Why should bank boards care about APIs?

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The discussion around digital transformation in has long revolved around the nexus of technologies that are globally driving this change. Technologies such as mobile, social, big data and cloud computing are surely impacting significantly all industries, but for financial services there are other silent technological revolutions taking place that, at the very least, can massively accelerate the technological disruption occurring in the sector.

If mobile, social, big data and cloud computing are the core technologies of digital transformation, for financial services the emerging underlying substrate are APIs (Application Programming Interface). Now, APIs have been around ever since someone wrote a piece of computer code that was meant to be reused by someone else and are common parlance in IT. However, the threat of fintechs and regulations such as the revised Payment Services Directive (PSD2) are elevating the IT lexicon to board-level discussions. Bank boards, in many cases for the first time, are being exposed to IT concepts and jargon that, not only they cannot afford to dismiss, but in effect they need to deeply understand as it becomes a key part of the future of competitive advantage in a digitally transformed industry.

Why should care about APIs?

APIs expose banks’ products and processes for use by third-parties. Since banking products are inherently digital and processes already are or can largely be automated, the development of an strategy drives three key advantages for banks:

  1. it enables banks to become a part of an integrated and larger value-chain;
  2. it offsets the threat of new entrants by establishing from the onset a “coopetitive” position for traditional banks;
  3. it drives from within.

I. Vertical disintegration of banks and ecosystem integration

The various impacts of globalization and in the financial services industry led to the emergence of niche providers, specializing in key activities of the banking value-chain. Most traditional banks tend to be vertically integrated organizations with relatively fixed cost structures and, as transaction costs decline, some of the key activities in the banking value-chain suddenly become cheaper to procure externally than to execute internally. As a result, we see a move to vertically disintegrate these activities and outsource them.

With the threat of fintechs and neo-banks looming, an API strategy enables banks to streamline their internal value-chain, becoming at once leaner and more focused, while at the same time, transparently integrate themselves into a broader ecosystem exploring new revenue streams and business partnerships. For instance, consider the ability of a car dealership to provide an immediate loan for a customer at the point-of-sale. In this scenario, the cost of sales would be handled by the car dealership. From the dealership standpoint, they would be able to close a sale on the spot providing great value and a great experience to the customer. Also, consider the fact that this is a contextual sale, where additional products, such as auto insurance with multiple coverages, can (and should) be recommended with increased probability of acquisition by the customer. Now, I’m not naïve to the point of disregarding the many existing hurdles of this or other similar scenarios, such as compliance and legal issues. However, even compliance and legal are prone to disruption by APIs and automation as well as by self-regulating technologies such as distributed ledgers and smart contracts (but that’s a topic for another post).

II. Healthy coopetition with fintechs and neo-banks

There’s no longer any question about the threat that fintechs, neo-banks and non-banks pose for the future of traditional banks. After the boom of late 2014, the “movement” came of age during 2015 and is now competitive across all categories – lending, personal finance, payments, retail investments, institutional investments, equity financing, remittances, consumer banking and more. CB Insights reports that global fintech investment is rising and that Q4 of 2014 was the busiest of the last 5 years with a total of $3.1 billion invested across 214 deals – that’s an average of $14.5 Million dollars per deal. There’s also increased acquisition activity, mostly by established fintechs rather than by traditional banks.

Additionally, regulations such as PSD2 will inevitably push traditional banks into the playground of fintechs and neo-banks. Strategically, it’s a dangerous place to be in for traditional banks, since most of them are not yet ready to compete with these new enterprises in their own ground. However, with the right invesments, such as APIs and open banking, banks are starting to develop the resources that’ll be a key part of the answer to long-term prosperity in an evolving and growing eco-system. Here are four key areas of cooperation and competition with fintechs and neo-banks that banks can explore in the course of their API/open banking strategy:

  1. Replace costly parts of the bank’s value chain with services provided by fintechs and neo-banks – this can reduce the bank’s cost structure and improve cost-to-income ratios;
  2. Increase the reach of the branch network through partnerships with non-traditional and specialized players (car dealerships, realtors, etc.) and increase the breadth of products by integrating specialized products from fintechs and neo-banks – this can increase share-of-wallet and sales;
  3. Provide OEM financial products and services, acting as the backbone for neo-banks – this can improve operating income;
  4. Traditional banks still have a lot of infrastructure that fintechs and neo-banks don’t have and do not want to have as it will hurt their business model. Banks can provide back-office services that are too costly for fintechs and neo-banks to develop – this can increase the interdependency of these players on the bank, mitigating the risk of their threat.

III. Looking within for innovation

It’s true that when talking about APIs and open banking, we usually address it from the standpoint of an outward-facing competitive advantage that can enable incumbents to compete and/or partner more effectively with fintechs. However, looking within traditional banks, we can also find areas where APIs and an open platform can help drive increased performance and efficiency.

To be fair, through the years banks have made significant investments in IT and in services platforms, primarily driven by interoperability and modernization rationales. The problem with these approaches is that they have mostly been IT-led and for a long time there wasn’t really a great business justification for them so they weren’t typically discussed from the business standpoint as a key strategic investment. Where these investments occurred, banks are now taking a new look at their IT assets and resources and realizing that they are better off than they actually thought. Some of those past IT investments have become key in this new digital economy, particularly when it comes to simplifying business processes and products.

Internal APIs are also key to driving innovation from within. They can work as a sandbox for internal development of ideas before external exposure to partners and others. In this area we see several banks hosting internal Hackathon events, pairing business and IT people in the development of new digital products and in the automation and simplification of internal processes. Internal innovation is key as the rate of change accelerates in the industry. Simpler processes, new innovative products, and a leaner organization will drive growth and efficiency for traditional banks. I believe that in the short term, we’ll see an increased focus in using APIs to build resilience into the banking business model, whether through innovative products and services, or through the ability to replace internal processes and services with external providers.


is digital advisor at Microsoft and this article was originally published on linkedin.