Open Banking – Strategies for Private Banks
Open Banking is the most prominent response to the strong push from technology, competition, regulation and customer expectations. Why should a privat bank’s Open Banking strategy be individual? What impact does it have on the IT architecture? How does it improving customer service? The «ex-custody 2.0 model» provides the answers.
Regulation, competition from digital giants, changing client expectations, the rise of open API technology and next generation scalable infrastructure are the forces unbundling the financial industry’s business model. «Open Banking», or the shift from a monolithic to a distributed business model, is one strategy for banks to harness these forces and generate value.
Four strategies for the private bank sector
As discussed in the Synpulse article, «The Open Banking Revolution» from Dr. Sebastian Heuser | Dr. Simon Alioth (www.synpulse.com, publications, articles, 2017), Open Banking will lead banks to adopt a mix of the following four strate- gies: integrator, producer, distributor and platform provider.
While banks have traditionally played the role of an integrator, offering their products to clients using their own client relationship channels and IT infrastructure, Open Banking provides them with a host of technical possibilities. These include being a producer, i.e. offering products through an API as white-label to other institutions; a distributor that combines innovative products from third-party providers on their platform; or a platform provider that brings third-party products and third-party clients together. Due to the variety of products that private banks offer, they may adopt a mix of these roles.
Profitable business model for each strategy
Each of the four strategies relies on a different business model to achieve profitability. The integrator does not need new revenue sources from Open Banking. Instead, it minimizes external risks by maintaining a maximum amount of control and ownership over its applications. Open Banking APIs from third parties are not used and only the regulatory minimum of one’s own APIs is exposed. The reduced dependency on third-party vendors keeps the related costs to a minimum. In addition, integrators promote themselves as preservers of wealth and secure financial partners that overachieve despite the wave of digitalization and increasing complexity. If they can maintain their client investment and investment fees by focusing on this niche, while making sure their IT operating costs are kept in check, they will run a profitable wealth management business.
The producer tries to maximize the reach of its products by having them distributed by third parties as well. The revenue from these products increases due to economies of scale and lower acquisition costs for new customers. A means to achieve this is white-labeling the most successful products and inte- grating them into the platforms of other banks. Another scalable approach is to offer product APIs (cf. «API economy»). This is getting simpler in an Open Banking world for two reasons. One is the wider availability of account and payment data as well as standardized APIs. The other is the strong growth in the IT platforms at banks that allow for the easy integration of third-party APIs. When the product is distribu- ted over a third-party platform, the risk to the bank is that client identification and brand awareness will suffer. Furthermore, in the European market GDPR will prevent the use of data from another bank’s customers, if there is no direct rela- tion to the product offered. That said, many financial institu- tions generate profits by offering their products to other banks. Examples include payment solutions of BBVA, Credit Agricole’s credit products, ETFs from the world’s biggest asset managers Blackrock and Vanguard, and Vontobel’s «deritrade» platform in the Swiss private banking market.
The distributor follows an opposite strategy to the producer’s. Financial institutions that adopt a distribution-only approach do not necessarily require a bank license. Their core strength is offering a user-friendly platform based on modern archi- tecture allowing them to integrate another bank’s products, FinTechs and financial information very quickly. Open Banking enables distributors to access data from other financial institutions without consent from them or a contract with them. Whereas traditional distribution revenue has been based on contractually agreed retrocessions, revenue in the age of Open Banking will be in the form of plat- form fees paid by producers and, more importantly, in mone- tizing client data and owning the client relationship. Client loyalty will be stronger compared with a producer’s due to the innovative product portfolio as well as the convenience to the user that such a platform can offer. The ideal scenario for a distributor is when clients use the platform for all their financial needs, irrespective of whether the product or even the account is owned by the distributor.
The platform provider tries to combine the advantages of offering its own products and distributing innovative client solutions from FinTech providers or other banks on a bespoke platform. Thus, it may act as an intermediate of third-party clients with third-party products. There is a risk that clients look for cheaper products on other platforms if the provider does not integrate external products onto its platform due to competition with his own products. A sophisticated platform is the only option that allows the bank to advertise its brand prominently and profit from greater scale. Innovative bank solutions are another benefit. A private bank as a platform provider will look to become the main bank for its clients as well as for other clients. Most of the wealth will be invested through the platform.
Scope of PSD2 and Open Banking products
The innovative products that arise from Open Banking can be separated into two areas ( fig. 1). The first area of products arise from the API data coming from regulatory requirements, most prominently these are the ones of the British Competition and Markets Authority (CMA) in Open Banking and the EU-wide Payments Service Directive 2 (PSD2). These products are dependent on payment account information as well as payment executions over the mandated APIs. The second area of products is part of the Open Banking movement and API economy in the financial sector in general. Open Banking is not just PSD2 or UK CMA regu- lation. The scope of potential products is much wider as they depend on more than just payment account data or payment execution. Many trend products like crowd funding, event-driven insurance, financial data economy or compari- son services are shaped by the Open Banking movement. In practice, many products depend on regulatory APIs but in addition also on data from other sources. We will demon- strate this in the next paragraph with a multibanking product called «ex-custody 2.0», where Synpulse lead the implementation project with one of its clients.
Multibanking – The «ex-custody 2.0» client view
Based on a project experience of Synpulse, we present how the client’s wealth overview can look like, if his bank can aggregate on one hand account information from mandated Open Banking APIs and, on the other hand, other data sources as well. Those other sources play an important role for private banks as data for their assets under management business is typically not covered by CMA Open Banking or PSD2 (API) regulation. Nevertheless, technology like the automated processing of client statements or enhanced screen-scraping allows, upon client consent, to gather and aggregate investment or lending data as well. The client’s full wealth can therefore be displayed in one place. From the bank’s perspective, what better place can there be than its own online portal? Terms like multibanking, account aggregation and holistic wealth management have been coined by the market. We want to add another term to those existing ones:
«ex-custody 2.0». Ex-custody is a well-known term in the industry. It refers to positions of an accounting area that are not banked by the bank itself, but where the bank takes over administrative custody and reporting tasks for the principal bank. Ex-custody 2.0 for multibanking is the next step, where the principal bank does not need to compensate the custodian bank for any services. In the case of screen-scraping, it does not necessarily know the other bank.
Contrary to other multibanking or account aggregation implementations, our ex-custody 2.0 model is not a stand-alone application or dashboard, but is fully integrated into the bank’s core banking and online banking system. Data is sourced from FinTech aggregators through APIs and batch files. Positions are then booked in a separate accounting area, before being fed to the online banking system. This allows the bank to offer innovative products to the customer that rely on inte- gration with both a booking and an online system. The client’s wealth view and the innovative products and services that can be offered in ex-custody 2.0 are shown in figure 2 – Open Banking includes much more than the scope of CMA/ PSD2 alone.
New products include:
- Multibanking: the service to manage one’s wealth on one portal
- Automated advice suitability based on all connected positions on the platform
- Dynamic Lombard lending based on bank and external investments
- Cross-selling via direct saving suggestions
- Risk profiling and portfolio monitoring across institutions and borders
- Balance sweeping across the family wealth or managed trusts and businesses
- What-if and scenario simulation through big data modules on the platform
As the spearhead of the emerging forces in the financial sector and a movement that will continue beyond regulation like PSD2, Open Banking will change the business model of private banks. It is a great opportunity, but also a great threat to existing business. The opportunities consist mainly of new scalability options for one’s own products; new integration possibilities for third-party products; and the creation of new product types using the available data from Open Banking. The main threat is the loss of the direct bank-client relationship. However, there is no mix of the four strategies that fits every bank’s business model. It is vital for a private bank to define a position according to the four strategies discussed here and to do so in an individual, conscious manner.