Direct banks have been around for a while. They first surfaced in the late 1990s with the popularity of internet. However, most early entrants didn’t make it to top of the charts among leading banks in their countries of operations. One can say that they were ahead of their time.
In the last ten years, however, things have dramatically changed in favor of digital businesses. In particular, four factors have led to this transformation. First and foremost, it’s the adoption of mobile devices, particularly smart phones, and consequent evolution of customer consumption patterns. Today, a large section of society is comfortable purchasing products and services online. Global providers like Amazon and Uber have led this transformation supported by a variety of local digital businesses across areas such as food delivery and grocery shopping. Second, the digital identity infrastructure has improved significantly in several countries. The shining example of the same is the Aadhaar program in India which has given digital identity to over a billion citizens in the country. Today the cost of digital onboarding has dropped to $0.07 for recent payment banks from $5 incurred by the commercial banks earlier, thanks to KYC through Aadhaar. Third, in many countries policies around digital contract signing have made it easy to execute contracts online. Fourth, regulators have also encouraged new competition to emerge by lowering the entry barriers and creating a conducive environment though open banking initiatives and new licensing programs. Riding on these advancements, most countries have seen a variety of digital financial startups in the areas of mobile payments, wallets, and peer-to-peer lending, among others. All these factors have created a conducive environment for a viable direct banking proposition.
One can see several diverse businesses – incumbent banks, non-financial organizations and startups tapping into this opportunity and announcing their direct banking initiatives. On one hand, there are bank-in-a-bank propositions where incumbents are launching new offerings such as liv by ENBD, Kotak 811 by Kotak Mahindra Bank, DigiBank by DBS and Nequi by Bancolombia. On the other, we have completely greenfield direct-only banks such as Monzo Bank, Starling Bank and Atom Bank.
I believe we will see many more such announcements globally in the coming months. As the trend grows, upcoming direct banks must keep three nuances in mind to create a successful proposition:
The trend has it that most direct banks offer mobile i.e. app based banking, and online (browser based) banking. The customers who are open to banking with a digital only bank are generally the tech savvy customers who would like to explore other digital channels as well.
Banking on social networks like Facebook, Twitter, newer channels using smart assistants like Amazon’s Alexa, Google Home and Apple’s Siri are not too far away. While a few banks like Ally are taking baby steps in letting customers check balances and make small transactions on smart assistants, it is the path to tread on for direct banks today.
Besides, open banking initiatives and a dynamic FinTech ecosystem imply that direct banks must integrate their products and services into third party platforms and applications.
Therefore, as one starts building the distribution strategy for a direct bank, one must account for multi-channel digital distribution spanning mobile, online, social platforms, smart chat and voice assistants, and APIs led delivery. While the business case for some of these channels may not be strong as yet, these channels will be critical to retain digital-savvy customers.
The recommended way of achieving this is to focus on building a strong foundation for omnichannel delivery by adopting a hub-and-spoke model. One can make strategic investments in an omni-channel hub which can power the channels of delivery required today, and also easily help to scale new channels swiftly over the course of time. It suffices to say that one of the reasons for the slow pace of digital innovation by incumbents is due to silo-based channel applications, a trap emerging digital banks must avoid.
Direct banks prefer to keep a simple portfolio and go by the mantra- ‘do little but do it well’. Banks like Monzo in the UK have focused themselves on building the world’s best current account. Atom bank has focused on Fixed Savers and Mortgages. That’s indeed a great strategy for digital-only businesses.
However, it’s important to remember that today banks no longer need to manufacture their own products to distribute. Thanks to the success of platform business models in other industries, banking is well poised to leverage similar strategies. For instance, Starling Bank in the UK has publically stated its marketplace strategy which focuses on filling number of adjacent spaces by distributing third party products such as Transferwise for international payments, and Flux for offering itemized bills and rewards program.
I believe, the ecosystem approach to offer a comprehensive suite of products and services will come in sharper focus in the coming months and year. From a technology perspective, direct banks that choose modern Open API-driven core platform and omni-channel hub will find themselves enabled to easily exercise this strategy, and propel themselves forward to compete effectively with incumbent’s comprehensive offerings.
Thanks to the lower costs of distribution, direct banks would always have lower servicing costs as compared to full service banks. Clearly, this allows direct banks to offer much better pricing on their products and services to attract consumers. Direct banks in India offer as high as 6% interest on the retail checking account, nearly 50% higher than the best rate offered by incumbents.
However, in the long run, this won’t be enough. One, with multiple direct banks popping up in every country, price-based differentiation will not be sustainable. Also many full service banks have launched their own direct banking brands with similar pricing options.
Clearly, to differentiate in the long run, direct banks would need to build their strength elsewhere. We will see some of them pivoting themselves around the ecosystem strategy, few others finding ways to constantly enhance automation and reduce costs to be the cost leader, while others may focus on specific customer segments and product categories to emerge as category leaders.
Banks would need to leverage personalization and offer tailored experiences keeping in mind the end customers’ needs and behaviors. Building trust in a faceless world is the key to long term mutually beneficial relationships with the customer. And this can be brought about only when the customer is delighted with the experience presented to her. Research has it that one in five customers are willing to pay their bank to understand them 1better). Leveraging customer information to understand customer needs, suggest appropriate goals to them, and recommend the right offers at the right moment will go a long way.
The direct banking business model, while not new, is yet to fully bloom in today’s digital context. Leaders in the space are yet to emerge. The strategic and technology foundations laid by direct banks today will determine their success in the years to come.
The financial brand