Digital Banking: Morphing into market places

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.”

The plan

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.

The competition

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.