Five years on from the revised Payment Services Directive (PSD2) – the regulatory framework that started an era of open banking across Europe, and a market-led push proliferating data sharing at banks in the US and Europe, among other jurisdictions – innovation in the sector has started to bear fruit.
Notably, open banking has laid the foundations for banks to create, or join, partnered ecosystems – a network of financial providers offering a one-stop-shop for all customers’ financial services needs including lending, payments, investments and insurance.
It is in this way that financial ecosystems play into the core tenet of open banking, shifting focus from the product to the customer and promoting convenience, choice and efficiency. With each specialised provider contributing its expertise through APIs – be it a bank, fintech or insurer – data can be securely and functionally exchanged to enable a single entity within the ecosystem to offer the services of its partners.
For example, “a customer could access their bank account, apply for a loan from a different provider, and invest in financial markets through another specialised entity – all within a unified ecosystem,” says Seshika Fernando, VP, Head of Banking and Financial Services at WSO2.
Yet, while the revenue-boosting possibilities for ecosystem partners are seemingly obvious, less than a third of the world’s biggest banks are meaningfully investing in banking ecosystems at present, according to a study by Boston Consulting Group’s Henderson Institute. In fact, the same study suggests nearly a quarter of large global banks are not investing in ecosystem models at all.
While open banking may have forced the issue for reluctant banks to foster financial ecosystems, particularly those with extensive data pools that may be time-consuming or costly to integrate into a financial ecosystem, the question remains: why are some banks reluctant to foster or join financial ecosystems?
The fear of losing control
For Fernando, the slow adoption rate of financial ecosystems at legacy banks comes down to a shift in mindset, one which many institutions struggle to adopt, having historically built walls around customers’ finances and data.
“Banks have jealously guarded their customer data against any external sources,” says Fernando. “With the introduction of open ecosystems, banks face a new challenge: opening their data to third parties while ensuring customer consent. This concept was counterintuitive and initially intimidating for banks. The idea of sharing customer data with external entities went against the long-standing approach of protecting data within their fortified systems.”
It seems, then, the slow uptake of open ecosystems at legacy institutions is as much a philosophical issue as it is a practical one, with the need to embrace openness and collaboration a significant hurdle for banks to overcome.
While concerns regarding data security, privacy and maintaining regulatory compliance were once paramount for banks, banking ecosystems have flipped this model on its head, necessitating data sharing with third parties.
As such, security models need updating to guard customers’ data across an entire ecosystem.
Prakash Pattni, Managing Director of Digital Transformation at IBM Cloud for Financial Services, notes: “In order to connect to an ecosystem, a bank needs to give partners access to its system. Open banking is great, but you really need to be able to do this in a secure way. It can take fintechs and startups 18-24 months to onboard with banks because the bank has to complete due diligence and security checks.”
The status of a bank’s legacy technology can, therefore, have a significant bearing on its willingness to join an ecosystem. As noted by Payoneer’s SVP for Europe, James Allum: “The fundamental challenge will be whether a bank’s in-house technology can support the development of a digital platform that allows the onboarding of partners and accounts, while addressing associated security concerns around data sharing and privacy.”
The difficulties legacy banks face, which predominantly need to overhaul their existing tech, is why Allum sees banks with a small geographical focus, featuring products “defined to meet local needs”, as more readily adapted to integrate into broader ecosystems. They typically have smaller tech stacks, less customer data and a greater will to integrate into a wider ecosystem to meet their growth aims.
However, given the extensive timescale legacy banks face when onboarding the services of fintechs and other relevant partners, it’s a matter of when, not if, most legacy banks will integrate into broader ecosystems. “We’re already seeing banks moving everything to the cloud, it’s just a long and costly process,” says Pattni.
“At IBM, we’re taking a hybrid approach, to help some banking clients accelerate a tech upgrade, moving relevant operations over to the cloud.” Though an expected undertaking from one of the world’s biggest technology providers, IBM’s work with banks firmly implies a growing willingness from legacy institutions to hasten their open banking capabilities and enter wider ecosystems.
Is big tech a threat?
As more banks cotton on to the financial ecosystem ball, it’s small wonder McKinsey has estimated the future of banking represents a US$70tn opportunity for those who break up their services into broader cross-industry platforms. Banks are coming to terms with the importance of financial ecosystems in providing revenue-boosting opportunities.
For Pattni, the key to maximising revenue from an ecosystem harks back to open banking’s core tenet: ecosystems are largely driven by customer expectations.
He says: “Big techs are constantly enhancing the richness of their platforms, integrating multiple payment options. People have gotten used to that level of service and are now expecting that from their financial service providers across the board, whether it's for offering loans or mortgage products.”
The adaptability and rate of evolution at big tech firms can be attained by “the ecosystem play”, according to Allum, “which allows banks to adapt to a changing financial system as the margins from traditional products like payments shrink.”
The slow migration of banks joining ecosystems – despite their willingness – has led to suggestions that big tech firms, which already have a foothold in digital payments (Apple Pay and Google Pay for example), could look to capitalise on this and launch their own banking services.
Despite these claims, banking is not something Fernando thinks will interest big tech firms. She says: “It is important to consider that big tech makes more revenue from banks through its advertising, media and cloud services. In many cases, big tech firms generate more significant revenues by partnering with or providing services to big banks rather than directly becoming banks themselves.”
This view is shared by BlueSnap’s EU CEO and VP of Product, Brian Gaynor, who believes tech firms will be put off by the amount of “glue needed to manage regulations and cash-in accounts”, something which banking infrastructures are traditionally built to accommodate. Tech companies are used to “moving significantly faster with their agile infrastructures”, Gaynor adds.
There is no appetite for tech firms to become mired in a pool of regulations; they are able to remain agile “by walking the tightrope” of compliance, avoiding an incurrence of full-blooded regulatory requirements according to Pattni.
He notes: “If big tech goes too far, these firms are going to become fully regulated, and then they're going to have to spend all this time and money on all the things banks do. But they're trying not to cross that threshold, their margins stay higher that way.”
So, while the threat of big tech swooping down to eat the lunch of legacy banks may not be in the interests of technology firms, it is still imperative that big banks reposition their systems to operate across ecosystems, lest they be outmuscled by challenger banks.
Most banks know it too, it’s just a case of updating legacy systems as quickly as possible to keep pace with technology and customer expectations. Once they do, though, the future of banking as part of a financial ecosystem looks bright.
The future of banking: financial ecosystems
In fact, once banks reposition themselves to a secure data-sharing model, they don’t even necessarily have to build ecosystem models from scratch.
As Fernando notes: “Ecosystems have already been formed, driven by the emergence of fintech startups, big tech firms, and other players within the financial services industry. Instead, banks can participate in these ecosystems by leveraging APIs and connecting their systems and services with external partners.”
There is a warning, though, for those that don’t integrate their services into a broader digital ecosystem – they may get left behind in this era of digital revolution.
Raphael Bianchi, Senior Partner at Synpulse and President of the Openwealth Association, says: “To be part of the digital revolution, companies must stick to what they do best and focus on joining existing ecosystems to help them integrate seamlessly with providers and help provide clients with the digital experience they expect.”
Despite the ever-hastening need for banks to join ecosystems, for Pattni, it’s just “a matter of time”. He concludes: “As banks get all the pieces of the jigsaw into place, we’ll definitely start to see more adoption of ecosystem models in the coming years.”