#Open Banking

Cost-to-income ratio: Reducing TCO and speeding up TTM

Sep 29, 2020 - 7 min read
Bruno Cambounet, Head of product marketing and digital solutions at Sopra Banking Software

Amidst a global pandemic, challenging macroeconomic conditions, the rise of new competition and ever-evolving customer demands, banks are under pressure to keep their total cost of ownership (TCO) down. 

TCO is a method of determining the overall cost of a product or service throughout its lifecycle — combining both direct and indirect costs. By knowing the TCO of a product or service, financial institutions can improve efficiency and drive down costs with industrialization, outsourcing and other cost-cutting techniques.

However, given current economic conditions and the fast-moving nature of the digital economy, cost-cutting alone is no longer enough. The TCO method is not as effective as it once was. Therefore, cost-to-income ratios have to be managed to ensure products and services are financially viable. To maintain profitability, banks need to reduce costs and expedite time to market (TTM), and to this end, open banking is a potential enabler. 

A growing challenge

In banking, the target cost-to-income ratio has moved from approximately 70 percent to below 50 percent. According to a 2019 Statista report, many banks are struggling to meet this benchmark. Last year’s average cost-to-income ratio in Germany was 84 percent; in France, it was 72 percent — both higher than the European Union average of 64 percent. Within these numbers, digital-only banks held a significant advantage — at least where TCO is concerned — reporting a lower rate by almost 25 percent. 

The problem for legacy banks is that service delivery is an ever-moving target and, as such, TCO analysis cannot simply rely on “traditional banking services,” such as account management. Rather, these banks need to uncover new sources of revenue.

To add further complexity, in the current digital economy, businesses need to have a laser-fast TTM to be competitive. Speed, however, is one area where banking lags behind other industries. According to Oliver Wyman partner Barrie Wilkinson, established financial firms are “hamstrung by legacy technology and organizational inertia that make new products slow and costly to develop. It takes traditional banks anywhere from three to six months to launch offerings that fintechs can introduce in two weeks.”

One solution is to become more active in the open banking ecosystem. This enables banks to speed up product development and lower their cost-to-income ratios with new, sustainable revenue streams that are futureproof and scalable. 

Complicating factors

The cost-to-income ratio is problematic for many banks because if cost-cutting alone isn’t enough, identifying new revenue quickly is key and difficult to assess. Yet, that doesn’t mean banks should take longer to assess market traction. Doing so will come at the cost of slower TTM and lost ground in the competitive landscape.  

If a bank fails to innovate in terms of customer and market opportunities, it is likely to become irrelevant. This is well-recognized in the industry, with 40 percent of European banks focusing on reducing TTM, according to Forrester. A critical element of this is finding more time-efficient ways to assess market traction. This is about testing, analyzing continuously and scaling up what works while minimizing what doesn’t. 

It is crucial that banks find ways to create faster product and service-lifecycle management. This is a challenge because, when it comes to innovation practices, financial institutions have proven to be less productive than software companies.

Those that have managed this successfully cite strategies that rely on minimizing approval cycles, fostering a connection between executive stakeholders and technical staff, and adopting agile development. While everyone wants to “go agile,” some are weighted with legacy systems. 

Open banking foundations

Pre-PSD2 pioneer SOFORT, a Europe-wide direct credit transfer service, allows people to transact without creating an account. SOFORT serves as a data intermediary between the merchant and the customer’s bank — users simply input their online banking credentials to use the system.

Years ago, many non-bank players were created to provide end customers with a comprehensive view of their financial data, and such practices initiated the creation of open banking regulations like PSD2 in the EU.

Such services have been included in the banking services portfolio. For example, Linxo, a French company that provides APIs and complete white-label apps for banking and insurance startups. Earlier this year, Linxo was acquired by Credit Agricole to “create opportunities for new digital and innovation services based on financial data for the retail, professional and corporate customers of the bank.” 

Open banking is perhaps the most promising opportunity to address the problems mentioned above. But for banks to leverage open banking’s true potential, they must go far beyond aggregation.

Bridging the profitability gap

The Covid-19 pandemic has accelerated digital transformation across the financial industry, and things are changing faster now than ever. Since PSD2 regulation came into effect in 2019, momentum has been growing, and the market is now ready to embrace open banking. 

For instance, the Berlin Group open banking standard is currently adding new APIs to the PSD2 regulatory standard to help support use cases beyond compliance. This is a clear step toward affording banks the ability to combine internal and external services to support the market.

Open banking can now be viewed as an opportunity, not an imperative. By being part of an open ecosystem, banks can position their platforms as open banking enablers. To do this, they need to be open, scalable, accessible, versatile enough to combine services and also have service-monitoring capabilities so as to better support decision-making processes, in particular to scale up or down any service and make sure it stays attractive.

By embracing these characteristics, banks can reduce product and service-lifecycle management by working with partners to test and analyze the market. They can gain access to wider marketing opportunities. And they can easily add new products and services to their existing catalog without lengthy and expensive R&D. These new products and services can rapidly be brought to the market, making a bank more adaptable to the consumer’s latest needs.  

By becoming more active participants in the open banking ecosystem, financial institutions can quickly assess traction, test product-market fit, deploy new products and scale successful ones. In this way, they adopt a software company’s speed, reducing TCO, uncovering new revenue, and ultimately lowering cost-to-income ratios.