We have all grown up reading and understanding that Banks make money by borrowing cheap and lending dear. It is, in large part, this arbitrage that has resulted in the huge profits that most global banks are used to making.
Whilst this has largely been the case for decades, increasingly several factors are putting significant strain on this tried and tested method.
- Declining Net Interest Margins: Even prior to the pandemic, the interest rates globally and regionally (due to the currency peg) were on the downward trend. With the ultra-loose monetary policy adopted to shore up the economies, banks are likely to face an extremely low interest rate regime for the seeable future. This clubbed with the increased competition for liquidity and increased transparency in pricing due to market comparison sites has resulted in a severe reduction in the Net Interest Margins of banks, a significant revenue stream.
- Lower economic growth: Countries in the region have been facing lower economic growth in recent times and the pandemic has further worsened the situation. Lower Oil prices, reduced inflow of tourists and lack of new job creation opportunities have all had an impact on bank profitability through subdued demand for credit.
- Shifting Customer Behavior- Bank customers are increasingly asking their banks to offer a digital-first experience. The need for a frictionless, fast and user customer journey that customers are used to in most of their daily lives (e.g. ordering food, shopping online, hailing a taxi etc.) is now taking center-stage within the banking world. This means banks must invest in building new capabilities while being stuck with a significant investment in legacy infrastructure.
- New models of Competition- Banking is now getting disrupted at a faster pace by hitherto unseen competitors. The Industry has seen and will continue to see Big Tech, Fintechs and Large Corporate Conglomerates all becoming a ‘financial services provider’ to their client base in one or the other way. They will be aided in this by greater customer insights from data analytics and AI based tools as well as their inherent ability to offer a much more frictionless, easy, and intuitive customer experience than many incumbents banks currently can.
- High cost of Regulatory and Compliance requirements- As financial services gets more tech-enabled, the possibility of cyber-fraud, identity theft and money-laundering incidents also goes up. This in turn will bring in a greater burden on banks to meet Regulatory and Compliance requirements that go with such scenarios.
The above factors have now compelled Banks to seriously re-consider their business models. The initial response to these changes has been to (a) lower operating cost by automating high volume, high value processes and re-organizing operating models and to (b) minimize losses by following a conservative credit risk policy and increasing loan loss provisions.
Although these steps are well intentioned, in the right direction and will alleviate some of the profitability concerns in the near-term, the long-term risk to Bank profitability will remain till such time that newer revenue models are considered, evaluated and adopted.
So, what should the Boards at these banks do? What are the options available that align with their strategic objectives? In my opinion, one of the ways in which Banks can navigate successfully through these uncertain times is by adopting a Banking-as-a-Service (BaaS) model of partnership with Fintechs.
So, what is BaaS and why should Banks seriously consider it?
Simply put, BaaS enables Banks to partner with different Fintechs by opening their core IT platforms via APIs to develop new services that can be offered to its customers in a seamless, simple way. It is also sometimes referred to as ‘Open Banking’; although Open Banking is a much wider concept.
Several countries have already begun introducing open banking regulations (with UK and EU leading the pack), indicating that the financial services industry is moving toward an era where shared data and infrastructure will become consumers’ new expectations.
More closely in the GCC region, there are several fundamental factors that will support and help accelerate the BaaS movement. From a bank’s perspective, some are driven by consumers while others are more inward-looking
- Consumer driven factors are high smartphone/ high-speed Internet penetration, high percentage of tech-savvy youth/millennials, increasing demand from consumers to be in control of their finances, wider choice of products and services that Fintechs can offer amongst others.
- Banks see Baas as an opportunity to lower operating costs by adopting a flexible, scalable, and modular IT architecture through Open APIs. In addition, when done correctly and with the right Fintech partners, BaaS will help Banks keep control of the customer relationship while offering them personalized solutions at scale and speed thereby creating new sustainable revenue streams.
Examples of BaaS in the region
There have already been some examples in the recent past although there is still lots more that can be done. One such example of partnership was Abu Dhabi Islamic Bank, a leading Shariah compliance Bank in the UAE partnering with Fidor Bank, a challenger bank to create a community based digital bank ‘Moneysmart’ for Gen Y (1)
In addition, Emirates NBD is the first regional bank to start transforming its core banking to API-based infrastructure. A step toward open-banking access and a true engagement with fintechs (2)
The road ahead is not without its set of challenges
Like most disruptive trends in the Financial Services Industry in recent history, the BaaS/Open Banking movement will have to overcome a few challenges before it becomes mainstream. I list below the ones that are likely to be of most importance:
- Strategic alignment between Banks and Fintechs– This is perhaps the most critical factor. Only those partnerships will succeed where there is an alignment of goals and objectives of the Bank and the value proposition that Fintech brings to the table.
- Regulation/Standardization of APIs: At present, there are multiple banks and institutions that are opening their platforms using proprietary API sandboxes to develop innovative solutions with Fintechs. There is a need to arrive at a standard protocol of APIs that can be universally adopted (easier said than done though!)
- Data privacy concerns: At the heart of BaaS/Open Banking is sharing of personal data by authorized service providers to offer solutions to the consumer. There are still concerns around how this sensitive data is transmitted, shared, and stored especially since all of it is on the Cloud.
In Conclusion, it is clear to me that Banks will have to think and act as a partner to the Fintechs to remain relevant to their customers while keeping that topline growing. The fundamentals of Banking have changed for good and the sooner Banks smell the coffee (and drink it!) the better it will be for all stakeholders concerned.
(1) https://www.businesschief.eu/corporate-finance/adib-and-fidor-offer-first-community-based-digital-bank (2) https://www.bloomberg.com/professional/blog/a-win-win-plan-for-u-a-e-banks-to-digitize-pair-with-fintechs/