#26 Digital Banking Platforms
Analysing Digital Banking Platforms, their history, the market structure and the decisions that banks will have to make
Hi all - This is the 26th edition of Frontier Fintech. A big thanks to my regular readers and subscribers. To those who are yet to subscribe, hit the subscribe button below and share with your colleagues and friends. 🚀
Introduction
Over the last 10 or so years, Digital Banking Platforms have become all the rage. DBP’s are a rethink of banking technology applications where higher value elements are pulled out of the monolithic core banking system so as to enable a more seamless management of the customer life-cycle. We will get into this in more detail later in the article. My interest in this space stems from a few core observations. The first is that non-bank consumer fintechs have made a lot of strides with regards to user acquisition globally. Moreover, the recent fund raise by Revolut which valued the company at US$ 33 billion showed the appetite investors have for digital challenger banks. Despite this, a recent analysis by BCG showed that of 249 surveyed Digital Challenger Banks, only 13 were profitable globally. Additionally, none of these DCB’s have achieved a market share of 2% or more in either total deposits or assets in their respective markets.
One can argue that we’re still very early in the innings and there’s a lot still to come from them. However, for me, the question becomes whether Digital Banking Platforms offer existing financial institutions the ability to offer a similar service as these digital up-starts thereby defending their market share and growing into new customer segments.
The article will thus analyse the evolution of Digital Banking Platforms, the key players in the space, how banks should approach DBPs and other considerations within the overall space.
Software is eating the world
The famous “Software is eating the world” quote by Marc Andreesen back in 2011 almost coincides with the shift by bank software vendors towards Digital Banking Platforms. In banking, the success of companies like Netflix and Amazon with regards to reimagining industries, led to a view that customers would come to expect similar or even better experiences from their financial services providers. This demand push factor meant that customers were now demanding better services from their banks and this included the same omni-channel approach that companies like Amazon took. Omni-channel in this case meaning that customers wanted a seamless experience across not only devices but consumer touch points i.e. branch, call centre and ATM.
On the supply-side, improvements in technology drove a complete re-imagination of what a bank’s core technology stack should look like. My article on “Core Banking Platforms” gives a good overview of how bank technology considerations evolved from mainframe servers to modern microservices driven architecture. The design of bank technology platforms evolved around a monolithic core where services, data systems, user experience and product engines were tightly packed into one system. This in turn was driven by the fact that consumer access points were limited and thus it was sufficient for a bank to have a monolithic core with bank-staff accessing the system through poorly designed interfaces whose core function was transaction processing.
Sample Traditional Core UX
Essentially, banking services were driven around transaction processing at ATMs and branches with document driven credit and trade finance services handled manually. A bank customer thus never interacted digitally with their money. Of course, banks bolted on specific apps and systems to “modernise” but these created data silos whilst building mountains of technical debt. I have personally been involved in such a situation, what happens is that you get diminishing returns to product innovation whilst increasing technical debt exponentially. The ultimate outcome is that the whole organisation develops innovation fatigue.
One of the fundamental issues with traditional CBS’ was the conflicting interest of trying to maintain a robust source of truth infrastructure whilst trying to foster rapid change to drive innovation. This is a fundamental conflict that is almost impossible to resolve.
It then happened that demand side factors collided with supply-side factors driving the realisation that banks needed digital banking platforms. As a recap, the demand side factors consisted of customer experience expectations driven by Netflix and Amazon. Supply side factors consisted of the maturing of cloud, microservices and data streaming services such as Apache Kafka.
The best way to understand DBP’s is to understand the paradigms behind how customers access banking services and the technology behind them. There are three core systems;
Systems of record - core record of truth in terms of customer balances and interest calculations;
Systems of engagement - how customers and staff engage with the overall system;
Systems of insight - the manipulation of data to generate customer insights;
Additionally, there are services that link all these together whilst enabling the integration to both internal and external capabilities. These are generally APIs.
In the past, traditional vendors packed everything into one “Core Banking System” and there was little regard for “insights” and integration services given that these were bank in a box platforms. I’ve written before about industry 3.0 commercial dynamics that are driven by standard infrastructure and product, with profitability driven by marketing and efficiency through cost control. The same applied to the banking sector.
The diagrams below represent the crux of what a Digital Banking Platform is.
Source: Forrester Research
The idea is that a bank’s technology architecture is split between the three systems identified above. At a lower level are core capabilities and systems including payments systems, core banking ledgers and KYC and compliance capabilities. These are then integrated upwards onto an aggregation layer that connects to a UX layer. With this in place, a bank can then create omni-channel experiences given that data and insights are aggregated. The diagram below from a presentation by Backbase is more intuitive.
Source: Backbase Presentation
The idea is basically the same, at a lower level you have systems of records and core capabilities such as KYC, payments and core ledgers. At the middle level, you aggregate these via APIs and connectors onto an engagement platform that interacts with the user experience layer. This layer can then be either branch platforms, apps or online apps. The core of the DBP is the engagement platform as you can then have separate vendors build the apps.
The same approach has been adopted by Kenya Commercial Bank (KCB) with their Vooma product. The architecture was broken up into separate parts. A core banking ledger was provided by Sopra with Huawei providing the digital banking platform which is largely a mobile money platform. For the UX, KCB used Kocela to build the app.
An additional benefit of DBP’s is that banks avoid the trauma of core banking system transformation. Using modern data streaming techniques such as Apache Kafka, they were able to do data replication thus empowering DBPs. It’s a general trend towards the dumbing down of the core. This dumbing down of the core will benefit players such as Oracle Flexcube who are able to market their robust relational database management capabilities packed into Oracle DB.
At a deeper macro-level, the shift towards DBP’s can be explained by the separation of the manufacturing of banking services and their distribution. In essence, the core elements of maturity transformation, liquidity transformation and fractional reserve banking is happening at the data layer whilst the distribution of banking services as regards to customer acquisition and management is happening at the engagement layer. This article is a useful resource on this dichotomy.
Digital Banking Platform Vendors
The move towards DBP’s is having a significant impact on the bank software vendor industry. For DBP vendors, traditional core vendors have adapted to the industry dynamics and have launched their own proposition through both R&D and acquisitions. New entrants have also emerged with very robust value propositions. It is expected that the DBP industry is expected to grow to US$ 17 billion in revenue in 2024 from the current spend of US$ 14 billion representing a 5% CAGR growth.
DBP’s are evaluated across separate verticals such as corporate banking, wealth and private banking, Retail Banking and SMB. It’s therefore difficult to evaluate the overall best. Omdia nonetheless have made a good attempt at this. The table below is from their 2020 report on the best vendors in the market.
Source: Omdia
At the top are platforms such as Backbase, Infosys, Temenos Infinity and Oracle Banking Digital Experience. In other verticals such as wealth, players such as Prometeia and Avaloq have very strong propositions.
The core approaches to evaluating vendors are;
Depth of functionality;
Advanced technology - use of microservices etc;
Existing customer base and references; &
Depth of customer service;
Different banks often have to put different weights on the above criteria based on a number of factors. Additionally, sometimes there are trade offs. For instance, some vendors have a lot of built in functionality but sometimes this comes at the cost of customisation. Others have a limited customer base due to a niche focus meaning that within their chosen vertical, they have the best product and approach due to focus.
One thing that I think is of note is that the approach to vendors should change and they should be viewed as technology partners rather than just technology vendors. The idea is based on the following premises;
Core banking platforms are becoming “dumber” i.e. restricted to systems of record only;
Adjacent technologies are maturing with propositions around payments, KYC, infrastructure and personalisation all available via an API;
With this in mind, value will move away from the “tech stack” and move towards higher element items such as mindset, culture and ideation. We have already seen this in the media industry with platforms such as “TikTok”. Essentially, TikTok has abstracted the complexity of producing media and now value is solely driven by creativity and innovation. Everyone has the same tools essentially. The value of a DBP platform vendor in the future should thus be based on the ability to co-create, generate ideas and solve client problems. This is probably why Backbase have done so well despite the existence of giant incumbents. Additionally, Temenos in 2019 acquired Kony thus helping to grow their Infinity product.
One possible outcome will be a significant change in the recruitment practices of DBP platform sales teams. It’s interesting when you interacted with the old CBS vendor sales teams, they always used to pride themselves on their sales capabilities. You’d be told stuff like “Samora, listen! I’m a salesman, I don’t care about what I’m selling, if you give me watermelons to sell, I’ll sell them… tell me what you want and we can close this deal”. This works well when you’re selling commodities, but will quickly break down when you’re supposed to help your clients innovate and solve their problems.
An additional impact will be the worsening economics of core banking vendors who do not shift their revenue profiles towards DBPs. A number of the traditional vendors still have multi-year lucrative contracts based on their core banking systems. This industry has shifted dramatically over the last 10 years. Pricing for licensing has fallen drastically whilst customer care has improved particularly for smaller banks. The shift towards a lean core is fully in play and new players such as Thought Machine, Mambu and 10x have fully embraced this with lean offerings. I foresee traditional vendors renewing licenses at a lower cost and losing some clients to modern lean core vendors.
How Should Banks Approach DBPs
It’s difficult to give an overall recommendation to “banks” given that the banking industry is varied. Some players are tech forward and are keen on innovating and delivering world class products. Others are serving niches particularly in Africa that are not keen on digitisation. An example is tier 3 merchant banks in Africa that do trade and wholesale banking to local businesses. Nonetheless, for the rest, it’s critical to first identify your north star when it comes to commercial strategy and revenue targets. Some basic assumptions must be made first;
Your client tastes and preferences may change over a 5 year horizon;
New technologies will emerge that unlock new product capabilities;
Integration to external parties and partnerships will be core;
Open banking and ecosystem approaches will do well;
With this in mind, it’s clear that DBPs are a core element to any bank’s future strategy either in built or vendor provided.
The main considerations are;
Target Market
In Africa, banks can either target the mass market or middle class and affluent segments. HNWI are also a consideration with an omni-channel platform given that these relationships are largely advisor driven. In the business segment, SME or corporate should be considered although corporate and mass-affluent platforms may have similar UX considerations. When it comes to the mass market, then mobile money platforms in my view are more useful than the existing DBP platforms from players such as Temenos, Backbase and Oracle. Huawei has partnered with both KCB and Ghana Commercial Bank to launch digital propositions. Here the core consideration is around Transactions per Second (TPS) and reliability as opposed to user experience;
In-House Expertise
This is becoming a very vigorous debate within the banking sector. Some banks have decided that they want to become “technology” companies whilst others are keen to remain banks. The talk about being “technology” companies in my view can be a bit ridiculous. A tech company is not just a company that has engineers making up the bulk of the workforce, although in Africa this in itself will be very difficult to execute. Being a tech company goes deeper into elements such as org structure, remuneration (particularly long term incentives), risk culture and hierarchy. The question is simple, would a 25 year old talented engineer rather work for Amazon or Google in Africa or work for a bank. I think this answer has a straightforward answer. Indeed, some banks in Africa such as Kuda Bank and Tyme Bank are tech companies, but these were birthed on digital principles from the start. Goldman Sachs in my view has the best approach, where there’s a blend of in-house building, vendor partnerships and acquisitions.
In other words, most banks don’t have the in-house technical expertise to build DBP’s. Some have the capacity to build the customer experience layer whilst partnering with a DBP vendor for the middle engagement layer. A sober discussion should be had about how deep your technical expertise is and whether you want to focus on banking or being a tech company. A focus on product management in my view is recommended. Tier 3 banks should mainly focus on vendor management.
Other considerations;
Market dynamics - some markets are card based whilst others are optimised for mobile money. Mobile money is built around instant payments and high transaction processing. Most vendors serving European and American markets are optimised for card infrastructures not mobile payment. This is where Chinese vendors are doing well in some African markets;
Multi-country deployments - For banks that have multi-country deployments i.e. exist in more than one market. Significant consideration needs to be given to the architecture and structure of your teams with core capabilities sitting at the group level with the ability to customise being granted to the local teams.
All that said, the DBP market is not happening in a silo. Firms such as JP Morgan and Goldman Sachs have taken a different approach to this. Their digital approaches are built on the componentisation of different capabilities. For instance, JP Morgan acquired Nutmeg in the UK with a view of embedding their robo-advisory capabilities into their challenger bank proposition. Marcus by Goldman Sachs has also been built on the same approach with some acquisitions such as the acquisition of Clarity Money.
Final Considerations
The rise of DBP’s gives banks the opportunity to rethink their strategies and product architectures. The biggest problem with banks right now is not their legacy tech but their legacy thinking. The dichotomy in the CBS sector of record keeping vs innovation coupled with the dichotomy in the banking sector of manufacturing vs distribution is having an impact on innovation within the sector. These dichotomies are difficult to resolve but nonetheless, they manifest in a two speed dynamic in banks where risk needs to be taken to innovate and create new products whilst risk needs to be managed to properly conduct your role as a manufacturer of financial services regulated by the Central Bank. Bankers thus are trained to be risk averse but at this critical juncture are being asked to be innovative. How do you solve this conundrum?
I don’t have the answer, but it’s clear that DBP’s are part of the solution with the larger solution being around organisational structure, recruitment, culture and mindset. Most bank leaders state that their biggest issue is “mindset”. Some banks may be better off focusing on the manufacturing side of things. Those that decide to build digital distribution will have to work hard to change mindsets, otherwise the decision of whether to go with Backbase, Temenos Infinity or OBDX will be moot.
As always thanks for reading and drop the comments below and let’s drive this conversation.
If you want a more detailed conversation on the above, kindly get in touch on samora.kariuki@gmail.com;