07 Apr 2021
Three decades ago, as a cadet finance reporter, I was forced to learn a bit about banks. University studies of medieval philosophy and genetics were not that useful (although, actually, the fundamentals of those disciplines have been….)
Two things I particularly remember: banks’ assets are ordinary companies’ liabilities (a loan is an asset for a bank); and banking, like ordinary business, was divided into wholesale and retail.
"Under its brand, a bank offers customers a full suite of products and services – but some are provided by someone else.”
Wholesale was about providing big ticket banking services to large companies and other banks; retail about serving individuals and smaller businesses. At the time, pre the housing booms of the last two decades, wholesale banking was a big deal. In Australia, for the big three (before Commonwealth Bank was publicly listed), wholesale banking made up about two thirds of revenues. Today it is home lending that makes up even more than two thirds.
Wholesale banking as a term has lost some currency but the products and services offered “wholesale” are once again becoming more important as banks increasingly unbundle their offerings while technology like the Cloud, Application Programming Interfaces (APIs) and software-as-a-service make it easier and more rational for a bank not to try and do everything itself.
Over the years, these wholesale activities have had names like “white labelling” – store credit cards were typically operated by banks even when they had the store’s name on them – but today the favoured term, borrowed from the idea of renting rather than buying software, is BaaS: banking-as-a-service.
From one perspective, a bank might choose not to perform some payment activities itself but use a payments specialist or it might rely on a specialist provider of authentication services. So under its brand, a bank offers customers a full suite of products and services – but some are provided by someone else.
From the other perspective, a bank might be one of those specialists who provides products and services to other organisations: maybe other banks, maybe ecommerce sites which need to facilitate payments and hold balances. Increasingly, non-banks or so-called neobanks and fintechs want to buy wholesale banking services to satisfy their customer bases.
Both perspectives offer advantages – and revenue – if implemented properly. Wholesale customers buy in bulk and they are typically more cost effective to serve. That allows the providing bank to offer services at a competitive rate so the customer bank (or corporate) can add a margin and still make money.
The platforms on which these services are provided are expensive infrastructure to set up but extra volume comes at almost no extra marginal cost. If you’ve spent $100 setting up a platform but are only using 30 per cent of its capacity, it makes sense to rent out the remaining capacity.
Meanwhile, those buying that capacity get access to products and services for their own customers which they could never afford or want to establish themselves. In particular, non-banks don’t necessarily need a banking licence nor the onus of financial services regulation.
According to Accenture’s latest Top Commercial Banking Trends, “commercial banks that use BaaS as a distribution channel achieve two to three times the industry average return on assets”.
Not all BaaS or “platform” strategies are the same. The spectrum ranges from essentially renting out space to forming a much more intense partnership. Some banks set up separate businesses for BaaS, distinct to the platforms the bank is using itself. Others establish structures which allow customers to operate on the same platform as the owner bank.
At this bank, ANZ, where the platform business is already a significant contributor, the strategy is on providing selected services (such as trade finance processing or credit processing) to other banks who might not have the ability to provide these services effectively and efficiently.
This makes sense for a bank like ANZ because of its significant institutional banking franchise and large number of financial institution (FIG) clients. By and large, ANZ uses the same platform it makes available. For example, ANZ is the market leader in Aussie and Kiwi dollar foreign exchange and also enables the use of the real time New Payments Platform (NPP) for smaller finance institutions and their associations.
A platform strategy such as this is hardly new for ANZ. In 1996, when ANZ was building out its Asian network with the focus – as is again the case today – on institutional banking, I wrote a story for the Australian Financial Review on ANZ “renting” its regional network to foreign banks.
Then ANZ chief executive Don Mercer said the bank would provide a “bolt on” network in the region for European and American banks which didn’t want to share their customers with potential rivals in their home markets – which ANZ was not.
The interbank alliances were based on ANZ’s then cutting edge Commercial banking service. Mercer describe the relationship as similar to the code shares used by international airlines to expand their network reach.
Pose a threat
A recent report by Oliver Wyman found BaaS is a great opportunity for existing banks, insurers and wealth managers to reach a greater number of customers at a lower cost by teaming up with non-financial businesses.
“But if they do not react in a rapid, strategic manner, BaaS could also pose a threat, as it opens up the financial services market to new challengers,” the report said. “Incumbent banks and other financial institutions need to make strategic decisions about how to enter this growing business – what products to offer and which partners to work with.”
Oliver Wyman argued “BaaS will bring together digital technology platforms and finance to change the shape of economies and most sectors for years to come”.
“BaaS is a clear opportunity for financial institutions to capture new revenue growth at a low cost. For distributors, it is an opportunity to open new revenue lines at attractive margins and gain a much deeper understanding of consumer behaviour through financial data.”
Just as there is a range of models for a platform relationship, there is a range of offerings. A bank offering a platform to other institutions might focus on services – such as identity, risk assessment, trade facilitation, payments clearing – or products – such as credit cards or loans.
It has long been recognised banking services are essential for a modern economy. But banks are not. The challenge for those banks offering their platforms to non-banks or other banks is some of these “partners” might be powerful rivals. A bank – as was often the fear with white-labelling – would lose the pre-eminence and value of being a customer’s major financial relationship.
But the strategic risk is that these rivals will emerge anyway – and they will seek platform services somewhere. The ability to rent a platform then is a growing market and potentially a major new revenue pool.
Andrew Cornell is Managing Editor of bluenotes
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
07 Apr 2021
11 Mar 2021