In the digital age, parents are often taught by their children. While Baby Boomers are digital immigrants, Millennials/Gen Z/Gen Alpha are all digital natives. Each generation uses the same technology but their relationship with it differs markedly. Boomers grew up seeing technology; Millennials and forward grew up knowing technology. In a similar vein, can established banks learn anything from the digital upstarts? In this blog we consider the benefits of a hosted applications infrastructure.

Building a bank from scratch is never easy and there’s a great deal to consider. Getting the technology right is essential to support profitable growth, and to comply with a growing array of complex regulations. Yet there’s been a record rise in the number of start-ups. In fact, Bloomberg predicts that the global digital banking market will exceed USD $9 billion by 2027*. How is this possible?

Most of the recent start-ups are digital-only banks. On the face of it, they have some distinct advantages. Being unencumbered with costly branch networks, legacy technology stacks and outmoded thinking, digital-only banks offer a fresh approach to banking with a total focus on the customer experience. Just as importantly, they often benefit from superior operating efficiency and can compete with incumbents on price. Customers clearly value good digital service from their banks – in the UK, 23% of bank customers have already fully switched to a digital-only bank.**

Taking a closer look reveals that many digital banks are also doing things very differently. Often, they don’t run their own core technology, but rather rely on partners or third parties – sometimes even other banks. Ironically, this age of increased competition is also one of greater collaboration. How did this happen? A look backward gives us a better view of the future…

Banking Then – a Scale Business

Since the dawn of automation, banking has been a business of scale. Banks invested heavily  ̶  and often speculatively  ̶  in core technology stacks that processed huge numbers of accounts, products and transactions. As more customer accounts were added, economies of scale drove down account manufacturing costs, so bigger banks could offer low (or no) charges. The need for a processing core also posed a barrier to entry for smaller banks, so the banking industry tended to be dominated by a few giants that could out-invest and out-compete the rest of the field. In many countries banking seemed a natural oligopoly  ̶  an industry dominated by a small number of large players.

Banking Now – a People Business  

The astronomical rate of technological change redefines what’s possible in banking. Regulations have encouraged innovation and numerous new market entrants in global locations. New technologies also enable individual banking services to be componentized and developed independently, in a manner designed to offer an exceptional customer experience. Application programming interfaces (APIs) allow components to be marketed individually, combined, and/or integrated with third-party technologies. In practice, an open componentized architecture also yields new processing models, such as Software as a Service (SaaS) and Platform as a Service (PaaS).

Software or Service?

Many of the new digital banks have adopted a SaaS or PaaS operating model as the fastest route to banking success. In this way, they have instant access to a proven infrastructure and can focus on the customer experience. There are other benefits too: service charges are automatically aligned with business success, and regulatory compliance is assured. New services models have enabled challenger digital banks to launch in record times, sometimes in as little as 90 days. What can incumbents learn from this?

The Search for First Principles

At a time when many banks are reviewing core processing platforms, there is a golden opportunity to revisit first principles and core competencies. For all banks, loyal customers are the key business asset, but for many, the legacy technology stack is fast becoming a liability. And, with the arrival of new competitors, the situation is likely to worsen. Where is the tipping point?

Banking on the Future

For many banks, of all types, a SaaS  or PaaS model should be highly appealing. The stellar growth in the number of digital start-ups shows how hosted services can accelerate time to market and offer the scale that’s needed to build success. Further benefits include insulating the bank from changes in technology and market practice. Free from these types of worries, a bank can focus on its brand, products and customers. Is there a downside?

Some banks are concerned about losing control of their technology strategy and fear that innovation may be stifled. While understandable, this is unfounded. Componentized software is almost infinitely configurable, so banks will be free to innovate at their own pace. Moreover, a bank can choose to retain control of those components deemed to be part of the “secret sauce” that deliver their competitive advantage. For example, many digital banks retain control of the customer experience, while a partner does all the processing.

Perhaps the biggest barrier to progress is the universal bank culture where everything is kept in the vault. At a time of great change, the SaaS and PaaS operating models offer a blueprint for a future without knowing what that future holds. In this light, SaaS/PaaS and a proliferation of hosted services seem both desirable and inevitable. Goodbye software, hello service.

* https://www.bloomberg.com/press-releases/2020-01-07/global-digital-banking-market-is-expected-to-reach-us-9012-34-million-by-2027-growing-at-an-estimated-cagr-of-3-2-over-the

** https://www.finder.com/uk/press-release-23-2-million-brits-will-have-a-digital-only-bank-account-by-2025