Outsourcing and competition in the banking sector: the rise of Cloud Service Providers

Cloud outsourcing may alter competition in banking by allowing smaller competitors to access scalable digital infrastructure. This paper studies the effects of banks’ outsourcing agreements with Cloud Service Providers (CSPs) in the UK banking sector using proprietary bank-provider contract data. We find that CSP spending is associated with lower operating costs and higher deposits, with reduced-form effects concentrated among large institutions. We also find that increases in capital requirements are associated with higher CSP spending, consistent with large institutions using CSP adoption to reduce dependence on legacy IT systems, improve operational efficiency, and strengthen long-term franchise value. We then estimate a structural model of competition in the UK deposit market to quantify depositor-demand effects from CSPs. We find that the demand-side benefits of CSP adoption are substantially larger for small and medium banks and building societies. We use the model to conduct two counterfactual analyses. First, we simulate a scenario in which cloud outsourcing was restricted prior to its widespread adoption. The counterfactual implies higher market concentration, lower market shares for smaller institutions, and lower depositor welfare. Second, we analyse a reduction in capital requirements. While lower capital requirements directly increase welfare through funding-cost effects, they also reduce incentives to invest in CSP adoption, offsetting roughly 32% of the direct welfare gain. Our findings suggest that cloud outsourcing has partly reduced technological barriers to competition in banking markets.