Financial Stability and Regulatory Compliance
The API Economy and Digital Transformation in Financial Services: The Case of Open Banking
Markos Zachariadis, Warwick Business School and University of Cambridge
Pinar Ozcan, Warwick Business School
The author is an independent contributor to the Global Risk Institute and is solely responsible for the content of this article.
The recent wave of digitisation in the banking industry and the emergence of new entrants such as fintechs and challenger banks are forcing established banks to reconsider their market strategy as well as rethink their value-added and services to their customers. This effect intensifies further if we consider the introduction of the new regulatory frameworks:
- Open Banking Working Group (OBWG) in the UK.
- The Second Payments Services Directive (PSD2) across the EU.
Both of these regulations aim at putting the customers at the centre and boosting competition in an environment where new players such as fintech startups and a new generation of financial products and services are emerging. Regulators anticipate that such regulatory interventions will increase innovation and provide higher transparency, security, quality of services as well as lower prices for users.
Central to these regulatory frameworks has been the introduction of (standardized) open interfaces, such as application programming interfaces (APIs), that will allow third-party providers to access securely and reliably customers’ accounts and even initiate payments on their behalf (hence the use of the term “open banking”). Such arrangement can have major implications on the overall banking architecture leading to a more modular, open, and horizontal structure in the entire industry, thus “unbundling” traditional players and giving rise to complementors (e.g. fintechs, tech companies, retailers, etc.) who are keen to provide new services as part of the new value chain.
Having said that, open banking is not just about the design and launch of open APIs. For it to be successful and productive it requires a fundamental shift on the role of intermediation in banking and the adoption of new business models that will take advantage of the emerging opportunities in this context. One of the most relevant business strategies that lends itself to this kind of transformation in banking is the platform strategy. Platform business models move away from the traditional vertical integration of the firm (also known as the pipeline business model) and introduce a flatter, more inclusive and innovation-centric approach to value creation. Technology is used to connect people, organisations and resources in the form of an interactive ecosystem in which value can be created through the interactions between consumers (demand-side) and external producers (supply-side), thus leading to a multisided market. Banks can achieve such market and become platforms by developing a core value proposition or infrastructure in the form of a product, service or technology on which a large number of firms (e.g. fintechs) can build complementary products, services, or technologies, thus creating a loosely assembled business ecosystem for innovation.
In our research we identified various efforts from incumbent banks as well as challenger banks and fintechs to adopt various platform-related business models based on their position in the overall banking architecture. Firms had to decide on their level of openness (i.e. how inclusive they are to external complementors and the control they exercise on the platform) but also how they put network effects at work on their platform and to what extent they believe they will benefit from them. In our sample, incumbent banks seemed to have an advantage due to their vast customer base (demand-side) but were limited from their “institutional logics” (e.g. legacy thinking around owning the customer) and older IT systems that did not offer flexibility for data integration and agile development of new services. Also, security and compliance was an important issue in their collaborations with ambitious fintechs which were new to the industry. Finally, creating an innovation ecosystem and establishing collaborations which would lead to the introduction of “not-invented-here” services was something that incumbents were not too comfortable with and went against their organizational culture. On the other hand, the challenger banks and fintechs we interviewed were far more agile, responsive and quick to develop and collaborate with external firms (both on the supply and demand sides). However, they lacked the reputation as trusted intermediaries and enjoyed a very small share in the market which made it more difficult for them to trigger network effects in the process of creating their platform. Having said that, this did not discourage some challenger banks to develop marketplaces (i.e. fintech app stores) and invest time and resources to establish strategic collaborations with fintechs in a short time with the hope that these propositions will attract future clientele. Cases that particularly stood out had a strong core proposition (e.g. offering great user experiences for their accounts and payments products) and offered detailed and comprehensive API documentation, developers’ portals, and sandboxes to attract interest from third parties and make complementors’ “on-boarding” a lot easier (low transaction costs).
Overall, through theoretical contributions in the literature as well as lessons from our findings we came up with a number of suggestions that financial institutions should consider in order to become platform leaders:
- Clear business strategy: adopting an articulated platform business model (supported from above and with “buy-in” from critical partners) rather than treating regulatory reforms like a compliance exercise will allow firms to take an active role in the reconfiguration of the market space that will surely have its rewards. Those who move early to establish an attractive platform will obtain a customer base that is increasingly unwilling to switch to competitors as more and more third-party developers offer services as part of the platform (“winner-takes-all” result by taking advantage of network effects). In turn, their growing customer base will attract even more developers, turning this virtuous cycle of growth further.
- Strong core banking proposition: investing in infrastructure and keep innovating on the core will help to maintain a central position in the ecosystem. This also involves having the right modular architecture and provide easy to use APIs with detailed documentation, community and access.
- Cultivate all sides of the platform and create vibrant ecosystem: creating a platform vision and culture is essential in order to expand the ecosystem and build a reputation. Being proactive to identify and recruit key complementors is important. The advantages of the platform and technology used will need to be highlighted so that the benefits are clear. In an open banking setting the most important would be to provide easy “on-boarding” for FinTechs and reduce the risk of use at the end-customer front (lower transactions costs). Reinforcing participation across the two sides will boost further network effects and establish the position of the bank in the market. Instead of focusing on short-term profits institutions may be better off by targeting long-term growth and creating a competitive environment for participants.