The pace of innovation in banking today is dizzying – easily the fastest I’ve witnessed in the decades I’ve spent in the industry.
This seems especially true in the digital payments sector where new entrants like Venmo, Square, and Stripe are disrupting the established payments ecosystem, forcing incumbents to offer new services and experiences lest they cede market share to tech companies like Amazon, PayPal and Apple.
This disruption is driven by changing customer expectations and demographics, but it is enabled by technical innovations that make the previously impossible, possible. Consider how access to high-speed internet and the smartphone fundamentally changed the way we pay bills, transfer money, and manage our investments.
The important thing to recognize is that what’s happening in payments is the harbinger of far bigger disruption to come. Technology capabilities inevitably will allow companies in other industries — tech in particular — to dig deeper into what are viewed as core banking services: checking and savings accounts and, ultimately, more complex services like mortgages and investment management.
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The Impact of Digital Payments Disruption
What does this initial disruption in payments look like?
Well, it covers both person-to-person and bill payment methods. The change in underlying conditions previously mentioned — customer demographics and enabling technologies — is driving an explosion of providers. In addition, this change is causing a shift in payment delivery from days-long durations to real time.
For in-person payments, Apple Pay has replaced swiping a credit card. To respond, the banking industry is launching Paze, a payment wallet offering comparable functionality. For money transfers, consumers can now use Venmo or Zelle. For consumers facing the challenge of being a “PayPal person” trying to send money to a “Zelle person,” Visa is launching a new service called Visa+ that seamlessly transfers money between the two.
Even the Federal Reserve system is getting into the act, with the launch of FedNow. This real-time payment “rail” will allow immediate money transfer between applications, and even allow immediate online bill payment, changing delivery timeframes from days to seconds.
A Preview of the Future Already Playing Out in Europe
In some ways, the United States is a laggard to the disrupted future of financial services. For a glimpse of what the future holds, one can look to Europe, where it’s already playing out.
In 2016, the European Parliament promulgated an open banking set of regulations. Open banking requires financial institutions to offer access to their services to third parties, who are free to build their own businesses on top of those underlying services. Application programming interfaces, or APIs, make this possible.
Predictably, the result has been an explosion of new entrants in the market. In the United Kingdom, for example, at least 202 new companies have registered to participate in open banking. A partial list of these companies can be seen here.
It’s obvious that the growth of real-time payment offerings in the U.S. is just the first step in an inevitable trend toward generalized open banking.
It doesn’t take a fortune teller to predict that banks must prepare for a future of API-enabled third parties operating in a rich ecosystem of financial services offerings tuned to address the demographic and technological trends outlined above.
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How to Respond to the Disruption
You’re an established large banking provider. You’ve invested billions of dollars over the past 40 years to address the market as it was. Now you need to respond to a changed world with different customer expectations, many more market players, and supercharged technology requirements.
What should you do?
Here’s what I tell financial service companies I engage with:
1. Create an API Layer
One of the most common responses I see within financial services IT organizations is that they treat each API offering as a one-off, with a bespoke implementation and a standalone management approach.
That inevitably results in a plethora of snowflake systems and expensive duplication of common functionality.
The right way to approach this is to recognize that exposing and managing APIs is a core capability going forward. An API layer with a consistent set of enabling functionality and operations is vital.
This layer allows integration of individual service APIs within a common framework. Much like the story of “Stone Soup,” everyone contributing to a shared layer delivers a much richer outcome for all.
2. Create a Real-Time Layer
The drive toward API enablement also carries a need to support real-time functionality. Unfortunately, 40-year-old core systems were designed for a world of long-duration transactions measured in days rather than seconds. That’s not nearly good enough for the looming world of open banking.
On the other hand, an immediate rip-and-replace approach to core systems is a nonstarter. What I recommend is that companies create a layer between the external APIs and internal core systems; this layer provides real-time capability by encapsulating part of the functionality of core systems.
Of course, creating a real-time layer and abstracting a portion of a core system still requires time and money — but a fraction of the amount needed for the rip-and-replace approach. More importantly, it enables large incumbents to respond to market demands in a 12- to 24-month timeframe.
This layer keeps incumbents in the game and responsive to emerging trends, which is critical in a rapidly evolving industry.
3. Prepare Core Systems for the Future
While the real-time encapsulation layer will work in the short term, rewriting core systems to incorporate real-time and API capabilities is a prerequisite for long-term competitiveness.
While there’s no easy button to magically make this happen overnight, the other recommendations outlined above provide enough breathing room to support the rewrite efforts. What companies should not do is consider the first two recommendations sufficient and declare the job done.
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When? The Sooner, the Better
The changes outlined above — demographic, technological and regulatory — aren’t going to stop. They’re an ongoing process and we’re still early in how they’ll play out. Consequently, preparing core systems for a world of ongoing change is vital and the sooner, the better.
Combining these three recommendations into an integrated plan will enable success in the future and avoid the fate of all too many companies that failed to see and respond to quickly changing markets. After all, no one wants to be the next Blockbuster. Or Circuit City. You catch my drift.
About the author:
Bernard Golden is an executive technical advisor at VMware, where he helps large financial institutions accelerate their digital transformation initiatives. He has decades of experience in technology and financial services roles, including serving as vice president of cloud strategy at Capital One. He was named to Wired Magazine’s list of the 10 most influential people in cloud computing in 2012.
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