By Stephen Ptohopoulos ACIB, CCBI*
Disclaimer: Views and opinions expressed are those of the author and are not necessarily those of his employer.
Open banking is the process by which bank customers (consumers and small businesses) share their account, transactions, and financial data with trusted third parties, in a secure and standardised way, enabling the latter to offer the former new and/or better products and services.
Arguably the country where open banking is most developed is the UK, although it has also been rolled out in the Benelux, Germany, the Nordic countries, France, Spain, Portugal and beyond Europe (e.g., Australia).
Open banking has emerged from the changes in the banks’ external operating environment.
Governments and supranational actors (most notably the EU) have sought to increase competition and innovation in the banking and financial services industries.
The role of technological change cannot be understated. Recent decades have seen the falling cost of computing power coupled with the emergence of distributed data processing and storage (Cloud computing). The 1990s saw the World Wide Web (‘Web 1.0’) come of age with the internet gaining traction and which has culminated in the widespread use of mobile devices connected to the internet, most notably smartphones. Open banking would not be feasible from a technological viewpoint were it not for the development of Application Programming Interfaces (APIs) which enable software programmes to ‘talk to each other.’
Incumbent banks began facing threats in the form of new entrants (including fintechs) outside of the narrow confines of the ‘traditional’ industry as entry barriers have lowered. We are increasingly adopting a ‘digital’ lifestyle. The youngest generations (Millennials and Zoomers) are ‘digital natives’ and their impact in society as users and consumers is only set to increase as they come of age and make up a bigger proportion of the overall population. Yet even consumers comprising of older generations, a sizable percentage of them are (at the very least) familiar with the basics and comfortable using mobile devices connected to the internet. The expectations of consumers have increased. While they may still be hesitant to switch banks, this ‘inertia’ is not as strong as it once was.
The regulatory environment has undergone wholesale changes and the impact of new legislation, most notably the General Data Protection Regulation (GDPR) and Second Payment Services Directive (PSD2) has been wide-ranging
PSD2 underpins the legal and regulatory framework of open banking. Therefore, before further discussing the subject matter it is important to outline those aspects of PSD2 that are particularly relevant to open banking.
PSD2 provides the legal and regulatory framework by which accredited third parties provide products and services to bank customers. In PSD2 terminology these accredited third parties are Third Party Providers (TPPs) and bank customers are Payment Service Users (PSUs). Account Servicing Payment Service Providers (AS PSPs) are regulated entities that offer bank account and/or payments services to PSUs, these typically being traditional banks (and therefore have a banking licence). There are two types of TPPs: i) those that offer services by aggregating the PSU’s account data (from all the AS PSPs with which they maintain an account) – Account Information Service Providers (AISPs) and ii) those that enable a PSU to initiate payments – Payment Initiation Service Providers (PISPs). It is important to point out that TPPs do not provide or operate accounts for PSUs and do not themselves handle or hold any transfer funds of the PSU. While TPPs do not require a banking licence the competent home country financial supervisory / regulatory authority regulates them. Furthermore, in the EU and PSD2 context, TPPs must adhere to the Regulatory Technical Standards on strong consumer authentication and secure communication, as prescribed by the European Banking Authority (EBA RTS).
As alluded to earlier, the key motivation behind open banking was its benefits for bank customers, in both the individual (consumer) and small business (SME) market segments.
Examples of benefits for consumers
- Account aggregation service, enabling the consumer to have a ‘single view’ of their financial position (total amount of credit balances and the total amount owed (debt) in the form of overdrafts, bank loans and credit card balances)
- Financial management tools, helping a consumer to budget, avoid getting into debt or help them to save
- Data analytics giving the consumer detailed information about the source of incoming funds, where / what they spend their money on, etc.,
- Price comparison service, enabling a consumer that wants to borrow to ‘shop around’ for the best loan deals on offer in the marketplace
Examples of benefits for small businesses
- Tools enabling a business to prepare their management and financial accounts, invoices, tax, and VAT returns
- Cash management tools
- Tools to help a business secure working capital finance or supply chain finance at the most competitive rates
It is important to point out that a customer’s bank account data will be shared with TPPs only if the customer gives their consent, (as alluded to previously) TPPs are regulated entities and that the legal framework of data processing is that of the GDPR.
As with any development, open banking represents both opportunities and threats for incumbent banks.
The result of PSD2 / open banking can be that a TPP gets to occupy the customer-facing end. An analysis of the value chain shows that this is where most value-added activity occurs and so the party that occupies this space will capture a sizable proportion of the overall value. With a well-designed customer front end, offering a superior user experience (U/X) (when compared to incumbent banks), resulting in elevated levels of customer engagement such TPPs collect a valuable commodity:- data (“if you own the data, you own the customer”). By deploying technologies like Machine Learning / Artificial Intelligence (AI) and Big Data Analytics TPPs can use the acquired data to gain insights and develop personalised offers to users / customers, creating cross-selling opportunities and thus potential new income streams. Therefore, for an incumbent bank there is the threat of disintermediation. Taking this to its logical extreme, it could mean that incumbent banks are relegated to a role in the value chain akin to that of a wholesaler.
To help me better explain the opportunities for incumbent banks I will refer to an excellent report produced by Tink* which is the leading European open banking platform (* The Open Banking Revolution, 2021 Report). Tink identifies four approaches (described by them as open banking archetypes). Irrespective of archetype, PSD2 and (where applicable) open banking mandates that incumbent banks make data available to TPPs via APIs.
Firstly, there are incumbent banks which view PSD2 only as a regulatory compliance issue and elect not to explore business development opportunities that arise from open banking. This is the Compliant Banking archetype.
Other incumbent banks may elect to effectively become infrastructure providers (utilities), enabling third parties to offer banking products and services to their customers. These third parties could be other incumbent banks, other types of financial intermediaries or even businesses in the non-financial sector. For example, an incumbent bank which has best-in-class, proprietary payments or trade finance software systems might wish to leverage (monetise) these intellectual property (IP) assets by making them available to third parties. This is the Banking-as-a-Service (BaaS) archetype.
Some incumbent banks take an approach which is something like “if you can’t beat them, join them.” They seek to leverage open banking to improve customer service and offer better products and services. They do this by partnering with TPPs (which are often fintechs). These incumbent banks seek TPPs that are typically providers of a best-in-class product. TPPs tend to be niche players, focusing on doing one thing well and in doing so provide a superior user experience (U/X) and/or address a ‘pain point’ in the customer journey. The products of TPPs are incorporated into the incumbent bank’s own product mix. This is the Enhanced Banking archetype.
The most radical approach is for an incumbent bank to become a new type of intermediary (digital aggregator), by developing into a financial services supermarket. Just like a supermarket may stock and sell its ‘own label’ products alongside substitute products (brands) of third parties, a bank, along with proprietary products and services could distribute those of third parties (a ‘pick ‘n’ mix’ of financial products). Furthermore, by opening its APIs an incumbent bank enables TPPs to build new products and services for their clients. The bank creates a digital marketplace (platform) bringing together buyers and providers of banking and financial services products. By facilitating (brokering) these exchanges (transactions) the bank generates income streams. This is the Banking-as-a-Platform (BaaP) archetype.
It appears that to date the take-up of open banking has been moderate to low even in countries perceived to be the most ‘mature’ with respect to this development. I do not have any hard facts or figures at hand, so I base this assertion on the few media articles and blogs I have read. It is early days so it would not be surprising if open banking has yet to gain significant traction. I would speculate that the following reasons may be hindering the popularity and widespread adoption of open banking.
- Lack of awareness and consumer information about open banking**
- Lack of financial literacy on the part of consumers**
- Lack of awareness about consumer choices (in terms of alternative banking / financial products and services that may be available)
- Consumers uneasy about sharing their banking, transaction, and financial information with third parties which they know little about or trust (coupled with a lack of awareness about the in-built data protection and data privacy safeguards mandated by the GDPR)
- Reluctance of banks to embrace open banking, seeing it (like PSD2) as a regulatory / administrative burden and/or perceiving it is a competitive threat. To be fair to the incumbent banks, PSD2 / open banking does imply having them undergo what amounts to a seismic shift in mindset and culture. The very reason banks emerged in the eighteenth century was to meet the need for a trusted party, in which customers would lodge for safekeeping their physical financial assets, whereas in the twenty first century PSD2 / open banking mandates that banks make their customer’s data open / accessible to third parties! (And at the same time the banks remain responsible for data protection and cybersecurity)
- The attitude of the domestic regulatory authorities. At the one end of the spectrum there might be regulators that are conservative, risk averse, even hostile to change. At the other extreme are regulators that are very pro-active and open to financial innovation. They are likely to push incumbents to change and innovate and/or induce greater innovation by allowing new entrants. Somewhere in the middle will be those regulators that are passive, largely unaware (or just simply ‘don’t get it’) in terms of changes underway.
**I would argue that industry stakeholders including governments, banking / financial services institutes (training and education providers), regulators, banking industry associations and the banks could be doing more in terms of informing and educating their publics / customers
The report by Tink cited earlier indicates that open banking is a revolutionary rather than an evolutionary development. I believe it will result in ‘win-win’ outcomes, benefiting not only bank customers but also incumbent banks. Open banking is about empowering consumers and small business owners since it puts them in control of their data and financial affairs. It is about innovation, greater consumer choice and enabling bank customers to get better deals. Enhancing the brand, increased customer loyalty and engagement, not to mention new business models, all of which can result in improved financial results are the potential upside for those banks that embrace open banking as an opportunity. Finally, I should also mention what expert commentators have said, which is that open banking is only the beginning, with the bundling of financial and complementary non-financial products, as the boundaries between the two become blurred.
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