Why banks fail to embrace digital platforms?
The practice of building moats around castles and towns to protect them from attackers can be traced back to the ancient civilizations of Assyria and Egypt. They were, during the mid- to latemedieval period, a common form of defense. In a similar anachronism, banks have "regulatory moats" around their business intended to protect them from outside competitors.
The regulations required to take deposits and make loans are so numerous and onerous that they deter new players from entering the market. Tellingly, in the past few years, there have been virtually no new FDIC-insured bank charters in the U.S.
This is changing with the rise of "open banking." Whereas past regulations have often acted like moats, new regulations are more likely to act as bridges opening into the banking's strongholds. In Europe, for example, PSD2 mandates that banks make account information and payment initiation available via application programming interfaces (APIs) to third parties. Banking providers have traditionally had monopolies over this data, but these APIs will realign and flatten the landscape.
It's not hard to see why a report from Accenture asserts open banking "could revolutionize how banks generate value." Many regulators around the globe see these changes as a way to spur innovation and competition within their markets, and are pushing the industry to open APIs.
Regulatory pressure aside, open APIs have arguably been a long time coming in banking. Digital native competitors weren't born in the era of castles and moats. Rather, they naturally use APIs and openness as a strategic advantage to build ecosystems that deliver the services today's modern consumer wants. When these ecosystems are successful, they can lead to "winner-take-most" markets and alter the competitive landscape for every other player in the segment.
Consequently, over the last decade, many of the largest legacy businesses in other industries have been supplanted in market cap by innovative platform technology companies. Somehow, however, digital disruption has left the banking sector's biggest players largely untouched.
Banks' core business is to aggregate deposits by paying savers interest and then charging interest to borrowers. This dynamic is fueled by "network effects," wherein the number of participants on each side of the business reinforce value for those on the other, and should thus align naturally with platform strategies. But that hasn't been the case. Why? It is it that armies often fight today's war the way they fought the last war, meaning they use the same technologies, strategies and tactics that helped the victor prevail in prior conflicts. The banking model has been successful for so long - why would financial industry executives consider any other way to compete?
Even though legacy tactics feel comfortingly familiar, the world has changed. Companies are now competing via digital platforms and ecosys- tems, and like every other industry, banking must adapt. A third of US Millennials believe they won't need a traditional bank in the future.
Strength often comes from openness and reach, not insularism and control. Just as the heavy cannon enabled armies to project force at greater distances, ending the era of the castle, APIs and ecosystems enable companies to project their services into many experiences and greatly increase their reach and power. This makes the castle walls of vertically integrated products look especially vulnerable to nimble attackers that use APIs and platform economics to compete.
To remain relevant to consumers and compete against non-traditional competitors, banking providers should consider adopting the strategies, tactics, and technology of the new digital landscape.