Morphing into market places
Are digital platforms the future for financial institutions? Deutsche Bank thinks so
• Ten years ago photos of newly unemployed Wall Street bankers with cardboard boxes in their arms symbolised the depths of the financial crisis. Most of the banks that survived the crash have now largely recovered, partly through rigorous economising as well as a huge state bailout. But they are still a long way off their previous heights. The management consultancy McKinsey has calculated that the banks’ return on equity, which slumped from 15% to just under 5% after the crash, has now levelled off at a modest 8%.
Growth has come to an almost complete standstill, at least in North America and Europe. Persistently low interest rates are as much to blame for this as the banks’ increasingly unlucrative private customer and investment business. What is more, the regulatory wall that for a long time protected the banks against competition from internet firms is now crumbling.
These new competitors are often so-called platforms – market places that make their living brokering between other parties. It can be very profitable: in 2017 Airbnb recorded turnover of about $3bn simply by acting as an agency for temporary accommodation. Amazon turns over nearly $32bn with articles from third-party sellers and the trend is rising. Whether it is Apple’s App Store, YouTube or the advertising space on Facebook, nearly all the major IT success stories of the recent past are platforms, often described as aggregators or two-sided markets. Can that kind of strategy also work in the banking business?
Yes it can, says Prof Geoffrey Parker. He is one of the first experts to have recognised the significance of two-sided markets at the turn of the millennium. “Banks (...) will soon start to feel the pressure,” he wrote in his 2016 book Platform Revolution. “Previously they were able to escape being disrupted by platforms, above all thanks to strict regulation and a comparatively conservative and risk-averse customer base.”
Christian Sewing, the new head of Deutsche Bank, is a believer and has called for his bank to become the leading platform. “When digital transformation turns an economy of producers into an economy of platforms, then the whole of economic life changes," he told a Frankfurt media congress in January. “In view of the market power the platforms have, it is clear that in many cases it is no longer the manufacturers of a product who are in command but the traders.” Sewing is under immense pressure: Deutsche Bank is one of the financial institutions with the worst performance recovering from the financial crisis and has been making losses for years. It’s been a long time since any good news emerged from its twin towers in Frankfurt.
The man entrusted with implementing the change is Markus Pertlwieser, digital head of the private and business customer division. In his view the financial crisis meant that for years the sector gave too little thought to new sources of revenue. “The classic revenue models are working less and less well. The number of customer visits to branches is continuing to fall. Yet in the digital sphere many offers are more rapidly interchangeable as the next offer is only one click away. Being an aggregator, who combines all these offers and has a direct customer relationship – that’s the position that will pay off in future.”
Having close links with customers is in fact one of the last strong points left to many banks. Deutsche Bank and its subsidiary, Postbank, together have more than 20 million customers and more than half of them do their banking business digitally. That is an advantage the fintechs, or financial technology sector, can still only dream of, despite the hype about them. In addition, online banking is firmly rooted in everyday life so offers permanent customer contact. People no longer have to be enticed into a branch or pestered with unsolicited emails. They come of their own accord, indeed often daily. Whereas they often only contact insurers, building societies or similar services once a year, if that.
Parker and other experts believe that monetising this intensive relationship by not just selling the bank’s own products but also acting as a shop window for all others must become the primary goal for banks in the future. Deutsche Bank seems very taken with this idea as it has now entered into a research partnership with the Massachusetts Institute of Technology, where Parker is part of the university’s Initiative on the Digital Economy. “Banks know a lot about their customers,” says Parker in a joint interview with Pertlwieser. Few other firms know them so well, he points out: the banks know when customers start a career, marry, have children or buy a house. Parker sees these phases in life as perfect opportunities to sell financial products, insurance and other services – ideally via a market place. Then the bank would not only benefit financially when the customers spend their call money elsewhere but also when they choose products that the bank itself does not offer.
“If we can offer this accumulation of services, we are in the best possible position,” says Pertlwieser. “A bank or insurance company that only supplies its product to a platform will always remain just the delivery man who stacks the shelves. But if so, they are replaceable. The one who owns the shelves is strategically better positioned. That is why we are building a shelf.” Pertlwieser has taken Parker’s book on board, but he is aware of the problems platforms may face.
For example, there is the chicken and egg problem. Just as a platform such as Uber cannot work with only potential passengers but no drivers, so a banking platform cannot work if there are customers but no providers.
The Deutsche Bank’s interest rate market at present has just two cooperating partners. Pertlwieser has read Parker’s chapter on selecting partners: if a platform does not successfully filter out poor quality or even fraudulent offers, then negative networking effects can very rapidly come into play, leading to honest users dropping out and the reputable suppliers following suit.
As platforms benefit hugely from networks, they often lead to “winner-takes-most” markets. Becoming the leading aggregator for all money matters would be a lucrative position to be in. But others are also building the kind of “shelves” Pertlwieser has in mind, including the ING subsidiary Interhyp, which arranges mortgages, and the services company WMD Capital, which offers access to investment strategies from 20 asset managers. The British bank HSBC is also focusing on opening and aggregation: together with the fintech platform Bud it has developed the HSBC Beta app, which can not only manage several bank accounts but also offers its users tips on savings and analysis of their expenditure. ING has started a similar project with Yolt.
The fintechs, which only a few years ago were seen as a huge threat for traditional banks, are now most successful when they combine their technical innovations with the size and trust enjoyed by an established financial institution. For example, the Banco Bilbao Vizcaya Argentaria (BBVA), Spain’s second-largest bank, has bought the startups Holvi and Simple, acquired the big data firm Madiva and invested in numerous fintechs. “At the end of the day, we will no longer be a bank but a digital enterprise,” BBVA’s head, Francisco González, told an interviewer.
As an example of his platform strategy, the BBVA app Valora enables users to find the likely price of a house simply by entering its address. The data is acquired from third parties reporting recent sales in the vicinity. Users can check how the interest payments for a corresponding BBVA mortgage would affect their monthly budget. According to BBVA, Valora users take out a mortgage twice as often as other potential property buyers.
However, it is by no means certain that it will be a bank that wins this race. Two online comparison portals are jockeying for position: Check24 and Verivox. Check24 made its reputation as a guide through the jungle of electricity and mobile phone tariffs. Now it is also brokering insurance deals and savings. Verivox has just acquired an app, Outbank, that links all of the user’s accounts in one place, from current account to PayPal. Previously, it took over the Aboalarm service, which scans current accounts for subscriptions and contracts and helps customers cancel them.
But competition also looms from a third side. Banks can become platforms, but it also works the other way around. In Japan the biggest online trader, Rakuten, is now providing many millions of customers with credit cards and offering financial products and services from mortgages to securities trading. The Chinese online giant Alibaba and its finance offshoot, Ant Financial, now serve more than half a billion customers at home and another 112 million in other countries around Asia. Ant is responsible for 51% of the $11tn of annual online transactions in China – processing 16 times the volume of PayPal. It is about to take a leap into the USA, partly through its planned purchase of the money-transfer company MoneyGram.
Amazon, too, is feeling its way forwards. It is offering its own credit card, its own payment service with Amazon Pay, and loans for small businesses under the name Amazon Lending. The next step: its own Amazon current account for young customers. Cooperation with a US bank such as JP Morgan is on the cards.
Customer contact is one important component for a successful platform and data is another. Whole new financial services become possible if data is made available through so-called application programming interfaces (API) and then combined with other data. The head of the 35-strong API team at Deutsche Bank is Joris Hensen. His job is to help developers program applications that create new services and business derived from the data of the bank’s customers. One possible example would be a customer looking to rent a particular flat. The idea is to enable him to send the landlord proof of his income without having to make copies of his pay slip or income tax returns. Another application would be furnishing proof of age. As the bank verifies the date of birth of its customer, it could provide information via an interface as to whether or not they are adult – or perhaps qualify for a concession on account of being over 65. “In each individual case, the customers decide what data they are prepared to release,” says Hensen. “So we don’t just hand out data but give our customers the opportunity to make their data available to certain partners in a way that benefits both sides.”
Hensen’s team is based in the bank’s “digital factory” on the outskirts of Frankfurt, far enough from head office not to get caught up in any infighting. All the same, the latest change at the top of Deutsche Bank is likely to have a positive impact on the work of Hensen’s team. The new boss is seen as a supporter of the API project and at the API/Open hackathon, which Hensen organised in Berlin in 2016, Sewing argued strongly in favour of opening the bank to a platform. The hackathon was won by the tiny Frankfurt firm of Dwins. Backed with millions invested by Deutsche Bank, it developed the app Finanzguru. Today this app is no longer solely for Deutsche Bank customers. If people allow the app access to their account data, it can manage their contracts, send cancellation reminders and even find the cheapest railway ticket. Electricity bills and the other costs of rented properties can be easily checked, and money-saving tips are offered based on activity in customers’ accounts.
“In contrast to the information held by the internet giants, data that records payments tells us a lot more as it is based on reliable facts,” says Hensen. “Someone who buys a season ticket for his club is undoubtedly a football fan. And someone who pays bills or withdraws money several times a month in various different countries is clearly someone who travels a lot.” The EU’s payment service directive PSD2 means all banks will have to offer part of this data via interfaces by 14 September 2019 at the latest, but Deutsche Bank is planning to go far beyond what is legally required – though not free of charge.
For example, PSD2 stipulates that transaction data for the past six months must be made available. Yet as many payments are only made once a year, a digital housekeeping book or a contract manager that can view and evaluate 13 months is more effective and more useful. And it is precisely for this access to 13 months of transaction data that the Deutsche Bank aims to bill its future co-operation partners. “If we can use our data to ensure a trader doesn’t miss a payment, or make it easier to buy something online thanks to our proof of age, then the service is worth its cost,” says Hensen.
He, too, has read Parker’s book very closely. “In order for a platform to grow and to benefit from network effects it is vital that access for all involved should be as smooth as possible,” says Hensen. The aim must be to clear away any obstacle that could deter someone from registering. “That is why programmers can register with us in a few seconds to use our interfaces.” They then start off in a so-called sandbox, handling sample data in a test environment. But that is enough to test their application with the interface. “Those who wish to work with us and read genuine data have to meet our strict data and security standards,” says Hensen. “But we have made this check, which takes about two weeks, operate as speedily and smoothly as the data protection laws allow.”
To operate smoothly is also the aim of perhaps the biggest project in Deutsche Bank’s platform strategy. Together with Allianz, Daimler, Lufthansa and other partners, the bank wants to offer central log-in and identification with its Verimi service. Many websites let users register with their Google or Facebook log-in in order not to have to create a new account every time and that is how Verimi is designed to work. The Verimi account will allow users to identify themselves easily, not just to businesses but also to officialdom, relying on the highest data protection standards.
“You certainly have to give Deutsche Bank credit for tackling the issues of digitisation and platform strategy in good time and in a professional manner,” says Karsten Junge, a partner with Consileon, a German business consultancy specialising in the financial sector. “Are they leading the field? Internationally definitely not, but they are the leaders among the big German banks.” Junge sees the banks as being increasingly in a similar position to electricity suppliers or mobile-phone service providers: the products are fairly interchangeable but as a major player you have important infrastructure, such as radio masts or a banking licence, and a big client base. “And in the same way as it can pay Telefónica to have its services carried out by a discounter such as Aldi Talk, it can be worthwhile for banks to open their platform for good offers from third parties,” says Junge.
He sees three main factors behind the financial sector becoming a platform: customer wishes, technical innovations and regulatory requirements. In future, regulation will demand even more openness from banks. “Why should regulation stop at PSD2? Why should it not be compulsory one day to disclose deposits and performance data via APIs? That is why banks already moving in this direction will have the edge on competitors later.”
Opening a few programming interfaces may at first seem an insignificant step, but Junge believes it has the same strategic importance today as a decision to pull out of investment banking or close a few hundred branches. “Being the one that has customer contact and provides this access to others – in the years to come that will become immensely important,” he says. “On the one hand, no customer will want two smartphone screens full of finance apps – so there will be a process of whittling down. And on the other, just as Rewe can promote its own brand, Ja!, in the financial sector, the power will go to the one with the dominant platform.”