The Second Payment Services Directive (PSD2) came into force across the EU last Saturday, opening access to consumers’ financial data to thousands of companies that aren’t banks.
The UK went a step further with Open Banking, enabling fintech players and retailers to take over the ownership of customer relationships from major banks.
In the Open Banking era, banks are expected to change from one-stop shops for financial products to platforms hosting a range of financial service providers – like the Apple app store or eBay equivalent for the sector.
But the true degree of change extends beyond this. Alongside new competitors, the economics that once favoured large banks are also shifting.
Economies of scale and scope will be increasingly centred on data collection and use. Barriers to participation in banking are being eroded by the advent of Cloud processing. And new frameworks of financial intermediation are emerging with Blockchain.
Data analytics has become the entry ticket to digital finance. Many fintech startups have predicated their business models on this. The latest regulatory pushes will likely cement their positions at the heart of retail banking, as they now have access to the archives of customer spending data previously only visible to banks themselves.
However, the real threat to incumbents will probably come from the likes of Amazon and Google: platforms with the investment capacity and technology architecture that can drive insight on scale. In stark contrast, the legacy IT estate is often an incumbent bank’s Achilles’ heel in the age of digital. As data is trapped in siloes and cannot be interrogated easily, not only are banks missing out on business opportunities, but they also risk becoming more vulnerable to cyber concerns associated with greater openness.
The Cloud radically reduces the need for upfront investment. Technology platforms that were dedicated in-house facilities are moving to become hosted by a third-party infrastructure provider with an extensive network of data centres. This shifts the cost structure of data and tech-intensive industries, banking included, and enables on-demand scalability and a spectrum of new business models.
Artificial intelligence (AI), encompassing technologies that use algorithms to sense, comprehend and act, is catalysing productivity in the industry.
The effect is akin to that of employing more people or investing more in capital, except that, unlike traditional productive factors that depreciate over time, AI improves itself with data – “data is to AI what food is to humans”.
Blockchain, a decentralised digital network that enables secure transactions without a trusted central party, captures the essence of disruption.
A mechanism that engineers trust by design, blockchain sidesteps the need for “middle man” institutions – banks included – and can pose an existential threat to traditional banking business models. Potential disruption aside, the possibility of sharing a common ledger across institutions could also radically reduce the cost of financial intermediation – something that hasn’t changed in the past century.
These developments, individually and collectively, force the future of banking away from the traditional banking model predicated on rates and fees, and drive banks to uncover new sources of non-interest income based on openness and collaboration.
Banking activities may start to look very different. On top of financial intermediation, banks may need to define rules of how they engage with fintech players in the ecosystem and explore strategies to monetise proprietary IP and data. The business model and tech architecture required to support this aspiration will likely be radically different from the operating reality of today.
The banking sector is finding itself between two seismic events: it is now post-financial crisis but pre-digital revolution. The latest technology and regulatory developments may just mean that 2018 marks the year zero of true digital banking.