite likely that some components of the extended ecosystem can be made available to other competing firms too. [Endnote 12]
Embrace cloud-native platforms to rapidly and inexpensively leverage Open Banking initiatives
As an outcome of the new digital ecosystem due to Open Banking, banks are in danger of losing control of their direct customer relationship to fintech companies and other service providers. This will in-turn re-define the term “customer loyalty” from the banks’ point-of-view. Banks will no longer be able to cultivate and harness customer loyalty in the traditional sense when they owned the customer data. SME banks should actively identify measures to leverage the available additional contextual data to price more sharply and deploy personalized products. In the short term, they should be prepared for loss of control over their key data assets, but they should use this opportunity to build platforms to leverage third parties (for data and content) and deliver increased customer value.
· Get the CEO and Board buy-in for transformation. CIOs need to urgently work with their business counterparts to develop strategies to leverage Open Banking. The business leaders and the Board will need to consider and review risks & opportunities of a cloud-native platform. This will need regulatory considerations and capital allocation towards operational risk. CIOs will need to take a lead and work with their counterparts in Risk to get Board and APRA approval.
· Define and agree on a cloud-first strategy. SME banks need to confirm the organizational cloud strategy. They need to consider and confirm options; for example, whether to deploy a single-cloud native core platform or a cloud-agnostic platform. Either way, they need to urgently migrate out of their 2-tier and 3-tier on-premise core platforms into cloud-native PaaS utilizing the available economies of scale, API based access to data, associated analytics and extensible financial apps.
· Define the core and partner/collaborate for the rest. When implemented, adjacent industries or specialized data payment data providers could end up owning customer relationships and turn to banks solely for payment clearing and account information. These transactions will grow increasingly complex and performance intensive as customers buy into Open Banking. Banks need to have a closer look at the cost and ability of servicing transactions, capacity and scalability of its infrastructure, and above all total cost of ownership. Banks need to focus on deploying core platforms rapidly, leveraging and collaborating with partners, vendors, customers to deploy configured processes. They need to build a culture of collaboration where a large proportion of the technology platforms will be deployed as a service.
· Leverage technology to provide for personalized employee and customer experience. SME banks have a significant advantage over the digital / neo-banks with limited physical presence, however; retailers and telecommunication firms are entering the financial services market who usually have physical presence as well as a more customer-focused ecosystem. To counter this, CIOs need to deploy Omni-channel platforms, emerging technologies like face recognition to make the customer experience at a physical location (like a branch) truly immersive.
Endnotes
Endnote 1:
In the aftermath of the Royal Commission, Data for year on year growth has shown that customer-owned banking institutions have grown their total housing loan book by 8.1 per cent compared to 4.5 per cent for authorized deposit-taking institutions (ADIs) and 3.7 per cent for the ‘Big Four’, however; the Big 4 together have about $3.6 Trillion AUM, the 66 members of the Customer Owned Banking Association (COBA) -forming a bulk of the SME sector — have a combined AUM of $119B. More than 80 per cent of mortgage borrowers have a loan with one of the four big institutions, making Australia’s financial sector one of the world’s most concentrated. This ABC article provides additional details.
Endnote 2:
https://www.americanbanker.com/opinion/open-banking-is-an-opportunity
Endnote 3:
These Forrester reports will provide further contexts — Report 1, Report 2
Endnote 4:
The table (Table 1) below provides a snapshot of some other jurisdictions that are in the process of implementing Open Data policy that is relevant to financial services.
Endnote 5:
Even before Open Banking was officially launched, East Africa has been an innovative payments and financial services market for a few years developing innovative VaR (Value-at-Risk) and PoD (Probability-of-Default) models for an emerging economy. Some firms like M-Shanwari use telecommunications data to develop innovative underwriting models making it easier for an unbanked population to access banking services with minimal friction and at market costs. Tala, now available in India and Philippines besides several countries in Africa; offers accessible consumer credit products, instantly underwriting and then disbursing loans to people who have never had a formal credit history. All transactions happen through a smartphone app and Tala famously doesn’t have a phone number listed. Tala has essentially built a modern credit infrastructure from scratch leveraging open data initiatives (from even non-financial sectors), big data and easily available, cloud-native AI/ML algorithms. Anyone with an Android smartphone can apply for a loan and receive an instant decision, regardless of their credit history. The application takes a few minutes and money is sent directly to the borrower’s mobile money account or other cash out options.
Endnote 6:
Ann Boden started Starling Bank as a Challenger Bank in 2014 in London during the early stages of information exchanges becoming more prevalent, almost a precursor to what became Open Banking Initiative. Starling became officially the first UK digital challenger bank to become a member of the Single Euro Payments Area payments system. From an official banking launch in mid-2016, Starling Bank was named Best British Bank and Current Account Provider (for the second consecutive year) and Best Business Banking Provider at the Great British Bank Awards in March 2019, a mere 3 years later. This Forrester report provides further context to how non-financial services firms are disrupting banking.
For additional reading, this AFR article would be useful to summarise the ongoing impact of Open Banking in the UK.
Endnote 7:
The UK market has been an interesting one where the incumbents are still leading the field with banks like HSBC aggressively targeting market share by leveraging open data and maximizing customer advocacy. HSBC, Barclays, BBVA and Santander have been at the forefront of the Open Banking revolution aggressively opening up their old 3 tier architectures using open APIs. https://www.globalbankingandfinance.com/how-the-big-banks-have-maximised-the-open-banking-opportunity/
Volt, a subsidiary of ING is advertising heavily in London and its key value proposition is that it has made its personal financial management platform available to non-ING customers, HSBC allows its platform to display all its finances on one screen across geographies, currencies, and accounts; even from other banks if they allow access to open APIs.
This Forrester report gives an overview of Open Banking and its influence in Europe.
Endnote 8:
The Treasury submission gives significant details of the Open Banking Initiative in Australia https://treasury.gov.au/sites/default/files/2019-03/Review-into-Open-Banking-IP.pdf
Endnote 9:
The common factor in most of the challenger digital banks or digital subsidiaries of financial services firms seems to be the use the ubiquitous cloud computing (Amazon or Google or Azure), leverage data (first party sources and procure third party data to maximize risk — benefit models) and focus on customer experience. For example, Starling Bank has a deep and highly developed partnership with Amazon Web Services (AWS) constantly challenging the platform provider to innovate and deliver services at scale. Starling uses Amazon for almost everything needing computing — customer experience to big data including Secure virtual server hosting, managed & scalable database engine, ‘Data lake’ data storage and retrieval, running code without provisioning or managing servers, etc.
· Secure virtual server hosting
· Fully managed, scalable database engine
· Automated cloud services
· ‘Data lake’ data storage and retrieval
· Running code without provisioning or managing servers
This is common to all the challenger banks in EU / UK — Monzo, Atom, N61, Fidor and the rest, they all built cloud-native platforms to leverage the resources the cloud computing firms offer — not merely access to inexpensive computing resources but the whole marketplace ranging from big data sources & AI/ML to marketplace platforms like Pocket that extend the core banking services to delivering unique customer needs.
Endnote 10:
The Australian Open Banking Initiative is a work in progress with some key elements including data standards yet to completely finalized. However, that hasn’t stopped some incumbents like Macquarie Bank and Citibank Australia to announce APIs to enable Open Banking.
Table 2 as under summarises the key dates for Open Banking roll out in Australia based on the submission on Open Banking to the Department of Treasury.
Endnote 11:
This McKinsey report summarises the impact of data sharing on business models
Endnote 12:
Platform models are increasingly becoming the model for choice for innovative banks, ANZ Bank for example in Asia runs its Trade Finance platform on a PaaS model utilizing a cloud platform from its vendor — Persistent Technologies. Forrester researched on the platform models in financial services sector recently and earlier this year
