Banks and credit unions are evaluating the options of building new business solutions using open banking APIs. Innovation options are vast, with the decisions made today having a significant impact on future success.
For the last several years, the financial services industry has been undergoing a transformation that has led to changes in business models, offerings, delivery mechanisms, clients, and more. This transformation has been fueled by major shifts in client expectations, regulatory pressures, and increasing competition.
Consumer needs and expectations have shifted as new demographics of clients enter the market and existing clients demand digital offerings. Millennials represent 84 million in the U.S. alone, and only 33% of them believe they need a bank at all, while more than 60% believe they will transact money differently than offered by traditional banks. While Millennials are often cited as the cause for new digital offerings by banks, Generation X/Y consumers, who account for approximately 50% of money in motion, have strong digital preferences and low trust in banks as well.
With financial services regulations currently undergoing scrutiny, they have been a source of constant pressure since 2011. Regulations have tightened, increasing the burden on financial services institutions (e.g., Dodd Frank).
Regulations lead to higher costs of doing business due to increased base requirements for capital, leverage, eligible bail-in liabilities, liquidity, risk governance, and the trading, clearing and reporting of derivatives. Regulations also add constraints on how balance sheets are composed and impact legal and operational structure.
But, regulations are also widening the playing field for consumer choice. PSD2 is enabling 3rd party players to manage a consumer’s finances such as bill pay, transfers, and spending analytics. Banks will be obligated to provide 3rd party providers access to their customers’ accounts through open banking APIs in the UK, enabling them to build services on top of banks’ data and infrastructure and leading to more options for consumers to manage finances. These same opportunities will be available in the US as regulations change.
New Options and Challenges From Outside Organizations
Fintech disruption continues to grow. There are 8K Fintech firms worldwide, with approximately $85B in funding, operating across the entire value-chain. According to the IBM Global C-Suite Study, more than half of banking and financial markets C-level executives expect competition to come from new industries. The CEO of a leading eastern European bank stated “[We are in a] fight over who will be the most intimate partner of the client. The bank? Facebook? Mobile operator? Mobile phone manufacturer?”
These new financial services firms provide more options for consumers. Financial service industry disruptors have introduced new types of banks, new payment methods, new forms of authorization, and even expanded banking to non-bank entrants. Access to financial market data, previously difficult and costly to obtain, is now readily available through APIs like those offered by Xignite.
Payment providers are also offering attractive direct and mobile payment options that reduce transaction costs, hardware costs, and maintenance associated with payments. Licensed startups such as Fidor are offering cloud-delivered banking services with new business models based on an API-centric core banking platform. Instant authorization services from firms like Plaid connect bank accounts to facilitate payments, verify account ownership and check balances in real-time to improve the ACH process.
Data Drives Internal Personalization Opportunities
Financial services firms need to provide always-available services that are personalized to clients and targeted for their needs. Clients will continue to have more choice as new entrants continue to disrupt financial services. Firms seeking to maintain their existing client base need to provide targeted services that meet the demands of clients who are looking for services personalized to them and the ability to transact from their mobile devices. For example, mobile advisors and personalized portfolio offer opportunities for innovation along with telematics and data driven insurance quotes in insurance.
Client expectations are driving capabilities in customer analytics, payments and mobile banking as well. In customer analytics, multiple customer data companies such as Axiom and Nielsen, as well as startups, are analyzing customer data for segmentation and targeting.
Segmentation data is being used for customer acquisition, where 63% customers use online information to learn about banking products and 45% customers comment on the banking service in social media. Companies like Gainsight leverage customer data for churn prediction. In payments and mobile banking, while there are 2B mobile phones worldwide, many challenges exist around regulation and fraudulent activity. The mobile payments market is growing quickly and is estimated to reach $1.08T by 2019.
Managing Risk and Regulatory Requirements
Firms also need solutions to manage risk and provide security in applications and information technology resources. Regulatory requirements have increased operational costs associated with complying to these requirements. There is an estimated $55B spent on Know-Your-Customer (KYC) and Anti-Money Laundering (AML) regulatory requirements by financial services firms.
In 2016, an estimated $55B in banking expenses were related to regulatory requirements. Large banks can spend well over $1B each year on compliance. Applications of artificial intelligence (AI) and analytics for compliance and risk modelling are becoming increasingly common as multiple vendors emerge.
Financial services firms needing leaner operations and tighter governance and compliance spent $634B in information technology in 2016. This equates to about 6-8% of revenue on IT as compared to other industries where 1-2% is spent on IT.
One area of budget focus is on cybersecurity and identity and access management (IAM) platforms. Investment areas include analytics in AI (classification algorithms) and fraud detection in payment processing. Cloud based IAM platforms are expected to reach over $3B by 2023. Large banks have also started to use biometrics for IAM, for example, using finger scanning and voice-recognition technology for authentication.
Increased Digital Expectations
Financial firms need to develop digital offerings and new capabilities to address the market forces of client expectation, regulation, and competition. Up to 30% of financial services budgets are dedicated to digital transformation and rapid innovation around data and reduced time to market.
Digital expectations drive a need for:
- Compatible structured & unstructured data for processing & analytics
- Microservice & API philosophy
- Cognitive processes run on standard & alternative data
- Digital currency and blockchain
Open APIs for Financial Service Innovation
In the quest to provide targeted digital offerings, cognitive APIs are emerging across voice, speech, vision and text processing and even including back-end automation such as automated customer service. Robotic process automation is growing, as larger financial services institutions have begun to embrace cognitive technology.
IBM’s industry platform strategy addresses the needs of financial services institutions by evaluating the key business process needs and software capabilities required to meet the demands of customers. At the very core of the strategy is to enable developers in financial services to take advantage of innovations such as cognitive through a set of microservices that access key data and functionality.
Applications have until now served single functional areas such as finance, human resources, and sales, where single, often referred to as “monolithic” applications, dominated and provided a broad range of capability in that functional area. These applications were siloed and often required customization to integrate. If there were APIs or services, they were often limited to use within that application alone.
Now, given the demands of application users – speed, flexibility of device, pervasive connectedness – there is a shift toward high performance applications that collect and process data instantly. Slow, siloed applications are becoming less adept at keeping up with these demands. Microservice architectures have become favored, as they encapsulate a business function independently and accessed via APIs that can be accessed by any application looking to interact with the business function.
APIs are contributing to the financial services disruption we are seeing along with disruption in cloud computing, mobile devices and the Internet of Things. APIs have become part of the building blocks that developers can use to create disruptive, innovative applications without the heavy investment of building capabilities from the ground up.