A Bank CEO’s Worst Nightmare: Silicon Valley + Banking as a Service

What’s the main thing that Amazon, Microsoft, Alibaba, Google and IBM have in common? They all compete in one key area: on-demand cloud computing. What if they decide to start offering “banking as a service” to enable neobanking in Canada?

By: Jason Periera Editor & Contributor: Alexandra Macqueen

Once Upon a Time . . . in the Valley

Key Insights

• Banks for “digital natives” are not only on the rise – they’re also gaining users much more quickly than conventional banks
  

• Tech giants have transformed the digital realm by acting as infrastructure, and the same opportunity exists in banking
  

• Today, Big Tech is facing the opportunity to turn banking from a “service” to a “feature” – for the entire digital realm

During the dot-com bubble, starting an internet company wasn’t cheap. In addition to high-cost software engineers, you needed significant capital outlay to cover the cost of purchasing, maintaining, and housing servers.

Then, in 2002, Amazon launched a new division that would end up, over time, changing everything. This new division was initially designed to meet Amazon’s internal needs by developing a common architecture, tools, and storage for Amazon’s various projects, and. there was some early discussion about offering this new server infrastructure as a service to third parties. 

Two years later, Amazon Web Services (AWS) – “the world’s most comprehensive and broadly adopted cloud platform” – launched to the public, and we’ve all been feeling the impact ever since. 

No longer do startups need to invest in hardware beyond laptops: they can develop their code and then piggyback on Amazon’s enormous infrastructure to host, store, and provide services to the world. With AWS, Amazon turned a large, fixed-cost outlay for startups into a highly scalable variable cost, while simultaneously building tools for developers so they no longer had to DIY their projects from scratch.

Today, Netflix, Linkedin, Dropbox, Facebook, NASA, Expedia, Slack, AirBnB, the Dow Jones, and countless others all outsource their server infrastructure to AWS – and AWS and similar services such as Microsoft Azure, Alibaba Cloud Compute, Google Cloud, and IBM Cloud have quietly become some of the most profitable divisions at their respective parent companies.

But what do outsourced servers and developer platforms have to do with banking? 

Enter the “Neos”

Readers who have listened to my financial technology podcast Fintech Impact have heard me talk about a presentation from QED Investors called “The Copernican Revolution in Banking.” 

The presentation makes the case that the future for current banking players lies not in their existing offerings, but in becoming infrastructure providers to "neo" or "challenger" banks. 

These banks are designed for digital natives, and they’re often initially developed as apps. To operate, they either sit on top of other banks’ infrastructure and banking licenses – or if they’re large enough, they use their own infrastructure and licenses. 

Because they don’t need an expensive bricks-and-mortar network, neobanks can leverage their cost savings into customer-centric user experiences – higher deposit rates, commission-free currency exchanges, no-cost money transfers, and ancillary services – all wrapped up in marketing directed at defined, niche segments (in the same way that Wealthsimple targets Millennials). 

Don’t believe me? Here are a few standout examples from FP Partners’ research on the neobanking sector:

• Revolut (UK): 30 countries and 8 million depositors in 4 years

• Chime (US): $805 million in venture capital funding, 6.5 million customers

• NuBank (Brazil): $906 million in venture capital funding, 15 million customers

• Koho (Canda): $50 million in venture capital funding, 250,000 customers

The upshot: while neobanks may be burning a lot of venture capital, they’re also acquiring customers at a rate conventional banks can only dream of. 

The Hard Road Ahead, and the Reluctant Dance Partner

But while neobanks are succeeding at attracting new customers, the road ahead is not without challenges. 

If you’re a young tech entrepreneur with a great idea about how you can serve a niche market with a novel neobank, you likely won’t have much choice when it comes to providers for the infrastructure you’ll need (although this depends on the country you’re operating in). 

(For proof, just listen to the episode of Fintech Impact where Koho’s CEO Daniel Eberhard talks about the need to basically develop everything from scratch.) 

The reality is that building a “banking as a service” platform is not a small spend. Will any of the Big Five Canadian banks be willing to allocate precious development dollars to enable new entrants to control the direct relationship with customers, all while using their platform? I have serious doubts. 

From the perspective of the Big Five, they’ve spent literal fortunes developing their brand and quashing competition. So why create competition, even if they stand to benefit from monetizing on infrastructure services without having to market or develop front end experiences? This question is especially pressing in Canada, where we effectively have a banking oligopoly – our banking market has a small number of participants, which together dominate the industry. 

Let's also not forget that bank CEOs, whether Canadian or otherwise, are generally not rewarded for taking risks: instead, they're rewarded for earnings and dividend growth. In fact, this limitation creates a blind spot when competing with big tech, which isn’t subject to such cashflow and risk constraints.

Enter Big Tech

I am not sure where (or when) I first heard it, but a quote that’s always stuck with me is “If you’re a CEO who isn’t in competition with Amazon, you should wake up every morning and thank God that they aren’t in your business – yet.” (And this was before Amazon decided to buy Whole Foods.) After all, it’s hard to compete with a company that apparently isn’t required to show a profit, especially when your company has to deliver consistent dividends. 

So imagine if one of the web services of AWS was . . . banking? Amazon could offer banking as a web service, and anyone could write software that sits on top of that service. This might include, for example, highly automated, white-labelled, frictionless deposit, credit, and transaction services available to anyone who creates the digital banking front-end. 

The result? Banking becomes a feature of your service offering, not a standalone product. 

Think about it: right now, banking and banking services are “a thing” that requires many touchpoints in the physical world – everything from going to an ATM, to online banking, to pulling out your credit card and entering your PIN are points of friction. But “banking as a feature” can integrate all of those steps to reduce friction – and in time, most commercial transactions will be executed simply by putting your thumb on a reader. 

If AWS – or any other cloud-computing providers – decides to incorporate banking into their offering, then neobanks can develop highly specialized offerings paired with highly targeted marketing. From franchisees to professors, or Boomers to Millennials, different niches have different shared experiences and challenges, and their needs are being currently served (or not) by generic offerings. Speaking their individual languages provides a far more compelling sales pitch than telling literally everyone they are “richer than they think” – a point I hammered home in “What the Globe & Mail Missed About Wealthsimple.”

Moving beyond banks, services associated with banking could also be offered by almost any company, in almost any line of business. If I have a credit with Air Canada due to a cancellation, why couldn’t they pay me interest on it? If I want to buy a TV from Costco, why shouldn’t Costco be able to offer financing on terms they set out, not those set by my credit card? 

Worth The Challenge? Here’s my Vote

I have no illusions about how difficult the future I’m outlining would be. Banking is one of the most highly regulated sectors in any country, and justifiably so: the security and soundness of a nation’s banking system is paramount to its economic viability. Regulators around the world are not likely to look kindly on allowing any of these listed tech giants to gain a foothold in (yet another) new sector.

Further complicating matters is that these tech providers already offer their services to the financial services sector, meaning expanding directly into banking might only offer up a Faustian bargain – where entering into banking could cost tech providers more business than it wins them. 

The real Faustian bargain may, however, be banking regulation – which protects consumers and the economy, but has largely become a barrier to entry for banking innovation, thus stifling new ideas and the competition from ancillary industries that could lead to improved client experiences and outcomes. In contrast, a tech infrastructure provider shaking things up by enabling banking as a service at an unprecedented scale could be exactly what the industry, and Canadian banking consumers, needs.

After all: If there’s one thing tech companies love, it’s businesses that scale – and nothing scales more than money itself.

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