Open Banking will shape the future of UK retail and commercial banking

Here’s what challenger banks can do to succeed

Like many new entrants to the industry, we think the banking landscape will change fundamentally in the future. The market will become increasingly diverse and modularised, with new companies specialising to offer very specific components of banking services or products. The potential for this future scenario is underlined by our recent research, which among others showed that as many as 39% of bank customers would share their financial data with other banks and third parties (such as Amazon, Apple, Tesco and so on) if in return they received benefits such as an overall view of their accounts in a single app, or being able to compare tailored product offers from third parties.

The advent of Open Banking is particularly influential in this sense. Supported by a new regulatory regime, this initiative means that banks will be required to share more customer information than ever before via technologies such as APIs, application programming interface. Making infrastructure available through standardised interfaces will be a major trigger for new competition, from many different sources.

Already, a large number of FinTech start-ups are working hard to establish themselves as platform providers for services such as payments, investment, and lending. These ‘digital value chain players’ are focused on providing excellent experience and functionality at lower cost, for specific traditional banking services. Whilst many bank CEOs we spoke with believed the threat of FinTechs was “a lot of froth and hype”, other CEOs thought they presented an opportunity to enhance their offering through partnerships.

That said, banks take the threat of larger tech organisations such as Google, Amazon, Apple and Facebook very seriously. Many CEOs believe it will be these players which drive the real change and disruption in the banking industry, by inserting themselves between the customer and the underlying bank they could take value from the bank and relegating them to the role of invisible ‘dumb pipes’.

The Second Payment Services Directive (PSD2), is an example of legislation that is accelerating this shift towards Open Banking and subsequent use of APIs, enabling banks, FinTechs and companies from other industries to transform the payments industry. Many of the CEOs we spoke to as part of our research viewed PSD2 as a significant opportunity to implement new digital strategies, as they will now have access to other banks’ customer data and can become an Account Information Service Provider (AISP). In this scenario, banks could consolidate or aggregate data from a variety of banks and create new propositions, such as a dashboard presenting all customer account information in one place.

So what will the impact of Open Banking be on new banking competitors, the so-called ‘challenger banks’, and incumbents? As discussed in our recent report, the key drivers of success will likely vary by segment, but all must respond to the open banking regime.

How each segment responds will shape the future of the market, for example:

High street players run the risk of losing the customer interface as FinTechs, other banks, or other industry players offer better functionality or usability in the front end, which simply plugs in existing accounts. There is also a risk that increasing demands for API-based modular architectures that creates significant drain on change resources due to legacy architecture. Banks able to move fast to develop a modular business and technical architecture can leverage their brands to dominate parts of the value chain - whether front, middle or back, while dynamically integrating offerings and data from other players.
Specialist lenders will seek to maintain their position as differentiated specialist “spokes” within a “hub and spoke” model, and may benefit from having their offerings presented to consumers by aggregators. However, there is a risk greater comparison of offerings will result in commoditisation and margin pressure. The impact (positive and negative) would be most significant for those who move fast to comply and participate in open ecosystem. Partnerships are likely to prove valuable to increase presence and the possibility of integrated offerings.
Non-bank brands that embrace open banking and react quickly could supplement their banking offerings, by partnering / integrating APIs to offer consumers a full service experience. The ability to innovate, along with leadership in data analytics and proposition development, would make it possible to truly differentiate and to offer value to target customers. Alternatively, not reacting rapidly could result in another party (bank / FinTech / other) innovating and eroding these players’ natural trust, proximity and data advantages.
Digital-only players should be well placed to respond, having modern architectures that are largely free of legacy and are already modular and API based. These banks are set up for innovation, with operating models and staff in place for rapid innovation, and they have typically been built with an open banking model in mind. They should therefore be able to select which parts of the value chain they wish to focus on (likely including the customer interface) and successfully scale in these areas. They will, however, be tested on security and end-to-end controls. As licenced banks that are small and ambitious, these players could be attractive partners, investment opportunities or acquisition targets - either for large players in other industries such as telecoms, technology or retail which have an interest in financial services, or for international banking groups hoping to compete in the UK.