He who has so little knowledge of human nature as to seek happiness by changing anything but his own disposition will waste his life in fruitless efforts — Samuel Johnson
The world of banking and financial services is at an inflection point. In addition to pureplay digital banks such as Ally, Marcus by Goldman Sachs, broking and investment platforms such as Robinhood and Wealthfront have joined the race to offer high yield digital savings accounts.
As banks becomes more digital and therefore homogenous, every bank must rediscover that which is its core competency and then build a platform around it. Also, the competitor set for banks is not just other banks rather it is any technology company on the planet. This article looks at the evolution of banks as a platform and banking as a service. It also provides strategies for banks to differentiate and to break away from a pack where the very definition of that pack is in question everyday.
The Implications Of A Price War
Predictably, after players such as Ally Bank, Goldman Sachs and others, Wealthfront announced a high yield savings account which yields 2.24% to depositors. All this while, Robinhood is contemplating a relaunch of its own high yield savings account which it had to withdraw amid a snafu with deposit insurer and miscommunication to prospective clients in December 2018. It is now officially a rate war to mop up savings in the United States . As the Federal Reserve attempts to hold the interest rate steady, thees is another issue which the Federal Deposit Insurance Corporation (FDIC) is contemplating — the extra insurance paid by so called ‘brokered’ deposit originators. Brokered deposits are deposits gathered by means other than in a branch e.g. digital deposits.
As per American Banker : ‘Under current FDIC rules, banks often pay a higher price for deposit insurance if so-called brokered deposits make up more than 10% of their total deposits’. A debate over a change in these rules not only has larger implications for a branch network but is also the biggest indicator that banks may slowly be transforming into ‘platforms’.
The debate over these rules also signifies an inflection point leading to an age where branches may no longer be the dominant source for gathering deposits or transacting business.
If banking was a game of chess, every banker needs to rethink its core DNA to identify a strategy that will distinguish the bank in the long run. Most of the things coming out of the technology factory e.g. blockchains (JP Morgan announced JP coin-a first by a bank), digital account opening and high yield savings accounts, robo advisors, end to end digital mortgages, AI, voice assistant chat integration, AR/VR capabilities etc.
Imagine the FinTech industry fueled by Venture Capital and Private Equity as a technology supplier to all banks. The natural inclination of any single player in that industry, just like a player in any other industry, would be sell its products and services to as many banking clients as possible.
This has two implications. FinTechs with the better technology become unicorns and set their sights at becoming banks themselves. Second, banks need to find other ways of differentiation than just having similar technologies with minor differences to offer clients.
The Unique and Morphing DNA of Platforms
Every platform had a core value proposition around which it was built. The percentage share of revenue that this core value proposition contributed may change. Let’s take a couple of examples.
Apple was created as a hardware and software company with the philosophy of an integrated approach ie Apple will make both the hardware and software that work closely with each other. In 1976, it began with the Macintosh and the MacOS. Its core DNA is still the same. The device has morphed from a computer to the cell phone. Today, the IPhone and it’s services business (subscriptions to Apple Music, iCloud etc.) make up more than 74% of its total revenue. The network effect comes from its App Store and devices such as Apple TV and the iPad which create a platform and an ecosystem for users to be a part of.
Amazon began as a platform for buyers and sellers to trade books. Although, it still makes more than 60% of its revenue in retailing, more than half of its income comes from it’s cloud business (AWS) and Prime subscriptions. As you can imagine, this shift in revenue streams from retailing to services has increased Amazon’s gross profit margin.
Microsoft is a similar story with its Windows and Office suites driving its core competency but the cloud business coupled with AI driving growth. The key difference is that Microsoft was always a software only company. It does make the XBox and other hardware but it’s core DNA is software. Compared to Apple’s philosophy, Microsoft and Samsung chose others to make hardware that integrated into their software.
Chinese giants such as the BATs ie Baidu (search engine which is China’s Google), Alibaba (e-tailing and Chinas’s answer to Amazon) and Tencent (Wechat is the Chinese equivalent of WhatsApp) were all primarily home grown creations because the American giants were restricted entry. WeChat grew by embedding financial services into its chat application while Alibaba grew with Alipay. In 2017, mobile payments amounted to $17 trillion — more the the GDP of of payments China. These platforms still retain their core DNA but now have grown into financial service giants.
In short, every platform including Facebook which makes 98% of its revenue from advertisement hade a unique beginning and then morphed into more diversified revenue streams. Almost all banks have the same core DNA with the exception of the services, markets and clients they began their journey with.
A Return To Core Competency
A banks core competency is to grease the economic machine. The strongest argument for having banks is because they channel savings into productive investments. Their primary obligation is to act as a fiduciary for their depositors and offer them yield while making loans on the other side to help individuals and companies meet their financing requirements. In that sense, the nature of banks may change but not the nature of banking. While serving this primary obligation, many banks have developed their own unique value propositions eg. a multinational bank can help clients as they go global, a bank with more branches can reach more small business owners, a bank with investment banking expertise can guide its clients to great IPO’s. To this core DNA, technology is an embellishment. In some cases, technology becomes the edge. Finally, technology will be the backbone of every Banks DNA. All throughout, the banks objective of making the economic cycle work has not changed at all. The next phase for a bank will be to offer an operating system that gathers savings and make loans by becoming a platform where a depositor can customize his interest rate and lender can customize his loan in a very personalized way. A platform is nothing but an operating system that can be customized. For every bank, it’s core competency will become the operating system and everything else will become applications (Apps) offered by third party providers which can be customized.
Let me give you an example. When a depositor approaches a bank to deposit money, the banks algorithm will automatically match asset liability, cash flow and create a hedge while offering the depositor a range of yield options to choose from eg $500 cash credit + 2% yield or a fixed 2.3% yield etc. In order to be hyper personalized, KYC will become the key differentiation for the bank. How well the bank knows a client will define its edge. It can then offer relevant bundles of products and services at relevant points in the clients journey.
Second, for hyper personalization to work, each bank must forge exclusive tie ups with experience providers eg the gaming industry, outdoor travel, adventure sports in addition to the gig economy when a large portion of the work force will be mobile and may have variable pay. Both the experiential and the gig economy are growing exponentially. The trick for each bank is to identify and lock down partnerships that will define the unique selling point of its platform.
Thirdly, there is a very likely possibility that banks may become utilities ie they may operate as an operating system in the background. Therefore, creating an unforgettable client experience as a front end will become each banks unique face to the client. It could be an algorithm that knows its clients very well or a plethora of options such as humanoid bots that allow clients to access their banking needs while removing friction anytime and anywhere on this planet. For a multinational bank, it could be seamless foreign exchange money movement using crypto currencies.
Lastly, when all else is done, a bank will have to really become accessible to every single person on the planet. Ironically, this argument is as much a socialist argument as it is a capitalistic one. As technology leads banks to a zero marginal cost and services based operating model, banks have no option but to search for strength in numbers. Financial inclusion will become every banking platforms’ mantra.