Retail Banking: what's next?
Although several challengers such as Transferwise, PayPal, and peer-to-peer lending took away a small market share, some major UK banks are still in the game despite running some of their processes on mainframes.
Retail banks have been first-movers in technology adoption, introducing ATM in the UK in mid-1970s. The initial goal of automation has been cost reduction, but soon moved into provision of new products and services, as well as channels – such as telephone banking, internet and mobile banking.
Research by Fincham found that banks had concentrated their IT strategies upon the automation of existing processes to reduce costs, and also in copying the trends set by their major competitors, rather than focus upon innovation and business transformation. As a result, the traditional structures, functions and priorities within the banking industry still remained largely unchanged. The disconnect between resources and capabilities, and entry of new players often results in banks closing their eyes to the new competition, preferring to compete in an old and familiar environment.
There are 3 main drivers affecting competitions in the banks:
- Customer expectations. Customer research shows that that consumer preferences shift towards convenience, with a desire of omni-channel experience with a strong mobile presence, many traditional banks have the smallest teams operating in this space, with some large banks having only 10-people strong mobile teams. This shift, however, takes out a crucial component on which retail banking has been built – the personal contact. 59% of banks’ profits come from customer-facing activities, such as origination sales and the distribution apparatus. Possibly, in additional to organisational inertia, the reluctance to move to online can also be explained by the fact that the banks are not ready to move their channel online.
- FinTechs. Since early 2000s, the market has seen a variety of new entrants into payments area (Paypal, TransferWise and Square); in the lending arena, a number of Peer-to-Peer(P2P) lending start-ups emerged (Zopa, Funding Circle) offering credit to under-banked segments and cheaper rates. Although the market share of P2P lending is relatively small, the reports suggest that the loan volumes are doubling every 6 months and have passed a £3B mark in 2015. Finally, new nimble competitors emerge, such as Mondo, Atom and Starling, not burdened with the history of bureaucracy and complexity, but built to service the customers while complying with financial regulation. NESTA research shows the UK alternative finance market was estimated to be worth £3.2 billion in 2015, an increase of 84% on the previous year, and is projected to surpass £5 billion in 2016. In addition to FinTechs, non-bank giants in technology, e-retail, media and entertainment, telecom and other sectors who have a strong customer relationship, are seriously considering ways to enter banking. Facebook, for instance, started offering money transfer services via the Messenger App in 2015. With 22% returns on origination and sales (compared to only 6% on credit), these companies are looking to ‘skim the cream’ by either offering aggregation and comparison services or selling banking products that are fulfilled by the bank.
- Regulation. Banks are subject to rigorous regulatory scrutiny for a while, but one of the new threats is the PSD2 directive requiring that by January 2018 all European financial institutions provide APIs (Application Programming Interfaces) for payments and account information. This means that banks will further lose the point of contact with the customers, as the APIs would enable growth for web portals and apps, allowing to manage accounts with multiple financial institutions.
Banks still rely on their reputation, brand name, regulation and customer stickiness within the current business model. What would be the main drivers in competition in 10 years and what capabilities would banks need to develop to be successful?
10 year scenario
New technological opportunities
Increased connectivity enforced by PSD2 regulation and competitive pressure will make even more data available, allowing innovative and lean competitors to turn it to their advantage. The future of retail banking industry will inevitably become a digital ecosystem with much closer ties than it is now. Digitalisation, connectivity and data will enable possibility for new services and products. BigData and Machine learning will enhance banks’ ability to manage and control risk while reducing costs; virtual and augmented reality will bring an inevitable change to how branches operate – or need for expensive branches altogether.
The banking landscape 2025
PSD2 will require banks to provide 2 APIs: Payment Initiation Service Provider (PISP) and Access to Accounts (XS2A), allowing Third Party Providers (TPPs) to initiate payments or access users’ bank account information after authentication and ‘granting access’:
With PISP, a third party will be able to initiate payments without use of Credit Card but initiating a payment directly from the customer’s bank account, while the XS2A will allow a TPP to receive information about the user’s account – such as available balance, transaction history etc.
It is likely that in 2018-19, a number of TPPs will emerge, some of them being existing players like aggregators, tech companies, e-commerce, alternative banking providers, banks, or new entrants. Such TPP will become a gateway into any account information, payments, and act as a primary sales channel with the actual products being fulfilled by the banks or FinTechs. They will be able to collect customer information and built loyalty, forming an emotional relationship with their customers, which banks now lack.
Although it is likely that soon after the regulations become implemented, a lot of such entrants will fill the market, after several years a clear leader or few will emerge – similarly like Facebook and LinkedIn are clear leaders in their respective fields. To be successful, this organization will need to design its offering to foster the network effects.
By becoming a Multisided Platform (MSP), a TPP will be able to foster not only network effects – exponential increase in value for all participants proportional to the number of participants, but also cross-network effects – which is increase in value for one side of the platform with the increase of members on the other side. At a minimum, this MSP will have 2 user groups:
- Providers of financial services (FSP) – Banks, Building Societies, FinTechs etc.
The value MSP would provide to the users is a convenient user interface accessing all accounts the user has in one system, with analytics built on top of that advising on a course of actions for their money. For the providers of financial services, the MSP would provide detailed segmentation data so they can develop and sell new products to the customers. More tailored products will need to be developed by the banks to serve their customers better, for instance:
The MSP will need to answer a lot of questions, for instance, who would be allowed on the platform, who carries the legal risks, what is the monetization structure, consider building in switching costs etc.
With a triple pressure of regulation, new competition from FinTechs and changing customer expectations, retail banking industry faces significant changes. With the onset of PSD2 regulation, banks are likely to lose control of customer relationship as the customers will be able to use the bank through other channels than those devised by banks. This will give rise to the breed of participant of already crowded financial markets space – the multisided platforms, connecting the customers and Financial Services Providers. These platforms will deliver value to the customer by aggregating their accounts information and providing a convenient interface to their financial lives, and by collecting customer data they will be able to serve banks offering financial opportunities. In order to jump the train, the banks need to strategically restructure their IT, making it more disaggregated, so that targeted and very fine-tuned products can be offered to the increasingly demanding customers.