In their quest for digital transformation, banks are at the crossroads between two operational models: banking-as-a-platform (BaaP) and banking-as-a-service (BaaS). Régis Coeurderoy and Matilde Guilhon write that banking-as-a-platform seems to be the favourite model, as shown by the number of operations carried out to develop it.
In an open banking context, the banking-as-a-platform model is clearly more attractive than banking-as-a-service for retail banks, who tend to mimic each other in order to maintain their space of legitimacy.
Open banking regulatory reforms implemented by the Competition Market Authority in the UK and the Payment Systems Directive (PSD2) in the EU have triggered the rise of technology-driven firms in the financial services sector (fintech startups) and encouraged retail banks to rethink their value-creation models. While traditional banking models are weakening, generating less profit and facing increasing competition from new players, banks are moving towards platform-based models that are more customer-oriented and offer seamless and user-friendly services.
Two platform-based models have stood out and received attention from banking executives and experts in recent years: banking-as-a-platform (BaaP) and banking-as-a-service (BaaS). Banking-as-a-platform consists of offering new, third-party services that cover both financial and extra-financial products. Banking-as-a-service depicts a model in which a bank makes its core technologies and infrastructure available to unlicensed players on a white-label basis via application programming interfaces (APIs).
After a few years of exploration by the major European retail banks, mainly conducted through external growth operations, banks are now at the crossroads between the two models, and the question of which model is likely to prevail remains open. Using in-depth interviews with bank executives about the decision-making process and hand-collected data covering the largest French banks’ operations since 2013, we investigated towards which platform-based model these banks are currently moving and examined the reasons underpinning their choices. Our study revealed that banking-as-a-platform seems to be the model widely favoured by these banks, as shown by the number of operations carried out to develop the model. With the notable exception of Société Générale claiming to be a banking-as-a-service pioneer, other French banks are relatively more cautious.
In terms of value creation, banking-as-a-service seems highly promising because it enables banks to capitalise on their technological assets and years of expertise in various areas, such as payments. In addition, it is a lever to reach a large population of clients while keeping acquisition costs down by partnering with non-financial firms. So how to explain this preference towards banking-as-a-platform? We have identified three main reasons explaining the domination of banking-as-a-platform over banking-as-a-service.
First, banking-as-a-service is the most difficult to characterise since the model has not yet reached its final form and is complex to put in place. Technically speaking, the deployment of banking-as-a-service is highly challenging since most banks’ core IT infrastructures are composed of multiple layers, corresponding to incremental developments that have been made to improve the global system. Moreover, these infrastructures have been designed in closed silos that are difficult to open and to interconnect with partners’ IT systems.
Second, banking-as-a-platform operations are mostly deployed through partnerships, which are more flexible than equity investments and acquisitions, and require a low level of integration. In contrast, banking-as-a-service operations take the form of equity investments, which are more complex to put in place. Banks widening their range of activities are likely to prefer partnerships, especially when they explore new value propositions far from their initial activities. This flexibility explains why banking-as-a-platform operations are prominent in banks’ platform strategies today.
Third, and most importantly, banking-as-a-platform enables banks to maintain the direct relationship with the client. Indeed, what changes radically between the two models is the position of the banks: in the BaaP model, banks are the heart of the platform ecosystem, while in the case of BaaS, banks offer white-label services to firms belonging to various ecosystems. Banks have a crucial competitive advantage that new entrants in the banking sector cannot boast today: clients’ trust.
Despite the financial crisis that has temporarily weakened clients’ confidence in their banks, a recent Ernst & Young survey shows that clients trust more their primarily traditional banks than other financial providers, and that privacy and trust are the two main drivers of their choice of banks. Therefore, with banking-as-a-platform, traditional banks are in a privileged position to diversify their offerings by partnering with third parties while guaranteeing the protection of consumer data. It is an opportunity to enhance their relationships with clients by creating tailor-made offerings corresponding to each moment of their clients’ lives. As they enlarge their scope of activities through banking-as-a-platform, banks narrow the focus on their clients.
A strong finding from our study suggests that banks walk on eggshells as they enrich their offerings in a banking-as-a-platform logic. Consumer trust is largely based on banks’ legitimacy and expertise in their core business. Now, banks develop their model significantly more in areas close to their initial activities (e.g., trade, short- and medium-term financing, services to entrepreneurs) compared to further areas (e.g., mobility, youth). By offering a plethora of extra-banking services, banks might ensure that they do not go so far that they appear as illegitimate players in new areas of services. Above all, banks should develop platform strategies that are coherent with their own assets and initial strategic positioning (such as local implantation, clients’ profile).
In short, we have highlighted some factors that we believe explain the preference for banking-as-a-platform. Is it, however, the “right decision”? In highly uncertain environments where players cannot benefit from traditional landmarks to make decisions, it can be like dancing in the dark near a precipice. So, what do you do in such a case? You dance like the others do, hoping that all are dancing on the dance floor – what we call here the herding effect for banking-as-a-platform.
- This blog post is based on Dancing in the dark: Regulatory reforms and incumbent banks’ evolution towards new value creation models in the process of open banking, ESCP Business School’s Geopolitics and global business impact series.
- The post represents the views of its author(s), not the position of LSE Business Review or the London School of Economics.
- Featured image by Nathan Dumlao on Unsplash
- When you leave a comment, you’re agreeing to our Comment Policy.