This is an edited version of a paper by Imran Gulamhuseinwala, Global Fintech Leader at EY, originally published for the 2017 Financial Conduct Authority (FCA) Future Scenarios Conference on the platform economy. You can find the original article here.
We live in the age of platform enterprises. By boosting access and promoting scalability, digital platforms connect buyers with third-party sellers, consumers with friends and advertisers, and riders with drivers. Rather than making goods and services and pushing them out to consumers, as in a “pipes” model, platforms connect networks of producers and consumers and facilitate their exchanges. Often, agents can be both producers and consumers.
The platform economy has recently been proliferating at an astounding rate. In 2009, for example, telecom networks relied on text messaging for 15% of their revenues, and they looked forward to high growth. But then WhatsApp emerged, and now it handles more messaging than all telcos combined.1
Could banking be next? The conventional wisdom is no, due to the industry’s complex regulation, low customer engagement, solid branding and franchise strength, and the stickiness of the personal current account (PCA). Defenders liken banking to the utilities sector: a heavily regulated industry that epitomizes the pipes model.
But we can imagine a platform-based architecture where consumers conveniently and confidently acquire financial services in seamless transactions with each other and with producers. This scenario could bring significant benefit to the real economy.
The trouble with pipes
Banks currently manufacture and distribute products to consumers through proprietary, one-way channels. They are skilled at sourcing capital, optimizing process efficiency and marketing to generate consumer demand. Company size and product uniformity are key advantages. This architecture has served the sector well and, absent other industry challenges, could well be optimal.
Unfortunately this top-down, efficient structure can also hamper banks from focusing on consumers and responding to changing demand. It also maintains an outdated binary producer-consumer relationship. As a result, the industry is now under serious strain. Retail branches are losing out to smartphones as the preferred medium for transactions: visits have fallen by a third in the past five years. The trend is accelerating as smartphones offer ever-greater functionality, and customers are increasingly comfortable with self-service.2
Traditional products are also in decline. More than half of millennial consumers prefer debit cards over cash, and they are not investing in home mortgages or car loans as previous generations did. The growth of simple, smartphone-enabled digital wallets may suggest that some are questioning the value of the PCA.3
To fill the widening gap between banks and consumers, thousands of FinTech start-ups are targeting underserved segments and overpriced products. These new players are picking apart the established banking activity chain. According to the EY FinTech Adoption Index, an average of one in three digitally active consumers is already a FinTech customer. Even traditional, nonfinancial institutions are encroaching on this space to support their core business — a third of Starbucks’ North American revenue goes through its digital wallet.4
Banks are struggling to adjust to the emerging digital economy. They still largely avoid cash flow lending,5 an essential service for businesses in the knowledge economy. Growth areas such as e-commerce, the gig-economy, the internet of things (IoT) and toll pricing are poorly served by the existing payments and credit infrastructure, which emphasizes high-value, low-volume transactions. Credit cards, the default payment option for many smartphone applications, still rely on an ecosystem of acquirers, issuers, schemes and processors, which adds cost to the process.
Policymakers are aware of these trends and are gradually re-engineering the sector, such as the Open Banking initiative in the UK (for which I have been appointed Implementation Trustee). They recognize that large and diverse firms do not suffice to ensure stability and may, in fact, be counterproductive.6 They are promoting competition and innovation to better serve the real economy.
The platform scenario
Instead of banking continuing with inflexible pipes, we imagine a future where banks become platforms for financial transactions. Rather than produce goods and services, they would create open ecosystems where consumers and producers interact. Smartphones would be the core tool for all users of the platform — a universal banking product as ubiquitous as a wallet or credit card, but with infinitely more functionality.
The platform providers would establish its “plug-and-play” infrastructure so third-party producers could easily connect to consumers. This would include the secure and user-friendly exchange of data, including authentication and authorization data, to reduce transaction costs. The platform would offer governance to maintain quality and trust among participants, as well as incentive structures so all users benefit from the value created. Once a platform had a critical mass of consumers and producers, participants would step up the innovation to serve each other better.
Platforms have the potential to deliver several benefits that are only imperfectly realized in the current system. Consumers would be able to send money seamlessly to registered individuals and businesses. They could connect directly with many independent producers with minimal switching costs and conveniently assemble the components of their optimal products. As their data on the platform grew, they would gain tailored support and guidance to confidently make decisions.
Producers, for their part, would gain better data and direct access to consumers, thereby reducing marketing and onboarding costs. Consumers would still control their data, but decide how to share it securely and conveniently to save money on financial services and other nonfinancial services products.
The platform providers would benefit as well. The network would become increasingly valuable, as the rising number of transactions generates a steady stream of data. The provider would analyze that data and offer insights to consumers and producers, which would in turn generate more interaction. Over time, users would develop increasingly rich platform identities that would have value in nonfinancial sectors as well.
How to get there
This scenario depends on some enabling elements. First is ultra-cheap, universal and real-time payments. In order to attract a wide variety of producers, platforms must reduce friction and support the micro-payments required by the digital economy. The platform must be robust enough to handle transactions from many diverse users, and allow instantaneous settlement so these users have no need for sponsoring institutions. Fortunately the UK’s Faster Payments initiative fulfills most of the requirements above, though so far it applies only to the 17 largest banks and building societies.7
Next is open banking.8 If consumers can securely consent to offer their personal data, they will have much more trust in the platform. If they control the use of, and see benefits from, sharing this data, they will engage more readily and intensively. The UK has fostered open banking with legislation for the General Data Protection Regulation and Payment Services Directive, which has been adopted by the Competition and Markets Authority. Open banking will allow consumers and small and medium-sized enterprises to share transaction data with third parties in order to access better deals and services.
Finally, the platform depends on a near to zero-cost know-your-customer (KYC) process.9 If producers can readily learn basic information on their new customers, they can bypass the lengthy onboarding and offer products immediately. Open banking will support some elements of KYC by allowing the digital transmission of bank data, yet many elements of KYC still require paper-based identification and even some face-to-face contact — inefficiencies that create significant barriers to switching. Unfortunately there are currently no government-sponsored initiatives in this area, either to create KYC utilities or to revisit KYC requirements.
If this hurdle could be overcome, along with improvements in the other factors, we believe platform-based disruption would come to banking. That disruption would appear most likely in the declining use of the PCA as separate FinTechs serve the various functions of those accounts. If the government went a step further and required that all zero-notice deposit accounts be held directly under pooled or nominee accounts at the central bank, FinTechs could accept deposits without the burden of capital requirements. And if policymakers provided an open architecture for identity and KYC, the industry could advance even more by avoiding a winner-take-all environment.
Platforms are unlikely in the current state of the banking sector, at least in the UK. But with some new government policies, the situation could change dramatically. Platforms could greatly benefit society and the economy by expanding access to banking services and by meeting consumers where they are now. Bankers and regulators would do well to study this issue further.