Why API Banking Means a New Role for Banks

Why API Banking Means a New Role for Banks

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Edgar, Dunn & Company

Edgar, Dunn & Company is an independent strategy consulting firm that was founded on two fundamental principles of client service: provide deep expertise and deliver actionable advice.

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Adapted from Edgar, Dunn & Company's (EDC) Advanced Payments Report 2017.

One hot topic in the payments industry is the emergence of "open banking" APIs (Application Programming Interfaces). Fintech startups have been using this technology for some time but now regulators, particularly in Europe, are mandating the deployment of such APIs for banks through the second Payment Services Directive (PSD2).

Just what is an API anyway?

The web is full of attempts to explain APIs in layman’s terms. One of the best explanations is to think about an API as the software equivalent of a TV’s rear panel full of ports and interfaces to plug other devices into. These connectors work for a TV pretty much the same way that an API works for software. They allow other appliances (DVD players, cable TV boxes, game consoles, etc.) to interact with the TV, pushing and pulling information (audio, video) to and from it, and hence delivering more functionality than a TV offers by itself.

APIs lie at the heart of this explosion of digital innovation in banking and payments. Soon banks will be required to provide third parties with access to customer data via open APIs. Regulators are rolling out new rules designed to formalize and encourage these new activities.

And even in markets where there are no such regulatory changes, banks are taking the initiative and providing greater customer choice. To ensure that appropriate levels of security are in place for open banking access, industry stakeholders are working to develop more robust security standards.

Why APIs?

The structure of the payments and retail banking market is breaking up. New players are building on top of existing bank infrastructure to create exciting new digital products and services. An entirely new set of activities in the banking value chain has emerged between banks and customers.

Opportunities fall into two currently distinct areas that will, over time, naturally converge. First, banks as API platforms will supply enhanced data-driven services through APIs based largely on internally derived data. This business model focuses on supplying third-party businesses. This is an indirect customer relationship model, but the bank is not entirely invisible to the end customer.

Why API Banking Means a New Role for Banks

The second opportunity is for banks to act as third-party service providers, offering products and services that integrate information derived from multiple external sources via APIs. This is a direct customer relationship model.

Around 83 percent of EDC’s survey respondents believe open APIs hold the key to the future of banking and payments, enhancing the development of different applications including account aggregation and payment initiation. Yet, 80 percent indicated that compliance is a major challenge for the adoption of an open API initiative. A similar proportion of respondents (78 percent) believe APIs provide benefits for all involved but the key ones for banks are providing a better service and opening new revenue streams.

Shifting landscape

The payments industry is in the process of rapid and unprecedented change. The PSD2 implementation deadline is now clearly in view and on the horizon of most planning cycles.

There are three primary factors that help shape this change:

  • Regulation to date has been a friend of incumbent banks and has served as a moat around the banking market. But now, regulators across markets are opening up the banking industry, enabling non-banks to enter the financial services industry to undertake specific activities.

  • Consumer behavior and expectations are changing. Consumers expect a new level of ease of use, immediacy and personalization, which is leading to almost invisible payment experiences. While the pre-internet generation is tentatively embracing the digital age, a younger digitally native generation is setting a new pace for consumer-facing businesses to keep up with. Consumer needs revolve around a digital lifestyle that is not going away.

  • Technology innovation is providing consumers with new services and is in turn being fed by massive new inflow of investment capital funding directed mainly at fintech startups entering and disrupting what has been a highly-regulated marketplace.

But how real is the disruption cliché for banks?

New API opportunities for banks

Technological trends such as APIs have already caused a shift in financial services. Regulation is now set to accelerate the industry’s transformation. APIs are consequently set to change the banking landscape and redefine the role banks play in a value chain no longer entirely under their control.

The adoption of open APIs by the banking sector will accelerate the decline of fully integrated universal banks. The traditional banking strategy of aiming to offer a full range of products and services (from retail to wholesale) to a wide range of clients with all the required infrastructure and back-office support under one roof is naturally coming to an end.

By opening up and unbundling the banking process, a new value chain is emerging that will yield a very different financial services landscape.

Banks can choose whether to treat new regulations as merely a compliance exercise or recognize that something more fundamental is playing out in the market value chain.

The statements and opinions of the writer do not necessarily reflect those of TSYS.

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Edgar, Dunn & Company

Edgar, Dunn & Company is an independent strategy consulting firm that was founded on two fundamental principles of client service: provide deep expertise that enhances clients' perspectives and deliver actionable advice that enables clients to create measurable, sustainable change in their organizations.

Every year EDC conducts a survey of industry experts - not consumers - but senior executives directly or indirectly associated with the payments industry. The survey results and its extensive research and experience advising clients on payments across the globe provide perspectives, reveal insights and highlight strategic industry trends.

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