Banking as a Digital Platform
Thanks to a recommendation from a colleague, I’ve been reading Platform Revolution: How Networked Markets Are Transforming the Economy–And How to Make Them Work for You by Geoffrey G. Parker, Marshall W. Van Alstyne, and Sangeet Paul Choudary, which has gotten me to thinking about how the concepts the authors discuss apply to digital transformation in the banking industry.
One of the key ideas in Platform Revolution is that by matching buyers and sellers, platforms allow their operators to earn returns on assets that they don’t actually own, such as the way AirBnB earns revenue from property it doesn’t own. For banks, this idea is not new. Indeed, although modern banking institutions have become large and complex, the core function of a bank has not changed: to match holders of idle capital with borrowers of that capital. Borrowing short to lend long has been the business model of banks since the Early Renaissance.
In exchange for taking on the liquidity risk inherent to this type of maturity matching, the bank derives its most essential revenue stream via the spread between lending and borrowing rates. To protect the public’s explicit (via deposit insurance) and implicit (via moral hazard) risk exposure, public institutions place regulatory burdens upon banks and in exchange for meeting those requirements bestow upon firms the coveted banking license, which conveys a level of public trust that non-bank competitors cannot match.
The income earned from the spread between borrowing and lending rates financed the creation of a diverse set of products, services, and lines of business. Then around 2008, everything started to change. One by one, the monolithic set of banking services which were once inextricably tied to one another came under assault both by substitutes and by complements. Don’t like your bank’s lending terms? Try a substitute, like SoFi or LendingClub. Can’t manage your budget easily through your bank’s website? Try a complement, like Mint. Not wealthy enough to qualify for an advisor? Try Betterment.
The old regulatory barriers that had kept competitors at bay no longer seemed to work. Some bank competitors emerged that simply did not care about regulation and intentionally sought to thwart it, such as bitcoin and the payment ecosystem that built up around it. Others began offering the large (and growing) accredited investor community the ability to loan money to individual borrowers through marketplace lending platforms. Rather than coming to banks’ aid with new types of protections, regulators having been badly burned in the 2008 Global Financial Crisis have thus far in fact encouraged competitors with measures such as PSD2, UK Open Banking, and the US OCC’s proposed fintech charter. Unbundling of banking services have become yet another tool for the prudential regulator to employ in combating moral hazard.
Thus should banks consider the move toward unbundling irreversible. What remains is the need to understand how to best approach unbundling in order to thrive in the platform economy. Within the context of Microsoft’s Digital Transformation Model, four areas of focus come to mind:
- Engage your customers: Meet customers where they are and be the bank that plays well with others. Customers will increasingly seek to interact with their financial institutions through variety of experiences, across channels and devices. The customer experience may be provided by the bank, or may be a third-party experience that leverages the information and functionality the bank provides through APIs. Successful digital banking platforms will be those that integrate almost invisibly into the background of the customer’s preferred digital experience: mobile, social media, hologram, and new experiences not yet commercialized.
- Transform your products: For a bank seeking to become a digital platform, the product is no longer defined by type of account but rather by the customer’s journey as they seek, acquire, and use they product over its lifetime. “The flow” to use the authors’ term becomes the product, powered by services (APIs) that the platform provides. Differentiation comes from removing friction from the flow and by providing governance (including security) along the journey.
- Empower your employees: Banks hold vast amounts of intellectual capital, much of it embodied in the people they employ. This vast store of knowledge about customers and business processes gives the bank an advantage over upstart competitors, but only if that knowledge can effectively be harnessed across the organization with the right set of collaboration technologies.
- Optimize your operations: Likewise, focusing human capital in places where it is most needed only becomes possible by automating routine front, middle, and back-office tasks. Mixing person-to-person interaction with automation at the right points along the customer journey will be critical for successful digital banking platforms. Streamlining regulatory compliance to effectively manage risk will continue to be important, as recent examples have demonstrated the cost of losing customer trust.
The rewards for banks that establish themselves as leading platforms will be great. As the Platform Revolution authors point out, platforms beat pipelines because they scale much more efficiently and benefit from “platform effects,” growing in value with growing use. Unfortunately for banks, platforms by their nature dislike gatekeepers and tend to dispense with them quickly. Transforming from a gatekeeper into a digital platform will challenge banks to rethink both processes as well as technology, but ultimately customers and the industry as a whole will benefit.
If you’d like to learn how Microsoft can help your bank along this journey, as always you can contact me at jabrian@microsoft.com!
Read more on the Microsoft Banking & Capital Markets and Insurance blogs.
