HOW BANKS CAN CREATE VALUE FROM THE RISE OF THE OPEN API ECONOMY IN FINANCIAL SERVICES
Part 1: Introduction and background
Two key challenges banks will face in an open API economy are deciding how best to develop and distribute new products and services, as well as with whom to partner and for what purpose.
Change is inevitable as banks explore opportunities to gain competitive advantage by leveraging open APIs in their business models. This exploration is fuelled by increasing demands from customers, regulators and politicians to drive innovation and competition within financial services. For banks in Europe with retail and small and medium enterprise (SME) customers, the open API economy will likely develop (at least initially) out of the PSD2 legislation due to take effect in January 2018 within European Union (EU) member states.
For corporate banks not explicitly covered by PSD2 legislation, open APIs can address declining satisfaction and high churn among their corporate customers.
In particular, many customers are frustrated with corporate banks’ progress in seamlessly integrating their services into customers’ increasingly digitized supply chains and harmonizing interface standards across banks. Not only do open APIs offer both sides a way through this standoff, but third-party services could be more easily accommodated and encouraged by corporate banks.
Financial institutions worldwide are keeping a watchful eye over open API developments in Europe and are likely to follow suit should European banks generate competitive advantage and new revenue streams by embracing the open API economy. Success in Europe is likely to spur customers, regulators and politicians in non-European countries to drive similar changes in an attempt to achieve the same benefits.
Many observers see the rise of an open API economy as game changing for the industry worldwide, and inevitably there will be winners and losers among banks as a result. Those that decide not to respond directly to the challenge and unlock the value of customer data will find it difficult to increase revenue and profitability to an ever more competitive customer-centric marketplace.
What impact will the open API economy have on retail and corporate banks?
Banks with retail and/or SME customer bases in Europe will be forced by PSD2 legislation to pursue one or both of the following courses of action:
1. Make customer transaction data held by banks available to authorized third-party service providers
PSD2 will force banks to share certain data they hold about customers with third-party providers known as account information service providers (AISPs). These AISPs will have access to customer data and, once authorized, will seek to use it for commercial purposes. The intention is to provide AISPs and, indeed, other banks and financial institutions with a defined level of data to encourage competition, increase product innovation and improve customer service. Banks can seek to respond to this challenge on their own or partner as they aim to monetize customer data in new ways.
2. Establish a new service for customer payments to be processed and charged
PSD2 allows third-party payment initiation service providers (PISPs) to provide customers with an alternative payment mechanism linked directly to their bank accounts, which could result in the disintermediation of existing card networks and their associated merchant service fees. This is good news for merchants because it should result in a reduction in absolute fees for customers who opt for a PISP-initiated payment rather than one made by debit or credit card. Moreover, merchants can benefit from the removal of liquidity risk within the transaction and the faster clearance of funds from the customer (assuming the underlying payment is made via a real-time payments rail).
If the merchant is of sufficient scale, such as Amazon or Carrefour, we may even see these players vertically integrate to become full-fledged PISPs, retaining 100 percent of the merchant service fee. In this scenario, banks’ current revenue levels from payment transactions will be under threat as new entrants offer a PISP service. With the reduction in merchant service fees, customers should expect to see some of these savings passed on to them in the form of cash rebates or more generous loyalty schemes.
Corporate banks, while currently not tied to explicit regulatory timescales like PSD2, are likely to come under pressure to leverage open API technologies to address declining satisfaction and high churn among their corporate customers. As noted previously, many customers are frustrated with corporate banks’ slow progress in harmonizing and seamlessly integrating their services into customers’ increasingly digitized supply chains and harmonizing interface standards across banks. Open APIs offer not only a solution to these issues, but enable third-party services to be more easily accommodated and encouraged by corporate banks.
Strategic response options for banks
Most banks in Europe are currently thinking seriously about their strategic response to the rise of an open API economy. Notably, some banks have started to invest in FinTech platform solutions that protect revenue and maintain client proximity.
Banks face two key strategic choices for the future: Operate either as a “white-label” service provider, delivering products and services for other banks and TPPs, or evolve into a trusted lifetime advisor to customers, operating at the epicenter of a new breed of customer-centric banking models.
However, some bank executives remain unconvinced the rise of the open API economy will really disrupt banking, even with legislation such as PSD2 coming into effect in the short to medium term. There is a degree of risk for banks taking this “wait and see” approach.
Banks should proactively respond to the strategic challenge of the open API economy
In terms of responding to the rise of the open API economy, CGI believes there are three key responses:
1. Refuse to change: Accept regulator fines based on an assumption that the fines are less than expected revenue loss from new competitors enabled by PSD2 and the cost of transformation
2. Comply at a minimum: Keep current business models largely intact
3. Proactively respond: Develop new customer driven products and services and/or create new distribution channels, either alone or by leveraging third-party providers
Leading banks are opting for the third response. For those banks that go with option three, the European Banking Association suggests there are four roles from which they can choose, each of which will change the traditional “producer-distributor” model banks employ today and are described below.
The four roles emerge as a result of using open API technology to interface between product development and distribution, which enables banks to decouple those two functions. The combination of decoupling and opening up bank APIs to third parties allows banks to play one of the following new roles:
A. Integrator: Bank continues to control both production and distribution of products and services
B. Producer: Bank focuses on development of products and services and distributes those via third parties
C. Distributor: Bank focuses on distribution of products and services created by third parties
D. Platform: Bank retains a stake in both production and distribution by acting as a market intermediary that facilitates activity among customers, producers and distributors in the market
In the coming years, bank platforms may become the norm for all financial services and products. Traditional banks that refuse to change their business model may be disintermediated from the customer and could become limited to the role of producer and, at best, play the role of back-office integrator for a number of “over the top” product and service providers in the marketplace (e.g., know your customer checks).
In light of these new roles and opportunities, we are recommending the following actions:
• Short-term (0–12 months): Consider your overall strategic direction in light of the rise of the open API economy:
» Refresh your business and technology strategy
» Determine your future markets and revenue streams based on existing/new products and services powered by an open API economy
» Define the pathway(s) to future operating model(s) based on specific products and services, recognizing the market will evolve over time
• Medium-term (12–36 months): Actively seek to “test and learn” using key strategies that leverage internal expertise and appropriate partnerships in the open API economy:
» Prepare for PSD2 regulation to be enacted (retail banks)
» Respond to emerging standards around open APIs
» Confirm your initial operating model, including your customer data approach
• Long-term (post-36 months): As the open API economy in banking continues to develop, consider the following:
» Respond to competitive threats and opportunities that emerge post-PSD2 implementation in the form of PISPs and/or AISPs in the marketplace (retail banks)
» Adapt your business model to protect revenue streams and customer relationships
» Build institutional capability to screen for new technologies and partners, ensuring you stay at the forefront of product and service development and distribution
Key operational challenges to succeeding in an open API economy
We are still in the early days of the open API economy within banking; however, time is of the essence for banks. The next 18 months, particularly in Europe with the advent of PSD2 legislation, will be crucial in establishing the correct operational and technical standards for open APIs and ensuring that banks and third parties have an agreed upon framework within which to operate.
This will inevitably raises important operational challenges for banks, including the following:
1. Implementing operating model changes to drive profitability
2. Establishing security and permissions among parties
3. Setting the right data strategy to ensure maximum value
4. Providing appropriate service levels for performance of the APIs
5. Establishing appropriate governance among financial service players
In light of the fact that banks will need to figure out how the open API economy will impact their business model and revenue streams, there is a distance to travel before banks can operationalize these changes.