How to build the business model of the future bank

Over the past eight years, the Bank of England’s Pru­den­tial Reg­u­la­tion Author­i­ty has autho­rised 61 new banks. Of these, it describes 28 as “real­ly de novo UK banks”, includ­ing fin­tech chal­lengers such as Mon­zo (estab­lished in 2016) and Star­ling (2014). The wider fin­tech field has even more play­ers. Deloitte, in its research for Ron Kalifa’s recent gov­ern­ment-com­mis­sioned review of the indus­try, found that about 2,500 fin­tech firms are oper­at­ing in the UK. 

But this busy sec­tor has had lit­tle effect so far on how con­sumers and SMEs actu­al­ly use bank­ing ser­vices. The big-five high-street bank­ing groups – Bar­clays, HSBC, Lloyds, NatWest and San­tander UK – still dom­i­nate the mar­ket. 

Con­sumers’ increas­ing reliance on online ser­vices dur­ing the Covid cri­sis might have seemed like a sil­ver lin­ing for fin­tech chal­lengers but, if any­thing, the pan­dem­ic has tight­ened the incum­bents’ grip. In par­tic­u­lar, they have dom­i­nat­ed the mar­ket for state-guar­an­teed bounce-back loans to SMEs because few alter­na­tive providers could afford to lend at the low inter­est rate (2.5%) stip­u­lat­ed by the scheme, accord­ing to Inno­vate Finance. 

The big play­ers still rule, then, but the Covid lock­downs have changed some finan­cial habits. Until recent­ly, open bank­ing – in essence, the right to share cur­rent account data with fin­tech pay­ment providers – has done lit­tle to boost com­pe­ti­tion. Yet the gov­ern­ment now expects that 60% of the pop­u­la­tion will be using it by 2023. That mat­ters, because what open bank­ing does is tease apart ‘bank­ing’ from pay­ments, enabling fin­tech firms to become the first point of cus­tomer con­tact for essen­tial every­day ser­vices.

“The core rea­son that retail banks exist is to car­ry out matu­ri­ty trans­for­ma­tion. That’s where they make their mon­ey,” says Jere­my Tak­le, co-founder and CEO of fin­tech firm Pen­ny­worth. By “matu­ri­ty trans­for­ma­tion”, he means that they take deposits, which might be with­drawn at any time, and use these to make long-term loans, which might not be repaid. 

“But the cred­it risk man­age­ment that banks per­form is just as impor­tant as matu­ri­ty trans­for­ma­tion,” says Tak­le, who was for­mer­ly a senior retail banker at Bar­clays. “Invest­ing in some­one else’s pri­vate debt is risky. Banks pool loans and there­by spread that risk.” 

Some peer-to-peer (P2P) lend­ing mar­ket­places have run into trou­ble because they’ve failed to act like banks, he adds. “They left mum and pop depos­i­tors tak­ing both cred­it and matu­ri­ty risk on to them­selves. And the remain­ing spread on that busi­ness was too small for the P2P providers to sus­tain, which is why some have become banks.”

David Birch, an author, con­sul­tant and investor in dig­i­tal finan­cial ser­vices, says: “We haven’t yet had a fin­tech rev­o­lu­tion or any­thing like one. The ‘chal­lenger banks’ are sim­ply more banks. They don’t have a dis­rup­tive busi­ness mod­el. The essen­tial busi­ness mod­el and the cost of inter­me­di­a­tion – a key mea­sure of pro­duc­tiv­i­ty – haven’t changed for gen­er­a­tions.”

Despite this, both Birch and Tak­le believe that cur­rent bank­ing busi­ness mod­els won’t sur­vive.  

Birch explains: “Most cus­tomer inter­ac­tions with a bank occur via pay­ments. That is where the main cus­tomer data is gen­er­at­ed. So, if you’re talk­ing about the retail finan­cial ser­vices busi­ness mod­els of the future, which depend on data, you should be talk­ing about pay­ment com­pa­nies such as Square, Stripe, or Pay­Pal.”

Open bank­ing is, arguably, the first real step towards that future. It means that banks no longer have a priv­i­leged posi­tion in pay­ments – or in cus­tomer aware­ness. The cur­rent account can be treat­ed like a jam jar into which, with the customer’s con­sent, fin­tech pay­ment providers can dip. And they can meld that account data with non-finan­cial infor­ma­tion to offer a new ser­vice. 

Some banks – albeit not the mar­ket lead­ers – are clos­ing their cur­rent accounts to focus on ser­vices such as lend­ing. M&S Bank, for instance, announced in March that it would “expand its range of pay­ment solu­tions” and con­tin­ue to offer a cred­it card, loans, insur­ance and sav­ings accounts. Some fin­tech firms, notably Atom Bank, may nev­er offer a cur­rent account. 

The rise of buy-now-pay-lat­er cred­it ser­vices “shows how quick­ly a good fin­tech alter­na­tive can grow”, Birch says. “The mer­chants are hap­py to pay not for a new pay­ment mech­a­nism but for new sales. I can envis­age mer­chants start­ing to offer their own apps with embed­ded finan­cial ser­vices. This is not a rad­i­cal pre­dic­tion. When JPMor­gan killed off its Chase Pay wal­let this year, it advised its cus­tomers to use ‘their pre­ferred mer­chant apps or Pay­Pal’ instead.”

The pos­si­ble changes are pro­found, there­fore. The Inter­na­tion­al Mon­e­tary Fund fore­sees poten­tial for the “dis­in­te­gra­tion of the tra­di­tion­al bank busi­ness mod­el. Spe­cialised providers of finan­cial ser­vices can chip away activ­i­ties that do not rely on access to bal­ance sheets, while plat­forms can inter­ject them­selves between banks and cus­tomers.” 

So what could the bank busi­ness mod­el of the future look like?

“Turn­ing sav­ings into loans is where the mar­gins are made,” Tak­le says. “For instance, cred­it card earn­ings are made most­ly from the inter­est paid by bor­row­ers. Yes, cur­rent account data is inter­est­ing and use­ful, but open bank­ing is enabling cus­tomers to share their data in exchange for bet­ter ser­vices with­out hav­ing to switch accounts. This changes the attrac­tion of man­ag­ing cur­rent accounts. These accounts are cost­ly for banks to oper­ate and cus­tomers sel­dom want to switch, which the first wave of non-banks learnt to their cost.”

Remov­ing that oner­ous cost base and boost­ing what a bank offers is, in Takle’s view, where fin­tech firms need to focus. Soft­ware-as-a-ser­vice providers such as Thought Machine and 10x Future Tech­nolo­gies are mak­ing this pos­si­ble. 

“Once real bal­ance-sheet dis­rup­tion arrives, enabled by much low­er plat­form costs, the min­i­mum effi­cient scale for a retail bank will fall, prob­a­bly to below 1 mil­lion cus­tomers,” Tak­le pre­dicts. 

He adds that Pen­ny­worth will focus on the “aspir­ing afflu­ent”: the top 20% of the retail mar­ket who have the largest account bal­ances but are “get­ting poor val­ue and imper­son­al ser­vice from their bank. We want to give them a per­son­alised alter­na­tive by putting a dig­i­tal bank man­ag­er in their pock­et.” 

Open bank­ing – then open finance and, even­tu­al­ly, open data – will enable finan­cial ser­vice providers (includ­ing the big play­ers) to curate a range of ser­vices for their cus­tomers with­out hav­ing to build or sup­port these in house. 

Tech firms cer­tain­ly seem hap­py to leave essen­tial bank­ing func­tions to the banks. Google, for instance, recent­ly shelved plans to offer a cur­rent account with Cit­i­group to focus on “deliv­er­ing dig­i­tal enable­ment for banks and oth­er finan­cial ser­vices providers, rather than us serv­ing as the provider”.

What oth­er devel­op­ments could shake up the sec­tor? Birch would like the industry’s reg­u­la­tors to insti­gate fur­ther dis­rup­tion. One way of doing this would be “giv­ing new forms of insti­tu­tions access to cen­tral bank mon­ey – the world of decen­tralised finance”, he sug­gests. 

Such a move could, even­tu­al­ly, do away with com­mer­cial banks alto­geth­er.