Paid Feature The banking landscape has changed so drastically in the last couple of decades that digital banks now pose an existential threat to mature and historic players.
As Lance Homer, Equinix business development director, digital payments and banking, puts it: “It's no longer about the big eating the small, it's about the fast eating the slow.”
It’s clear that traditional banks need to go digital or risk losing market share. Demand for digital banking is growing fast as consumers change their banking habits, traditional banks are shutting branches in record numbers, and competition is becoming fiercer. Even the challenger banks don’t entirely escape the need for ongoing development of digital banking and the payments and banking infrastructure.
“The start point for modernisation is unique for every banking business,” says Adrian Mountstephens, business development senior manager, digital payments and banking, at Equinix. It’s dependent on many factors - where in the world you are, whether the business is expanding, whether there's capital, whether it’s a 20-year-old or a 200-year-old business, and more.
“If you're at Starling, Monzo or Revolut then you’re in a modern business and in the cloud, so you get all the advantages that go with it,” says Mountstephens. “But if you're in a European high street bank that's been around for 100 years you’ve got quite a lot on your plate. You’re closing branches, looking at the debt book, at Covid loans, at growth, inflation and interest rates. And the CIO is being told the business has got to be more like Starling, Monzo and Revolut.”
As Mountstephens says, traditional banks are not playing with the best hand. They have huge investments in legacy tech, which naturally informs their response to modernisation and drives their decision making.
According to Ciaran Chu, head of cloud transformation at payment solutions company ACI Worldwide, 85 per cent of IT budgets in traditional banks is aimed at keeping the lights on, so there’s relatively little left in the pot for transformation. At the same time these businesses know they need to move from this centralised and rigid legacy architecture to a hybrid distributed platform that is agile, connected to other ecosystems and distributed at the edge.
Says Homer: “Banks need to assess what they want to be in the future and how they get there. It will be different for everybody, but some of the past strategic differentiators and barriers to entry have changed.”
Equinix points to the following key trends behind banking and payments modernisation, which Homer says need to be considered holistically rather than in isolation. They are:
- banking as a service (BaaS)
- core banking modernisation
- local processing of banking and payments
- real-time domestic payments
- open banking
- cross-border payment rails.
According to Homer, these six trends fit into three types of deployments - Infrastructure, Edge and Exchange. Infrastructure deployments like Banking as a Service and core banking modernisation are often hybrid cloud in nature and driven by proximity to cloud providers. Edge deployments will be done to solve latency, data sovereignty or other regulatory requirements that require infrastructure to be in a particular geography for local banking or real-time payments. Exchange deployments are driven by the need to be adjacent to the customer and partners in the payments and banking ecosystem for both open banking or the various payment rails.
Let’s take a look at each trend.
Banking as a service
BaaS enables businesses to offer banking functions without having a banking license. Fintechs, in particular, can leverage BaaS for quick market entry with significantly lower upfront capital investment. For the bank, BaaS offers a way to expand their reach, gaining new revenue and new customers, through the non-financial companies white labeling the bank’s services.
UK digital bank Starling, for example, has a BaaS technology package, dubbed “Starling-as-a-service”, that allows a business to build its own financial products on Starling’s banking platform. Starling launched BaaS in the UK in 2018 where it has 25 payment and banking services customers, including Raisin, Moneybox and Vitesse.
The service launches in France, Germany, the Netherlands and Spain next year, with Starling handling the technical and regulatory demands, and enabling its customers to focus on their customers. Homer says that BaaS has the potential to grow as it becomes easier to separate the component parts of a bank, with new entrants choosing the services they need.
Banks contemplating offering BaaS should be considering private network connectivity for lower latency, reliability, and security to their customers, whether they are in the cloud or colo. The ability to do this with software-defined networks and virtual circuits can be done quickly and cost effectively.
Core banking modernisation
Centralised, mainframe-based, with limited data exchange and reliant on batch processing - it seems that core banking systems have been around forever. Their modernisation is typically viewed as very expensive and high risk. But to be fully digital, stay relevant and meet customer expectations of real-time insights either from the bank or from the fintechs who access customer data at the bank, CIOs need to modernise this core. Core banking software vendors need to show that the bank’s core banking projects can be successfully delivered on time and on budget.
Beyond the challenge of system integration, banks can struggle to connect and have a plan for downsizing systems around the core banking system that are not ready for the cloud or the bank doesn’t want to put in the cloud. Bare metal as a service is emerging as a way for a bank to tackle this challenge.
Local processing of banking and payments
Challenger banks are expanding and moving into new markets. Traditional banks that operate across a number of countries are moving towards a distributed architecture to provide a better, lower-latency, user experience, and also to comply with data localisation and sovereignty requirements and keep data within a country.
Some markets are becoming stricter about this, and globally the requirement for data localisation is on the rise. In Malaysia now, for example, all transactions on domestic payment cards must be processed onshore. And in 2019, in response to growth in e-wallets, the Reserve Bank of India stated that payment data should be stored in systems located in India.
It makes sense for financial institutions to respond to this trend with localised hubs and digital infrastructure that can be run as-a-service. It allows them to comply with local regulations and turn services up and down quickly as needed. Additionally, finding a global partner that can support and connect the bank or payment company’s infrastructure in all of their critical markets is a key consideration.
Real-time domestic payments
Real-time payment (RTP) and instant payment schemes are on the rise - there were 56 RTP platforms operating around the world in 2020, and many more are under development. With them comes the need for financial institutions to move from batch to real-time processing and to upgrade their IT infrastructure to connect to real-time payment platforms. Real-time payments also require banks to be able to receive and process data-rich messaging formats like ISO20022.
Real-time payment systems are more demanding - technically and operationally - than batch payments, says Homer, and require more resilient network infrastructure. With the need for lower latency and ultra-high availability, the RTP ecosystem participants are best off colocating in the same facility where access to the real-time payments platform resides.
The drive towards open banking - aimed at giving customers a clearer view of their financial data - means that banks must create APIs, so that third parties can access the customer’s banking data with their consent. Open banking is driven by regulation in some parts of the world and by innovation in others. In Europe, PSD2, the EU’s revised payment services directive, is complete and in the UK, the CMA’s Open Banking initiative continues to mature. Market forces are driving adoption in the Americas and APAC.
The success of Revolut in Europe is forcing a reaction from European banks, says Mountstephens. With its “one app, all things money” Revolut is sweeping up customers across the continent, he says - in 2020 its retail customers hit 14.5 million compared with 10 million in 2019.
As Open Banking continues to grow and becomes critical market infrastructure, it will be important that the participants - banks and fintechs - have robust and secure connections to each other similar to how all other financial rails have done.
Cross-border payment rails
Payment rails are not immune from the need to modernise their infrastructure either as their customers move to the cloud and new business opportunities form. For example, cloud-based payment companies can’t deploy the traditional routers and servers that Visa or MasterCard typically provide, in their cloud provider’s data centre. As a result of this move to cloud, the payment rails are modernising the ways their customers can connect to them. Visa, for example, recently launched Visa Cloud Connect, which offers their customers who are in the cloud a secure way to connect to VisaNet, its global processing network.
The credit payment rails are aware of the trends around open banking and real-time payments; seeking ways they can make this into new business opportunities for their large and widely connected global networks. The opportunity for the payment rails is to become a network of networks that tie together local real-time payment ecosystems and act as a bridge between banks and fintechs. Therefore, being adjacent to cloud providers and having network access at the edge in the market where real-time payment platforms reside is critical.
These trends all share some common themes: real-time processing, open access to ecosystems of customers and partners using APIs, enhanced data sets, and rapid product development cycles. Whereas once banks differentiated themselves according to their interest rates as well as numbers and locations of ATMs and physical branches, now, says Homer, their differentiation is all about the products they can offer - and speed matters in launching and improving those products.
Mountstephens adds: “The challenge the banks have is how to keep up with the likes of Starling and Revolut who are responding to these trends better and faster and will attract customers and take the bank’s revenue if they don’t react quickly. With their existing IT capabilities they can make one product release a year, so they need something that runs in the cloud that allows them to make continuous new product releases with a really lightweight touch.”
Equinix has been interconnecting companies and helping them share data for over 20 years and has 10,000 customers - 1,200 in financial services - so it’s not unreasonable for Homer to refer to Equinix as “the world's digital infrastructure provider”. “A customer can deploy servers or network equipment as-a-service, inside Equinix, anywhere we operate, quickly and efficiently,” he says.
Adds Mountstephens: “It means we're uniquely positioned to help those businesses on their digital transformation and modernisation, because we’re helping hundreds of them every day. We can see the successes and the failures. And we have a team of solution architects who help our customers to take the steps they need to, in order to effect a new model of IT infrastructure that is as-a-service, agile, nimble and cost effective, wherever they need it to be.”
Sponsored by Equinix.