As open APIs begin to shape a new banking landscape, banks’ immediate focus should be on improving core differentiating services, taking advantage of their access to infrastructures and networks.
The introduction of open banking APIs in the U.K. in less than a year raises the possibility of separating the banking market into two distinct parts: a producer market and a distributor market. The producer market will likely comprise existing financial institutions that create financial products and services. However, unlike today, customers will be able to access these products and services through distributors, via mobile apps, websites, voice control in addition to more traditional channels such as bank-agnostic call centers and branches.
The producer and distributor markets will have very different dynamics compared to the current vertically integrated market and to each other. The question for today’s banks is: Do they compete in the distribution market to win the majority share of customer interactions or in the production market through innovative products and services? To create a winning strategy, banks must understand the market forces.
Changes in the producer market
In the producer market, the threat of new entrants is likely to remain low. The journey to a full banking license remains long and complex, and the infrastructure will not likely change. So, while some challengers have made inroads into banking, no one expects this space to become flooded with newcomers. This is largely because new initiatives, such as open banking in the U.K. and the European PSD2 – both due to go live in 2018 – aim to make existing banking silos accessible to third parties, rather than reduce barriers to entry.
Furthermore, the threat of substitution already exists, with third-party financial services providers vying for customer attention in payments, credit and investments. Peer-to-peer loans and micro-investment companies have already become popular. In addition, existing financial institutions, such as asset managers and investment companies, who may be struggling to sell directly to their customers because of lack of distribution, will compete with banks in the new divided landscape.
With challenger banks continuing to disrupt the producer market, rivalry will increase as challengers with cutting-edge technology implement APIs more easily and make their services more accessible to distributors than incumbent competitors.
Changes in the distributor market
Open banking aims to drastically lower barriers to entry into the distributor market, making the threat of new entrants much higher there. For the first time, independent third parties will be able to offer their own distribution channels and focus on improved customer experience, for one bank or many banks. Imagine brand-agnostic branches and apps with seamless access to every product and service of every bank.
The threat of substitution in the distributor market for existing and new players alike will be high. Although trusted third parties (TTPs) must be industry-authorized, smooth onboarding and speed-to-market will drive rivalry in the new distributor market, as players battle for the competitive advantage of a majority.
As with other markets, customer networks may be the deciding factor in securing larger shares of consumers. Distributors will act as intermediaries with access to the producer market as suppliers and the consumer market as buyers. A distributor with a large network in both will certainly see their bargaining power increase.
In addition, offering loyalty incentives and personalised bundles of products and services will increase consumer dependency, making distribution services stick.
Best of both worlds?
As the distributor market emerges, banks will find themselves as incumbents in the producer market. They will need to compete in the distributor market or take an informed decision not to do so. Regardless of the initial choice, banks’ strategy should focus on improving the core services that differentiate them in the producer market, taking advantage of their access to infrastructures such as RTGS (real-time gross settlement) and domestic and international payments networks.
Banks have the opportunity to watch the distributor market mature and decide whether to enter the market independently or ally with a successful partner while focusing on core competencies. Partnering with a distributor could prove beneficial in the short-term but stifle growth opportunities as compared with opening services to all distributors.
Banks joining the distributor league should consider creating a separate business entity. This will enable flexibility and faster responses to changes in the distributor market without the restrictions of legacy infrastructure and business models shaped by the producer market.
Charles Wood is a principal consultant with a background in computational physics research and data analysis. He has several years of experience as a solution architect on large API platform builds for European and South American banks.
The content and opinions posted on this blog and any corresponding comments are the personal opinions of the original authors, not those of Capco.