Day 3 of the Swift Operations Forum Europe (SOFE) 2018 featured a look at how the new era of open banking will have a dramatic impact on the financial services market.
The final morning of SOFE 2018 in Amsterdam explored what the future of banking may look like, bearing in mind the issues of new technology, cyber security and regulation that have been discussed throughout the conference.
Dr. Markos Zachariadis - who is associate professor of Information Systems Management and Innovation at Warwick Business School, University of Warwick, and also a fintech research fellow at CDI in University of Cambridge - gave a keynote presentation on this topic, with particular reference to open APIs and the digital economy.
Starting by looking at what drives change in financial services, Dr Zachariadis identified regulation, demand, technology, and organisational and market structure as four key drivers that both impact and are impacted by each other. He said that this has been seen over and over again throughout history, citing examples including the trans-Atlantic cable in 1858 linking and exchanging information between the two biggest stock markets of the day. The London Stock Exchange 'big bang' of 1986 was another example, a technological change of market structure in itself, this was also the result of a regulatory change aimed at dealing with market inefficiencies.
Today there is a regulatory context in open banking - from the second Payment Services Directive (PSD2), and Open Banking in the UK. The whole idea is to open up access to data in order to improve market outcomes. At the same time, technology has developed at a pace, particularly when it comes to APIs. Dr Zachariadis said that banks need to not only think of APIs as technology, but also to conceptualise them as a product that can be priced, managed and promoted.
He noted how APIs have led to a rapid growth in platforms, citing Apple's iPhone, with its iOS and apps, as a key example. Apple was quick to push APIs to the public, and the iPhone's foundation as a platform made the difference. The apps were made by outside developers in the community, not by Apple itself, but it hosted them and brought them quickly to the public, setting itself apart from other handsets at the time and driving growth that buried the establishment In 2007, Blackberry and Nokia had a massive 70% share of the global handset market, but by 2013 they only had 4% thanks in large part to the iPhone's astronomic growth.
The platform concept has opened up and is now seen in many industries, with Dr Zachariadis using Uber, Airbnb, Facebook, and Instagram as prime examples. Most people are now familiar with the quote about Uber being the largest taxi company but not owning any cars, Airbnb as the largest hotel chain without owning any property, and so on. What all of these businesses have in common is that they connect people, service providers and service requirers.
What platforms do differently is that they sell reductions in transaction costs, not products. It is a business model that creates value by enabling interactions between external producers and consumers. Platforms can also scale more efficiently and quickly by eliminating the gatekeeper. They can unlock new sources of value creation and supply. For example, Marriott cannot easily and quickly build new hotels wherever they want, whereas Airbnb can pop up wherever housing exists.
Dr Zachariadis then went on to talk about network effect, which is the value that is created when more and more people join a network. There is a positive effect when users join and enlarge a network. The benefits increase for everyone - the more companies that join a platform, the more value they can extract from the network.
Network effects need to be taken into account when valuing this new breed of company. Dr Zachariadis cited a debate around the value of Uber that played out in the press a few years ago. While NYU financial professor Aswath Damodaran valued Uber at around $5.9bn, Uber board member and investor Bill Gurley placed the valuation closer to $17bn. Gurley's argument was based on the principle that the more people that join the network, the more drivers will join, which leads to greater driver competition, faster pickups and lower prices, which then appeals to even more people to join the network.
Context for financial services
How does the platformification disruption seen in other industries relate to banking? Dr Zachariadis noted that APIs in banking and platformification offer the ability for financial institutions to create a business ecosystem and add value for clients. The question is how to do that. He pointed out that while banks need to sell lower transaction costs, they still need to sell the trust and reassurance to the customer that the banking business relies on.
Dr Zachariadis ran through four types of platforms in the financial services world that have emerged since PSD2. These are:
- Incumbent bank platforms.
- Challenger bank platforms, which do brokering much better Dr Zachariadis said. Examples of this include Starling Bank and Revolut.
- API aggregator platforms, which connect banks to fintechs.
- Account aggregator platforms and services.
Naturally, challenges exist in the move to open banking for incumbents. Brand equity is one challenge. If banks start offering products and services from a wide array of fintechs and third-party providers to customers via their platform, there is a chance the bank itself could be somewhat forgotten. Dr Zachariadis used a photo of a number of NASCAR cars to illustrate this point, with their chassis almost fully covered in sponsors’ badges.
Establishing and maintaining trust in a time of data breaches is another challenge for banks. Dr Zachariadis made the point that there is a tension between the time to market of new products and apps versus security. While everyone wants to have first mover advantage, nobody wants to put out solutions that are ultimately compromised.
Banks are also challenged by the enhanced transparency that is demanded by new regulations. This will see banks and third party providers competing on service quality, as product comparisons are much easier thanks to communication via APIs.
Following his presentation, Dr Zachariadis was joined onstage by Leo Punt, head of EMEA Services and Support at Swift, for a short Q&A on some of the issues that had been raised. Punt began by asking whether there is room for utilities in the financial services market of the future. Dr Zachariadis said there is, but he is unsure for how many, saying that there may be some consolidation for banks that go this route to undertake. He made the point that utilities in this space are not platforms, but that they can be very profitable.
Conversation moved on to blockchain. Noting how technology drives bank evolution, Punt asked whether distributed ledger technology (DLT) will have an impact on bank models of the future. Dr Zachariadis said that there is a variation between DLT platforms. DLT can affect how financial services work. He commented that there are some questions over governance in the DLT world, so it is important to ask how far banks can go down the DLT route. Who governs these infrastructures? While some argue that private blockchain could be the way to go, Dr Zachariadis noted that if you move to the private blockchain, you are taking away 80% of the benefits of blockchain, which creates questions over whether it can add value or not.
Touching on the key theme from day two at SOFE, Punt then asked if the platformification development in financial services is being hampered by cyber threats. Dr Zachariadis agreed that, in a modulated environment, this is an issue that may delay the launch of more open business models. He did also note that there is an opportunity for banks, if they can be an early adopter and can demonstrate a stable platform, they can get a huge first mover win. The sooner banks can cut transaction costs, the sooner they can earn more customers.
Dr Zachariadis closed by offering two key takeaways to the SOFE delegates:
- Think about what you could offer to customers that isn't in your value proposition right now. Look at things built outside that you can offer to customers.
- Everything starts from sharing data. The biggest value of being a platform is access to more data than ever. How can you use this to bring more value to yourself as well as to your customers?
That brought SOFE 2018 to a close, after three days of discussion over a great variety of plenary sessions and workshops. When SOFE 2019 begins in 12 months time, it will be fascinating to see how far financial services has come in the digital transformation journey.