Dr. Markos Zachariadis Associate Professor of Information ... · SWIFT Network (Scott and ......

Warwick Business School

Dr. Markos ZachariadisAssociate Professor of Information Systems Management & InnovationFinTech Research Fellow, CDI, University of Cambridge


Currently:- Associate Professor in Information Systems & Management, Warwick Business School- FinTech Research Fellow, Cambridge Digital Innovation (CDI) University of Cambridge

Previously:- Research Associate at the London School of Economics, Dept. of Management, Information Systems & Innovation Group- Research Associate at Judge Business School, University of Cambridge- Visiting Scholar and Tutorial Fellow at London Business School, Dept. of Management Science and Operations- Research Assistant at the Centre for Economic Performance, London School of Economics

Technological Innovation in Financial Services


What drives change in financial services?Trans-Atlantic cable in 1858(Garbade and Silber, 1979)

Demand

Organizational & Market Structure

Technology

RegulationLSE Big-Bang in 1986(Clemons and Weber, 1990)

Securities Immobilisation

in 1973(Donald, 2012)

SWIFT Network(Scott and Zachariadis, 2014)

Presenter

Presentation Notes

Regulators’ objectives can be understood by their key mandates. In no specific order, these are: (1) financial stability, (2) prudential regulation, (3) conduct and fairness, and (4) competition and market development. The regulator’s mandate is to guarantee stability, market integrity, compe on, fair consumer protec on and a growing amount of transparency. The cost for nancial incumbents (FIs) to be compliant is increasing and companies that are able to reduce compliance costs will be able to focus on enhancing the customer experience and increase the perceived value of services. Companies that do not adapt will eventually reach a point at which the perceived value does not exceed the produc on costs and they will be overtaken by the compe on. RegTechs operate predominantly in this eld and try to act as a bridge between established nancial ins tu ons and regulatory bodies. THE CREATION OF THE CONTEMPORARY DEPOSITORY MODEL (Donald, 2012) “Indeed, a backlog of securities settlement brought the New York securities markets to a near halt in 1970, in a disaster referred to with names like the ‘paper crunch,’ ‘paper blizzard,’ or ‘back-office crisis.’ Up until the 1970s, most American securities firms took care of their securities transfer paperwork through the manual work of clerks. As trading volume on the New York Stock Ex- change (NYSE) more than quadrupled during the 1960s, firms were unable to settle transactions quickly enough to meet outstanding delivery obligations, even though the NYSE closed 1 day per week and held abbreviated trading hours in order to give members time to catch up on their paperwork, so that over 100 brokerage firms eventually either entered bankruptcy or were acquired by stronger competitors. The US Securities and Exchange Commission (SEC) convened a conference of experts in 1971 to consider solutions for the securities settlement crisis, and industry experts offered either a decentralized, electronic model or a centralized depository model as possible securities settlement structures. A report that the SEC prepared on the 1971 conference explained that most market participants backed the model using an electronic network to transfer demater- ialized securities, but were concerned that it could not be implemented quickly and safely, given the state of the law and of technology in 1971. Also, a number of industry experts argued that investors would not voluntarily switch from paper to electronically evidenced securities. The depository option presented the significant advantage that the NYSE already operated a Central Certificate Ser- vice (CCS) that employed the model. As a result, in the United States, the depository model was adopted and enforced by the enactment of }17A of the Securities Ex- change Act of 1934, which instructed the SEC to “use its authority . . . to end the physical movement of securities certificates in connection with the settlement among brokers and dealers of transactions in securities . . .” The CCS was in 1973 transformed into The Depository Trust Company (DTC).”


Banks underperforming• Banks’ profits (ROE) fell dramatically since the financial crisis and never

bounced up.• IT was a “luxury” when banks needed to cut costs.


Banks lost credibility


Technological advances and customer expectations rose Technologies that did not exist before

2006/2007:iPhone, iPad, Kindle, 4G technology, Uber, Airbnb, Android, Oculus, Spotify, Nest, Bitcoin, Blockchain, Square, Instagram, Snapchat, WhatsApp, Google Chrome, Kickstarter, Pinterest, Venmo, Slack, Google maps, etc.


Emergence of FinTech New technologies brought further appetite to

entrepreneurs and investors to explore the market in financial services.

> Fin.Tech *noun* : (abr. ForFinancial Technology) aneconomic industry composed ofcompanies that use technologyto make financial systems moreefficient.


FinTech taxonomy- Mobile payments- Cryptography, P2P,mobile money

- Market platforms,data standards- Bettermarketconnectivity

- Socialtrading,Robo-advisors, algos- Analytics

- Sharing economy- IoT, wearables,

sensors

- P2P- Banking as

platform,mobile

banking

-Crowdfundingplatforms, angels

Source: WEF (2015)

Presenter

Presentation Notes

We have structured our framework against six functions of financial services and eleven clusters of innovation. Functions of Financial Services: Even in an environment of rapid change to the design, delivery and providers of financial services, the core needs those services fulfill remain the same. We have identified six core functions that comprise financial services : Payments Market Provisioning Investment Management Insurance Deposits & Lending Capital Raising Clusters of Innovation: We have identified 11 clusters of innovation exerting pressure on traditional business models. We identified six important themes that cut across functions and touch multiple clusters of innovation: Streamlined Infrastructure Emerging platforms and decentralised technologies provide new ways to aggregate and analyse information, improving connectivity and reducing the marginal costs of accessing information and participating in financial activities��Automation of High-Value Activities Many emerging innovations leverage advanced algorithms and computing power to automate activities that were once highly manual, allowing them to offer cheaper, faster, and more scalable alternative products and services Reduced Intermediation Emerging innovations are streamlining or eliminating traditional institutions’ role as intermediaries, and offering lower prices and / or higher returns to customers The Strategic Role of Data Emerging innovations allow financial institutions to access new data sets, such as social data, that enable new ways of understanding customers and markets Niche, Specialised Products New entrants with deep specialisations are creating highly targeted products and services, increasing competition in these areas and creating pressure for the traditional end-to-end financial services model to unbundle Customer Empowerment Emerging innovations give customers access to previously restricted assets and services, more visibility into products, and control over choices, as well as the tools to become “prosumers”


Areas of Disruption


“Unbundling” of the bank

Source: CB Insights


The FinTech/Bank narrative… The good, the bad, and…. the regulator!

- Banks and incumbent financial institutions: financial crisis, charge high fees, low transparency, etc.- FinTechs jump in to save the day!- The regulators push for a more fair playing field breaking Banks’ monopolies and giving a chance to FinTechs to innovate for the benefit of the consumer.

Banks and FinTechs compete for the same market- …only to realize after a while that they can’t make it on their own – banks need the innovation and FinTechs need the customer base.


Access to data to improve market outcomes To enhance competition regulators needed to break up

banks’ monopoly. December 2014: First report by Open Data Institute /

Fingleton Associates report.


PSD2 & Open Banking going live

August 2016: After concluding there was too little competition in UK banking, the Competition and Markets Authority (CMA) ordered the UK’s nine biggest banks to open up their data to third parties.

November 2017: Final version of PSD2 by European Commission.

January 2018: PSD2 & Open Banking went live.


Regulatory context Payment Systems Directive II (PSD2):

Payment Initiation Service “a service to initiate a payment order at the request of the payment service user with respect to a payment account held at another payment service provider”Account Information Service “an online service to provide consolidated information on one or more payment accounts held by the payment service user with either another payment service provider or with more than one payment service provider”

Open Banking Working Group (OBWG):“designing a detailed framework to enable thedevelopment of an open API standard in UK banking”


OB Implementation Entity The Open Banking Implementation Entity (OBIE) is the company set up by

the CMA in 2016 to deliver Open Banking.

Governed by the CMA and funded by the UK’s nine largest banks and building societies: Allied Irish Bank, Bank of Ireland, Barclays, Danske, HSBC, Lloyds Banking Group, Nationwide, RBS Group and Santander.

Key roles:- “Design the specifications for the Application Programme Interfaces (APIs) that banks and building societies use to securely provide Open Banking”- ”Support regulated third party providers and banks and building societies to use the Open Banking standards”- “Create security and messaging standards”


What’s an API? API: {Application Programming

Interface} “set of functions or procedures

used by computer programs”to access, control or transferdata from other operating systems (Jacobson, et al., 2012)

“electrical sockets that have predictable patterns of openings” into which, other applications that match those patterns can “plug in” and consume them in the same way electrical devices consume electricity (Berlind, 2015).

InternalPrivate

ExternalOpen/Public

Presenter

Presentation Notes

Prior research documents the significance of using platform boundary resources (e.g. application programming interfaces) for cultivating platform ecosystems through third-party application development.� Platform governance: platform owners increasingly recognize the importance of supporting application developers to build and sustain platform innovation… therefore, it is considered important to design platform resources that facilitate a shift of design capability to external actors (“frictionless entry” as the “What is the governance process by which proprietary platform owners can simultaneously maintain platform control and stimulate third-party development through platform boundary resources?” (little is known about the means by which platform governance is accomplished through direction, control, and coordination of third-party developers through the common resources of a platform.) ___________________________________________ Practically, any industry that information is an important ingredient is a candidate for the “platform revolution”… A platform is a business based on enabling value-creating interactions between external producers and consumers. The platform provides an open, participative infrastructure for these interactions and sets governance conditions for them. Its main purpose is to create matches amongst users and facilitate the exchange of services enabling value creation for everyone. ____________________________ Through open APIs we also get some glimpse of “open data” and the potential to increase transparency... In more closed systems where there are information asymetries


Conceptualizing APIs As technology APIs offer the possibility of integration: “a way for

computers to talk over a network” (Jacobson, et al., 2012). As software products APIs need to be priced, product-managed and

promoted - bring product to market (Parker, Van Alstyne, etc.). As boundary resources APIs can “control and coordinate/cultivate”

platform ecosystems (Ghazawneh & Henfridsson, 2013). As mini-contracts they can be used to lower transaction costs and

eliminate friction between a principal and agent.

Presenter

Presentation Notes

Prior research documents the significance of using platform boundary resources (e.g. application programming interfaces) for cultivating platform ecosystems through third-party application development.� Platform governance: platform owners increasingly recognize the importance of supporting application developers to build and sustain platform innovation… therefore, it is considered important to design platform resources that facilitate a shift of design capability to external actors (“frictionless entry” as the “What is the governance process by which proprietary platform owners can simultaneously maintain platform control and stimulate third-party development through platform boundary resources?” (little is known about the means by which platform governance is accomplished through direction, control, and coordination of third-party developers through the common resources of a platform.) ___________________________________________ Practically, any industry that information is an important ingredient is a candidate for the “platform revolution”… A platform is a business based on enabling value-creating interactions between external producers and consumers. The platform provides an open, participative infrastructure for these interactions and sets governance conditions for them. Its main purpose is to create matches amongst users and facilitate the exchange of services enabling value creation for everyone. ____________________________ Through open APIs we also get some glimpse of “open data” and the potential to increase transparency... In more closed systems where there are information asymetries


From APIs to platforms

? ?Blackberry Nokia

2007 20% 50%

2013 2% 2%

Presenter

Presentation Notes

In fact in 2007 7 companies controlled 91% of the industry profits in 2013 Apple alone controlled 92% of the industry profits!! iPhone was founded in 2007 and launched their app store in 2008 with 500 applications! Today 2.2 million.


Digital Platform RevolutionFIRM YEAR

FOUNDED EMPLOYEES MKT CAP(2016)

BMW 1916 116,000 $53B

UBER 2009 7,000 $60B

MARRIOT 1927 200,000 $17B

AIRBNB 2008 5,000 $21B

WALT DISNEY 1923 185,000 $165B

FACEBOOK 2004 12,691 $315B

KODAK 1888 145,000 $30B (heyday)

INSTAGRAM 2010 13 $1B (acquisition in 2012) Source: 2016 Parker & Van

Alstyne, with Choudary

- “Uber, the world’s largest taxi company, owns no vehicles; Facebook, the world’s most popular media owner, creates no content; and Airbnb, the world’s largest accommodation provider, owns no real estate”

- Tom Goodwin (Havas Media)


Most famous global brands

% is growth relative to prior year, $ is value of brand equity

2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).

Source: Interbrand 2015 % is growth relative to prior year, $ is value of brand equity

Presenter

Presentation Notes

Coca Cola >= $3B+ global $565.1 US Google $569M US,


13 of these are platforms

2016 Parker & Van Alstyne, with Choudary – licensed under Creative Commons Attribution-ShareAlike 4.0 International (CC BY-SA 4.0).

Source: Interbrand 2015 % is growth relative to prior year, $ is value of brand equity

Presenter

Presentation Notes

Coca Cola >= $3B+ global $565.1 US Google $569M US,


Platforms overtaking products


Transaction-Cost Economics The rules of the competition for ‘hierarchies’:

- Positive economies of scale: Businesses created efficiencies through reducing marginal costs and sourcing production in house.- When transaction costs were high it would make sense to integrate operations and control value production.

Choice of a different organizational model – the market:- When transaction costs fall (e.g. search, coordination, negotiation, information asymmetry costs) then is makes more sense to buy the product instead.

Platforms sell reductions in transaction costs not products!! (Munger, 2015).- Core of the firm will shrink but periphery will expand.


Platform theory Platform is:

- Business model that creates value by enabling interactions between external producers and consumers (Parker, Van Alstyne, etc.).- Selling reductions in transaction costs not products – e.g. iTunes/Napster or UBER/P2P Austin Market where the platform bears the risk! (Munger, 2015).- Open infrastructure and set governance conditions (Gawer and Cusumano, 2002)

Platform can:- Scale more efficiently by eliminatinggatekeepers (e.g. You Tube)- Unlock new sources of valuecreation and supply (Airbnb)

2016 Parker & Van Alstyne, with Choudary


Platforms leverage network externalities Network externalities (or network effects) are present when “the value

of membership to one user is positively affected when another user joins and enlarges the network” (Katz and Shapiro, 1994).

These are common in telecommunication networks (e.g. telephone, fax networks).

The value of the fax is subject to how many people have fax-machines!

Presenter

Presentation Notes

Joke with best salesman in the world is the person who managed to sell the first phone!


Great value in network effects… Positive network externalities:

- Same side network effects (Zachariadis, 2010)- Cross side network effects (Economides, etc.)- Data-driven network effects: the larger your network grows, the better your platform curation can become (Van Alstyne, et al.)

NYU Finance Prof. Aswath Damodaran ($5.9B) vs. UBER investor Bill Gurley ($17B) (2014)


APIs in banking: “platformification”

Ability to create a business“ecosystem” and add valuefor clients.

How to go about and do that? What are the choices banks

and non-banks have in orderto adopt platform strategies in financial services?


Open Banking/ Bank-as-a-Platform


Changing banking architecture• Open Banking will potentially change the way banks operate and will

lead to a more ”modular” architecture and way of organizing.• Banks operate on a traditional “pipeline” business

model/arrangement. They produce everything themselves (vertical integration).

• Opening up their APIs will potentially allow to 3rd party developers to deliver parts of the value chain of the banking service (e.g. distribution, or API layer, etc.)


Banking transformation


Four types of emerging platforms We have identified 4 (and a half) types of

platforms that have emerged due to PSD2 regulation:- Incumbent bank platforms- Challenger platform banks- API Aggregator platforms- Account Aggregator platforms + services


Incumbent bank platform Owns/controls most

layers from Core banking infrastructure, interfaces, distribution channels.

Adding white-labeled services cautiously (services2customer).


Incumbent banks slow to adopt


Others slightly faster


Challenger bank platform Owns/controls most layers from

Core banking infrastructure, interfaces but supporting many distribution channels via TPPs.

Marketplace arrangement: adding and integrating to FinTechs(fintech2customer).


Digital and “challenger” banks There are more than 40

challenger banks in the UK at the moment

Majority are digital banks (no branches – app only) and are native to open APIs as well as platforms.

Low costs; some have banking license/others sub-license.

Operate on the basis of modular architecture; often “borrow” a core banking engine (Wirecard; Fidor, etc.)


Neo-Banks ”getting it”


API Aggregator platforms Owns/controls the API layer

infrastructure by putting forward the technology, APIs, etc.

Cloud arrangement controlling information in the process.

Marketplace arrangement: adding and integrating banks to FinTechs(come control over curation).(banks2fintechs)


Bud- Sign up: https://thisisbud.com- Link all your accounts on bud (white-labelled for banks)- Search for services/fintechs on their listings- Consume other products via bud platform- Open APIs (or screen scraping e.g. Yodlee)


“Bank-less” API marketplacesOpen source APIs for banks (since 2010):


Account Aggregator platforms + services Owns/controls the distribution

layer by providing a customer interface that gives access to all bank account info.

Marketplace arrangement: adding and integrating to external services (either in finance and/or to utilities, etc.) –(bank2customer2service).


Loot Bank app- Sign up: Loot.io- On-boarding in 5 minutes- Receive instant account- Receive pre-paid MasterCard via WireCard(white-labelled)…


Yolt by ING Bank (in the UK)- Account Aggregation- PFM tool- Payment initiation- Compare offerings

(energy deals, Foreign Exchange, international payments, etx.)


Challenges around Open Banking Open Banking and PSD2 implementation hasn’t

been easy. Both Banks and FinTechs face different

difficulties. Various challenges have emerged:


Brand equity For Open Banking, “branding is a big challenge… I am seeing the logo

many times, getting frequent reinforcement of the relationship that I have with my bank. If I start to do that somewhere else, that reinforcement is gone.”

APIs open the possibility of “white labeling”

“The battleground will be either on the channel and customer engagement side [choice of platform or marketplace] and the services provided [value proposition].”

Challenges for smaller players as they try to establish their brand and compete with incumbents:“…one negative experience can be very hard to over come.“


Brand equity

“Are you ok being Nascar? If you keep your brand, can you get the best FinTechs?”


Establishing Trust Scale and trust are on the side of the incumbents “Banking, no matter how fun theymake it, isn’t really fun – ideallywhat you want is peace of mindand minimal interaction. This giveslarge and established banks a hugeadvantage.”

Smaller players may struggleto “convince” customers to trustthem with their money (securityconcerns).


Time-to-market vs. security Fintechs: “We need the banks to get to the consumer, and the banks

need us, we are the small guys who can innovate, but even if they realisethat, how do you move a giant at the same speed as yourself?”

Banks: “I’m absolutely sure we will have a case somewhere, also in our portfolio, where something doesn’t all work right and we’ll have to deal with that. That was one of the discussions we had with compliance, how do we manage reputation in that case?”


Enhance transparency Banks and other providers will need to revisit and justify pricing of their

services as APIs will expose costs:

“if you look at all the regulation – PSD2, IDD, etc. – they are all specific about how you have to be very explicit regarding how you charge for your financial services... how [you] justify the cost… you have to unbundle so it has to be very easy for me to buy only what I need…”

Banks and TPP will compete on service quality as comparisons will be much easier to communicate via APIs.


Who “owns” the customer?

Modularity in services –

the “unbundling of the bank”

Customer data ownership?

Wider access to customer

intelligence and the “sharing of the customer”


Collaboration with Smaller Players (Fintech 2.0) Collaboration is a relatively new concept in banking Will banks be able to let go of their traditional business model

and rethink revenues/security standards/data to collaborate? APIs have been within closed systems so far (private) Lessons from mobile payments (Ozcan, 2014)

Will regulation/market make it easier to co-create products and services? API standardisation will ease the process of working with

developers


Partner or Acquire? Will banks go the route of acquiring or

partnering with competitors? Lessons from academic studies on co-opetition

Thinking again about transaction costs and the cost to integrate versus “partner” based on a platform (or market?) model.


Competing with other platforms and building an Ecosystem A future where banks (& fintechs) will potentially

need to compete with technology / platform providers (e.g. Amazon, Facebook, Alipay, Apple) at a more leveled playing field.

This may be a particular challenge for banks as they have much less experience than these other players in building ecosystems.


’Platform-as-a-Bank’ Platform-based “high-tech” companies moving into the

finance space – platform envelopment (major overlap of client-base! (Eisenmann et al., 2011).– Facebook Messenger allowing for TransferWise X-border Payments- Facebook registered for E-money license in Ireland (December 2016) moving into payments.- More will follow… (e.g. Amazon Payments/P2P Lending, etc.)


Email: [email protected]: @MarkosZachLinkedin: https://uk.linkedin.com/in/markoszachariadis

mailto:[email protected]

https://twitter.com/MarkosZach

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Dr. Markos Zachariadis Associate Professor of Information ... · SWIFT Network (Scott and ......

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