Difficult times for banks. The existing business models are becoming less and less profitable and the new business models are either specified by the regulator or demanded by the customers. Gone are the days when banks could be successful as universal banks. A special business model (Banking as a Service) has developed not least based on regulatory requirements that could again become a source of income for banks, which at the same time establishes them as an important pillar of society.
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This applies to the provision of infrastructure and services not only to private customers but also to Fintechs, banks and specialist institutions. This sounds little disruptive at first, but on closer inspection it is. But let’s look at the development historically:
The bank outsources some of its processes
Banks have initially begun to outsource their own processes to third parties. This concerned individual processes such as “onboarding of employees”, PC provisioning, programming services or other procurement services. So, while at the beginning banks were still outsourcing services oneself, the question soon arose as to whether a bank does not want to be active as an outsourcing provider itself. And they learned in the years before how to manage outsourcers.
The problem, however, was that banks are IT-heavy and have to use their core banking system to provide IT services. It turned out that existing core banking systems were rarely able to offer external interfaces or, for example, were not suitable for multiple clients. It was therefore good that the EU adopted the so-called PSD2 Directive, which obliges banks to give external service providers access to their systems.
The bank as an outsourcing platform
Within the framework of the revised Payment Services Directive (PSD2) of the European Banking Authority, certified third party service providers were enabled to request account information and trigger payments upon customer consent. These services are provided via a dedicated Access-to-Account interface between third-party vendors and banks. API is the abbreviation for Application Programming Interface. Developers can access the functions of an application via an API interface. The API defines the correct way for a developer to write a program that requests services from a system (core banking system) or other application.
It is primarily through this standardisation and specifications that banks have recognised the significance of this development, namely that they can offer infrastructure and additional services as service-providers.
The bank as a Service-Provider
Third-parties no longer have to set-up their own (cost-intensive) banking-infrastructure, but they can rent or buy services from the service provider (i.e. the bank). The bank can achieve significantly higher margins for not only leasing-out infrastructure, i.e. for access to the platform for e.g. payment services, but also by offering third party providers banking services.
It should be noted here, that under MaRisk, however, that even if all banking related processes can be outsourced to a bank as service provider (= banking as a service), the decision-making authority must remain with the bank license holder.
Financial advantages for banks offering services to third parties are: Additional sources of income based on: 1. service fees, and 2. infrastructure rental/use and 3. possibly funding income (interest) and 4. possibly investment income. The cooperation agreement with the respective third-party determines which sources of income will be used in the individual case. The bank has the option of deciding which type of partnership to enter into, depending on the industry, business model and partner.
On the part of the service provider, consideration should be given to whether to set up its own company to take over service providing or whether servicing should be provided within existing organisational structures. From my point of view, it has more advantages to set-up an own company and to develop the servicing transparently with an own team and own culture and leadership.
Implementation and risk
In essence, banks as service-providers can offer nearly all banking services to third parties. This could be really everything a bank has to offer:
- Regulatory services
- Risk services
- Compliance services
- Treasury services
- IT Services (Platform)
- Operational Services (Storage, Scanning, etc.)
- Accounting Services (local and international accounting, etc)
- Audit Services
- Underwriting services
- Collections Services
As mentioned above, almost all banking processes can be offered by the service provider. For Collections Services, for example, the service provider can handle dunning notices, collections itself, reporting, and legal support. Key Performance Indicators can be used to measure the quality of the services and make it transparent to both the service provider and the BaaS customers how the services are to be evaluated. The partner must consider to what extent he would like to outsource services and where the break-even between cost savings and efficiency lies.
To enable the integration of services between service-providers and a third-party, it is advisable to use the SIPOC (DMAIC tool) as a Lean Six Sigma method. SIPOC stands for the column names of the SIPOC diagram.
S – Supplier
I – Inputs
P – Process
O – Output
C – Customer
The SIPOC is used to record an overall process at the beginning of a process change and is used to clearly delimit processes in process chains. The output of one process becomes the input of another process. This is comprehensively documented and used as the basis for the process change.
The risks of being a service provider
As outsourcing service providers, banks must bear in mind that they themselves should maintain customer contact via their own brand. The banks must not degenerate into pure infrastructure providers, as was partly the case in the telecommunications industry. This means that offering services exclusively to third-party service providers, who then have and maintain customer contact, should not be the goal. Customer ownership is an important success factor for future development. What is important is that service providing to other banks, specialist institutions or fintech companies must remain an additional business to the core business of the bank.
The business case must therefore include the following components 1. how high the investments and implementation costs are; 2. which revenue components flow to the bank and 3. whether or how high the cannibalisation costs of the bank’s own customers are.
The change process is a culture change process. This affects almost all areas of the bank. Processes, organisations and the attitudes of employees will be changed. This places high demands on a good project management.
These projects usually last several years and lead to a fundamental change in the way banking is understood within the company and by the outside world. Those who are first movers here have a clear advantage, as they can get the biggest piece of the cake of future earnings potential.
The benefits and challenges can be summarized as follows:
- Development of new sources of income
- Improvement of the cost/income ratio by creating income generating units in the back office
- First Mover Advantage through use of current regulatory requirements (PSD 2): The first in the market will achieve the greatest advantage
- Increases in efficiency resulting from provision to external customers also improve internal processes
- Possibility to use “Banking as a Service” for both external customers and internal customers
- Digitalization boost for the core business
- Identification of cooperation partners is necessary
- Culture change is a challenge for the employees, as effects are present on almost all processes.
- Organizational anchoring is to be clarified
- Project duration is approx. 2-3 years
- Comprehensive project management for various subprojects needed
- The IT platform (core banking system) is essential for the success of the project.
- Servicing means that the service provider acts as a service provider in the market.
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