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Open Banking’s Early Initiatives & Likely Winners

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Open banking is the concept that banks will open their platforms to third-parties for them to transact business with the banks’ customers and suppliers, and is required by regulations which are coming into force. Many advocates believe that this will spur innovation in financial services and create new business models. Here I look at the open banking landscape and at initial efforts being made to capitalize on the initiative.

Background

For centuries, banks have operated on a closed platform business model to create differentiation and barriers to competitive threats. The past few decades have seen banks investing in capital-intense technology platforms which significantly reduce the cost of delivery for tier one banks, providing them with a large cost advantage over lower tier banks. However, in recent years, regulators have sought to open platforms to increase competition in the industry, thereby benefiting consumers. The expectation is that new financial services vendors emerge and provide differentiated services to consumers and businesses at lower cost, made possible from using a tier one bank’s platform. 

Tier one banks are willing to give up the cost advantage of their proprietary platforms because of regulatory requirements. Key legislation necessitating open platforms include:

  • PSD2: The payment services directive 2 (PSD2, a European Union regulation adopted in November 2015 and effective January 13, 2018) mandates banks to operate open platforms to promote innovation in payments
  • Competition and Markets Authority (CMA) ruling in the U.K. requiring the largest nine banks to allow licensed FinTechs direct access to the banks’ data down to the level of transactions in transaction accounts.

A closer look

The banking ecosystem has well-defined participants, which include:

  • Tier one banks: own the platforms
  • Bank suppliers: includes exchanges, BPS vendors, financial product vendors (e.g. card schemes, loan investors, and securities issuers)
  • Customers: consumers and enterprises
  • Competitors: other banks and financial services product vendors.

Under a closed platform scenario, tier one banks take a proprietary role in financial products they sell. In effect, they buy the product and sell it to the customer. If the product is unprofitable, the bank loses money. Under an open platform scenario, the tier one bank takes an agency role (brokerage) and if the product is unprofitable the third-party vendor loses money, while the bank still makes its commission. Bad products can lead to brand impairment for the bank, but no direct losses.

In theory, opening platforms should lead to:

  • Greater product innovation benefiting customers with greater choice
  • Lower prices for products, because customers can choose the same products from multiple vendors without having to incur the switching costs of moving to a new platform.

How will this theory play out in practice? What type of products are being developed to sell via open platforms? And is this likely to increase choice and/or reduce costs? 

Case studies

Early initiatives to capitalize on the open platform phenomenon include:

  • Integration of multiple customer channels into one set of dashboards to facilitate bank management predicting customer behavior and managing CX
  • Implementing roadmaps to integrate third-party mobile services vendors into the bank’s offerings
  • Creation of an app store-style marketplace to offer analytics services (e.g. budgeting, robo-advisory, or mortgage broker) to consumers
  • Third party offerings looking to integrate into open banking platforms:
    • 3D visualizations of transactions (Money Journey)
    • Mobile app to help visually impaired (Speaking Bank)
    • Personal finance (Moneygarden and Spendchart)
    • Accounting packages (Kashflow).

As the examples above show, third-party offerings to date have been focused on either digital relationship management (portals drawing from multiple sources) or financial product offerings (channel access or advice). Since it is very early in the market evolution it is not surprising that there are no highly evolved offerings yet. And there certainly are no category killers or ultra-low-cost product vendors as yet.   

Conclusions

Open platform banking has spurred a great deal of enthusiasm for its ability to create new successful financial services vendors and increase bank customer choice. Emerging vendors offer interesting products, but ones without a sustainable moat. To develop sustainable differentiation, FinTechs will need to make heavy capital investments into their product sets. Only two types of vendors will be able to make these costly investments:

  • Large specialized vendors: in-country vendors who have a high market share in a specific product set (e.g. the largest mortgage lender in a country)
  • Foreign vendors: vendors operating in a foreign marketplace with industry characteristics that allow it to develop offerings which are well-suited, but unavailable in the domestic market (e.g. Asian banks able to deliver ultra-low-cost mass market products, or Swiss banks able to deliver sophisticated wealth management products).

The next five years will see a burst of high capital investment into the creation of heavily featured financial products for the open banking marketplace. Vendors who succeed will be the ones who can create a compelling, but narrowly defined roadmap for development. Successful execution of the roadmap will require effective curation of early user feedback to create product features which are intimately tied to user requirements. We expect over 80% of vendors will fall out of this race. But in five years, a few vendors will have grown to be titans of the financial industry for their product set, with superior operating metrics (i.e. very high margins and ROEs). 

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