May 16, 2015

The API Opportunity in Banking

APIs in Financial Services have been in the news lately. In the recently released report by the Chancellor of the Exchequer in the UK (the equivalent of the Secretary of the Treasury in the US), that government will launch a call for evidence (request for proposals from interested parties) of how APIs can be used in Banking. The stated goal is to enable financial technology companies to develop innovative solutions to allow customers to make better comparison between different banks and financial products. It is not so far in the future that Banks will have customer data and transaction capability exposed as external APIs and a web of mobile apps will have built-in financial capability such as p2p payments on social networks. Some banks such as CapitalOne and payment ecosystem players such as Visa, Mastercard, First Data and fintech leaders such as Yodlee already have been doing this successfully.

In the face of this democratization, it would appear that Banks would be at the risk of losing. With Bank data exposed as APIs, could innovative technology companies build smart apps and increasingly own the financial relationship with the customer and thereby reduce Banks to being the “dumb pipe”? I don’t think that will happen. On the contrary, this democratization presents an opportunity for Banks to innovate at scale and monetize data with significant upside. Innovation in financial services is occurring led in a big way by non-bank entities such as Paypal, Ondeck, Wealthfront, and LendingClub (to name a few) that are operationally distinct from a traditional bank. They are more agile and built for continuous innovation; their business models have lower distribution, operational, risk and regulatory cost when compared to Banks putting the Banks at a significant disadvantage. Opening up the Bank through secure APIs will change this dynamic by extending, in a controlled manner, the Bank’s platform and data to a select community of developers in essence creating a level playing field when it comes to innovation. An inter-connected and intelligent financial ecosystem will also reduce risk and losses due to fraud and defaults resulting in a more efficient system. In the following paragraphs, I expand on my thesis above:

Exposing APIs and expanding community of Digital developers will enable Banks to innovate at scale: Revenue/employee at large national banks are typically from $200k to $300k (this includes Digital and non-Digital functions, the ratio of Digital revenue/Digital employees is far less for Banks) and the same ratio for a company like Facebook is more than $1 million. While Facebook is not a Bank (although it does generate revenues from Payments), one of the reasons for the higher revenue/employee is that Facebook has a robust foundation of APIs that enable developers to easily integrate with Facebook and its data to create mobile and web applications. Facebook monetizes the API usage in multiple ways. The Bank of the future will provide APIs for Banking functions and information that will allow developers and innovators to integrate experiences in ways that would be prohibitive for the Bank to do alone. This in essence would create an ecosystem of digital developers and innovators that leverage the Bank’s API, similar to the Facebook ecosystem essentially enabling Banks to scale their innovation efforts. Some of this is already happening with card linked offers, small business credit and in digital advice (roboadvisors) and we will likely see a maturation of APIs in that they will be more public and with improved security and privacy controls.
Monetized APIs and data will represent a significant source of revenue: Industry estimate put that revenue from commercialization of data in financial services (across capital markets, commercial banking, consumer finance, and banking and insurance) to be of the tune of $300 billion per year. To put this in perspective, the annual revenue (interest and non-interest) of one of the top 5 large Banks in the US is about $100 billion. This additional revenue represents a huge opportunity for Banks and much of this revenue will be realized with data exposed as APIs. Banks will have to carefully assess their architecture that delivers API and also the richness of the data delivered. Using the mining analogy, more refined precious metal (insights) will command higher prices than raw earth (data) or even mined ore (analytics).
Distribution of services will become ubiquitous: Digital fundamentally marks the shift from an inside out to an outside-in enterprise. Banking services will move to where the Customer is and how they want it and not the other way around. APIs will enable Banks to extend their banking functions to the reach of 3rd party apps, websites and even devices (with the proliferation of the internet of things) thereby extending the reach of the banks than was previously possible. This could level the playing field for small and medium sized Banks to compete with large Banks that have large footprints and enormous digital budgets.
Overall risk in the system will go down with a connected financial ecosystem reducing losses and cost from fraud and defaults. Regulatory reporting and exams, suspicious activity monitoring for AML, payment fraud detection can be redesigned to be more effective with APIs and open data sharing amongst Banks and regulators. Traditional credit risk assessments will be replaced by more Big Data based risk assessment that will include network analysis, income projections from thousands of data points available in form of APIs. This paradigm shift will not only reduce the aggregate risk of the system but also reduce the cost of managing risk for Banks.
APIs proliferation in Banking will unleash a brave new world of increased connectedness, ubiquity and innovation. Banks should carefully evaluate their API roadmap for 2015 and explore incubating extended communities of developers to augment their digital development teams.