Open Banking: What it is & how it will change banking?
By: Samuel G. Smith
Tags: Open Banking, Financial Services, Banking, Fintech

Definition

Open banking: Banks sharing data through application programming interface’s (APIs) with third party developers, who provide financial services to the marketplace. I.e. Instead of using your credit card to make payments online, companies can allow your bank account to make payments directly online, avoiding the credit card fees.

How it is applied

The third parties figuratively sit atop the financial institutions, and get access to the bank accounts, and other information of the bank by paying a regular fee to the bank. Third party developers then use the banking data, to provide financial services to the marketplace, in competition with the banks themselves. Designed to increase banking competition, open banking doubles as a way of taking a large step forward in changing the way financial services are offered.

EY offers the idea of the four pillars of adoption, which can be directly applied to open banking. These outline the likelihood that open banking will take-on an grow in any given environment:

(1) Regulatory environment.

(2) Adoption potential.

(3) Consumer sentiment.

(4) Innovation environment.

(1) How open are banks and governments to the idea of large data sharing?

(2) Do the current behaviours of consumers in a given region make it seem likely open banking practices will be adopted?

(3) What are the consumers thought’s on open banking and personal data sharing?

(4) Is the entrepreneurial environment likely to foster innovation amongst financial firms?

Arguments for

It could be said that the current financial services sector largely looks indifferent from its state in the early 20th century. Be that good or bad, one could say that this was the result of the incumbents creating high barriers to entry, and crushing (or acquiring) any entrepreneurial hopefuls to stymie any change in the industry — just look at the lobbying against increasing transaction speeds by banks in the US. The enforcement of open banking then seeks to be a forceful play to invite innovation into the sector.

Primarily designed to foster competition in financial services, there are inevitably going to be side effects. As a by product, we expect to see smaller entrepreneurial firms take their piece of the market, in a way in which we hope to foster innovative changes, for the betterment of society. Where the push is needed most is consumer sentiment. The majority of consumers are not jumping at the idea of banks sharing their data, one exception to this may be China. Take the UK, people are more likely to get divorced (8.4% per year) than switch banks (4% per year).

Arguments against

Banks can understandably be opposed to the idea of open banking, after all, other than some measly fees from the third-parties, they don’t stand to gain much from the initiative directly. Bain & Co. studied this, and noted 10–20% of banking profits could be at risk in this space. However, when we step away from banks there are still structural issues with open banking that need be addressed.

The stand out issue is privacy. In the wake of the EU introducing the general data protection regulation (GDPR) consumers are hesitant and firms are cautious when it comes to data sharing for fears of a breach. That regulation is leading the charge in implementing open banking helps overcome this partially, however the question becomes; how can we help consumers become comfortable with the idea of sharing their banking data openly with third party institutions?

Customers considered “high-risk” from the banks perspective — high risk meaning customers most likely to adopt fintec solutions — fall predominantly in the young & affluent category. This is estimated as 55 years or younger, with an average income of GBP 55,000 or more. Bain & Co. say despite covering only 15–20% of the banks clientele, they are responsible for approximately 45% of banking profits. Once these clients are on board, we can expect a gradual shift toward open banking practices with increasingly less resistance to data sharing practices. So is it necessary that regulators force adoption onto the consumers? Perhaps not. The path to open banking seems inevitable now, though we can expect without a push, the path to full adoption will be more delayed.

One more nuanced argument against open banking, goes to state that the market lends itself not to atomistic competition, but rather sets itself up to be dominated by the tech giants; Facebook, Amazon, Apple, Google, etc. The structure of open banking reduces entry requirements for firms. Unfortunately, these same entry requirements are required for both small fintec’s and large tech multinationals, yet the tech giants have far greater power to capitalise on the space. Now, this argument doesn’t go so far as to say that having Facebook ,etc. operate new transaction processing systems on the consumers behalf will be necessarily detrimental to the consumer. But, the purpose of open banking was to remove monopolies in financial services, not to aid in creating larger ones outside the space.

Current global implementations

Globally the approach to open banking varies, largely in the regulatory sense. The United Kingdom is leading the charge, with a regulatory push, enforcing open banking since early 2018, whereas Singapore incubated a fintech industry to foster competition in its local market. Despite different approaches to open banking, there remain similarities; (1) financial services as we currently know them are changing (how fast, we don’t know). (2) There is an increased demand for data sharing, forcing a heavy reliance on the use of APIs.