Open banking: more margin cuts?

New regulations designed to boost banking competition in Europe will be a win for customers but bad news for the banks, both incumbents and challengers.

Open banking legislation – the European payment services directive (PSD2) and the UK open banking standards – will compel banks to offer third parties access to customer transaction and balance information.

Under this regime, banks must treat such requests on an equal basis to requests from its own systems. Also, lenders may not charge for such access – say, providing a history of transactions on an account – unless a customer would have to pay for this if they came direct.

UBS analyst Jason Napier expects greater impetus to fee-driven banking as a result, particularly in markets such as the UK which begin with a (largely) free in-credit model.

“But that’s a difficult transition to sell to customers," he said. “Overall, the customer wins, we think. Open banking will mean more transparent and effective oversight of their finances.

"Customers will better understand the cost of their banking and the returns and fees generated by their savings and investments. And it will become faster and less risky to change service providers."

Key questions

The key questions for Napier are how rapidly customer behavior changes and whether incumbent banks – which will set the price for credit – are able to adapt.

In short, he argued in a client note, the customer wins, churn rises and product margins likely come under pressure, all else being equal.

“The key questions, to our mind, are how quickly this happens, how significant the margin pressure might be, and whether increased efficiency is an adequate offset.”

As the UBS analyst sees it, this will result in a better deal for customers but is a long-run threat to bank margins and market shares.

Lower product margins and higher churn underlines the importance of cost effective funding as well as lower processing and distribution costsprocessing and distribution.

“In the near term, we think that incumbent banks have the most to fear from each other. Brands are well established; balance sheets are generally strong and products largely commoditised," said Napier.

The ability to take share in a more fluid market, therefore, comes down to differences in funding costs and cost to serve as well as risk appetite and return aspirations.

“Lenders usually won't pursue and certainly wouldn't admit to a strategy of seeking sub-par returns or higher-than-average risk, in our view," he added. “In the next downturn, we'll learn which firms were forced into this approach and we suspect UK unsecured lending could be an area in which this shows up.”

'Too complex'

On the one hand, Napier argued, the incumbent banks have scale, customer inertia and competitive advantage in funding. “But they're also too complex and facing an expensive and drawn-out requirement to replace their aging core banking platforms, we think.”

New players have the edge in processing but lack cost effective funding, according to the analyst. As he sees it, this problem will become more acute when cheap central bank facilities wind down.

Access to cost effective funding from central bank schemes have all but eliminated flow funding cost disadvantages. But Napier expects this situation will likely normalise over the next 5 to10 years, barring any negative geopolitical or economic events which could force more stimulus and lower rates.

“New entrants have never had it so easy, bank-in-a-box technology allows start-ups like Metro Bank to open on the high street with relatively modest cash burn," he said. 

"Regulators, like those in the UK, are publicly committed to simpler, cheaper and more rapid approval of new entrants. There are significant regulatory hurdles to negotiate in setting up a new bank but massive cost is not one of them."

The UK’s open banking regime starts in January while PSD2 takes effect in the rest of Europe in 2020.

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