Why Haven’t More Banks Embraced Digital Platforms?

The practice of building moats around castles and towns to protect them from attackers can be traced back to the ancient civilizations of Assyria and Egypt. They were, during the mid- to late- medieval period, a common form of defense.

In a similar anachronism, banks have “regulatory moats” around their business intended to protect them from outside competitors. The regulations required to take deposits and make loans are so numerous and onerous that they deter new players from entering the market. Tellingly, in the past few years, there have been virtually no new FDIC-insured bank charters in the U.S.

This is changing with the rise of “open banking.” Whereas past regulations have often acted like moats, new regulations are more likely to act as bridges opening into the banking’s strongholds. In Europe, for example, PSD2 mandates that banks make account information and payment initiation available via application programming interfaces (APIs) to third parties. Banking providers have traditionally had monopolies over this data, but these APIs will realign and flatten the landscape.

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Why Platforms and APIs are Replacing Legacy Strategies

It’s not hard to see why a report from Accenture asserts open banking “could revolutionize how banks generate value.” Many regulators around the globe see these changes as a way to spur innovation and competition within their markets, and are pushing the industry to open APIs.

Regulatory pressure aside, open APIs have arguably been a long time coming in banking. Digital native competitors weren’t born in the era of castles and moats. Rather, they naturally use APIs and openness as a strategic advantage to build ecosystems that deliver the services today’s modern consumer wants. When these ecosystems are successful, they can lead to “winner-take-most” markets and alter the competitive landscape for every other player in the segment.

Consequently, over the last decade, many of the largest legacy businesses in other industries have been supplanted in market cap by innovative platform technology companies. Somehow, however, digital disruption has left the banking sector’s biggest players largely untouched.

Banks’ core business is to aggregate deposits by paying savers interest and then charging interest to borrowers. This dynamic is fueled by “network effects,” wherein the number of participants on each side of the business reinforce value for those on the other, and should thus align naturally with platform strategies. But that hasn’t been the case. Why? It is it that armies often fight today’s war the way they fought the last war, meaning they use the same technologies, strategies and tactics that helped the victor prevail in prior conflicts. The banking model has been successful for so long — why would financial industry executives consider any other way to compete?

Even though legacy tactics feel comfortingly familiar, the world has changed. Companies are now competing via digital platforms and ecosystems, and like every other industry, banking must adapt.

A third of U.S. Millennials believe they won’t need a traditional bank in the future.

Strength often comes from openness and reach, not insularism and control. Just as the heavy cannon enabled armies to project force at greater distances, ending the era of the castle, APIs and ecosystems enable companies to project their services into many experiences and greatly increase their reach and power. This makes the castle walls of vertically integrated products look especially vulnerable to nimble attackers that use APIs and platform economics to compete.

Adapting to Open Banking

To remain relevant to consumers and compete against non-traditional competitors, banking providers should consider adopting the strategies, tactics, and technology of the new digital landscape. Banking executives need to stop dwelling exclusively on financial products as they have in the past, and instead broaden their focus to include end-to-end value chains and digital ecosystems.

Value in today’s digital economies is created via ecosystems of software — not just within the vertically-integrated offerings of a single bank. Consumers will access financial data across a range of devices, use cases, and platforms. Developers are a key component in this diverse ecosystem, leveraging APIs to produce new services, and often combining APIs from multiple parties to produce richer, more useful, and more cohesive connected experiences for end users. Banks and credit unions that don’t work with developers to build open APIs may not only to be locked out of these new value chains but also may see their customers move elsewhere.

In addition to recognizing the importance of developers, banks and credit unions should consider designing and building value chains that solve consumers’ problems, taking into consideration the full customer journey and reaching beyond the banking domain to solve customer problems. This might include sourcing next-generation digital partners that serve home buyers, car lessors, or college-bound students and their parents.

With the moats draining and drawbridges lowering in the form of APIs, the landscape has changed. The banks that thrive in the future will likely be those that respond to these changes with purpose, leveraging openness to expand their platforms, drive customer choice, lower costs, and unlock new engagement models.

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