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Digital ecosystems: The future of banks?

Retail banks are under fire from two sides – from regulation on one flank, and from competitive pressures on the other. It’s been estimated that Basel III’s requirements will reduce banking industry profitability from about 15% of ROE to between 8% and 10%. Consumer protection watchdogs are preventing banks from making up the shortfall by charging various fees and commissions – which leaves banks only with cost reduction as the primary driver of profit.

Under such pressure banks have two main options: find a way to innovate, and focus on their strengths.

Innovation is a tall order. Despite the considerable effort of sales and product departments to find new sources of revenue, it seems that most of the innovation is happening outside the financial industry. Banks are hampered in their efforts to innovate by a back-log of regulation and legacy information systems that were designed for the “old economy”, while other industry players move ahead with unbundling retail bank services.

The situation seems grim, but banks still have a handful of strengths. First, they have and will continue to have a large client base. Second, they have unique expertise in credit risk that’s yet to be toppled by ‘social scoring’ or behavioural analysis of our shopping habits. Third, banks have rich data sets about their clients, even if they’re not using that data as they could. And most importantly, banks are right at the centre of our intra-country and cross-border payments infrastructure. There’s a possibility that, sometime in the future, blockchain based infrastructure may take over, but that’s a long, long way off.

That’s why the recent announcement that the Government plans to develop a detailed framework for an Open API (application programming interface) by the end of this year could present a real opportunity for banks. The Government believes that greater standardisation in the use of open data in banking would allow for the development of third-party apps that are compatible with the systems of all UK banks. Allowing fintech players to build apps for their clients that take advantage of Open API would speed up the innovation process, while allowing banks to focus on their strengths.

In fact, a viable strategic option is to think of a bank as a digital ecosystem - a complex value chain consisting of participants providing either content or a platform (fintech players) to distribute the content (banks). Banks could transform themselves into leading players in a digital ecosystem of third-party services that would be built on their existing client base and infrastructure.

In practice, the financial digital platform would resemble an ‘App store’ of verified apps, including services such as smart budgeting, micro-payments, retailer specific payment apps, loyalty schemes and Bitcoin exchanges. Clients would only give consent for the app to access their data through a secure API – putting the client firmly in the driving seat to choose functionality and a user interface that suits them best. Banks provide what they’re best at – risk management and smooth operation of the payment infrastructure - while third party app developers provide the innovation. And innovation in the sector would feed off itself as developers compete to come up with the best, and most installed, app in their category.

Going it alone is no longer an option for banks. There are already seven major global digital ecosystems competing against each other: Apple, Google, Amazon, Facebook, Tencent, Alibaba, and eBay. Each has aspirations to enter the financial industry and most, with varying success, have already taken the first steps. These digital ecosystems will pose a far greater danger to retail banks than their traditional competitors or individual fintech companies. Whatever the result, thinking in terms of digital ecosystems brings cooperation between banks and fintech companies into a new dimension.

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