Open banking allows third-party developers to build applications and services that plug into the technology backbone of a traditional financial institution. Using open-source technology and APIs, third-parties can build new financial tools leveraging private customer data that was previously inaccessible. This is why — in theory, at least — open banking promises to accelerate innovation, thereby giving consumers more options and greater convenience.
In the U.K., open banking has been law. In August 2016, regulators there issued a ruling requiring the nine biggest banks — HSBC, Barclays, RBS, Santander, Bank of Ireland, Allied Irish Bank, Danske Bank, Lloyds and Nationwide — to allow licensed startups direct access to their data, including account transactions. Europe followed in January 2018 with the PSD2 rules requiring European banks to share customer transaction data with third parties that request it (with customer consent).
In the U.S. and elsewhere, open banking freaks out most executives working in the financial industry. The prospect of opening up all the information they have about their customers is a scary proposition. But like it or not, open banking is a reality, and it’s here to stay.
Proponents of open banking say fears are unwarranted. It provides the opportunity to increase market scope, to offset diminishing payment revenue streams and, perhaps most importantly, can help position an institution as a provider of the best products and experience. This is why a small, but growing, number of financial institutions are already experimenting with it.
One way or the other, open banking will continue to propel (or drag) the banking industry into the digital future, forever changing the way the industry has traditionally functioned. It definitely pushes most financial industry executives outside their comfort zone.
“Open banking is the attempt to move away from banking as a vertically integrated business where you have an institution controlling almost everything from the front-end customer management to the product manufacturing through balance sheet and risk management,” says Alan McIntyre, Senior Managing Director of Global Banking at Accenture. Instead, he says, the business world is becoming a series of horizontal layers that connect with each other and exchange data easily.
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“Vertical integration in banking is on its way out.”
— Gianluca Corradi, Simon-Kucher
“Vertical integration in banking is on its way out,” wrote Gianluca Corradi and Oliver Peacock, both with Simon-Kucher & Partners in International Banker
The two consultants hold up IBM as an example of what banks should not do. The once-dominant computer company nearly succumbed because it failed to recognize the fact that the computing was no longer a vertically integrated business. “It didn’t react to change until the only advantage it had left was its ability to integrate computer systems for large businesses. It survived the industry’s paradigm shift — when it could have thrived.”
Their conclusion: Banking providers that are unconcerned about open banking need to rethink their attitude — and strategies.
Driven by Competition, Not Regulation
Presently, U.S. financial institutions are not required to open their customer and transaction data up to third-party providers. While the likelihood of a government mandate in the U.S. seems slim today, regulatory winds could quickly shift under a new administration. For the time being, U.S. regulators are more likely to set guardrails around data sharing. The Consumer Financial Protection Bureau’s 2017 data sharing data sharing principles encourage sharing, without requiring it.
Required or not, McIntyre at Accenture says open banking has potential in the U.S. to become a competitive weapon — or at least a defensive one. He points to Capital One’s DevExchange, BBVA’s banking-as-a-service platform, and CBW Bank’s Ylabs Marketplace as examples of multilateral exchanges that make APIs available to anyone to use.
Down the road, the majority of U.S. banks and credit unions could be facing the prospect of numerous financial institutions operating as Amazon-like platforms for cutting edge financial products and services.
Legacy Technology Continues To Be a Big Hurdle
PwC predicts that in the U.K., 64% of consumers and 71% of businesses will be using financial tools built on open banking platforms by 2022. But will open banking be the final nail in the coffin for traditional banks and credit unions in the U.S.? That’s a stretch at this point. After 25 years, Amazon is the dominant retail player, but they aren’t the only success story. The world’s most valuable company has undeniably changed the landscape, however. And a platform or “ecosystem” built around a similar approach in banking could do likewise.
“Banks can continue as usual, but without a plan for the new landscape, this position is not likely to be a winner.”
— Mobey Forum
Experts generally agree that traditional financial institutions don’t have to just wait to be disrupted. They can turn a threat into an opportunity. That’s easier said than done. Moving to an open, or platform, business model is a major change of direction. Besides convincing senior executives and boards, it requires the kind of modern technology that most U.S. banks and credit unions currently don’t have. The vast majority continue to operate using older versions of core software.
In a report, Mobey Forum says, “Banks can continue banking as usual — producing and distributing their own products. However, without a strategic plan for the new landscape, this position is not likely to be a winner.”
“Even the most modern versions of most banks’ core platforms,” McIntyre maintains, “are not software-as-a-service, like Salesforce, where every six months you get a new release with the latest features and functionality.”
That reality greatly hinders the kind of agility and innovation needed to implement open banking.
But Wait… Didn’t Open Banking in the U.K. Flop?
On the first anniversary of PSD2, a U.K. tabloid ran with this headline: “‘Biggest banking shake up’ fails to increase current account switching.”
Many U.S. financial institutions may wonder how seriously they need to take the open banking call-to-arms when they read headlines like this one. But that’s not the whole story.
Initial rules focused on banks making data available to third parties for aggregation purposes and for payment initiation. Only the data aggregation part of PSD2 has taken effect, McIntyre points out. The payment part doesn’t kick in until September 2019. “That’s where I think the real action will begin to happen,” the consultant says.
As an example, he points to what Deutsche Bank is doing with the International Air Transport Association. The two organizations are building a system where airline ticket purchases don’t go through traditional card networks, but are handled as direct bank-to-bank payments using PSD2 mechanisms.
“I tell American institutions that that’s what they should watch and learn from,” McIntyre says. “If merchants really start to drive customer adoption, you could see a material change very quickly.”
According to McIntyre, several of the big traditional U.K. banks, including HSBC and Royal Bank of Scotland, have embraced open banking rules to move closer to the “Amazon approach” to business. They are beginning to offer third-party products and services alongside — or in lieu of — their own.
Using open banking, HSBC’s Connected Money app allows customers to see all of their current account, savings and mortgage accounts in one place, regardless of the provider.
All that “goes go a long way to building customer trust by showing you’re not trying to do everything, and that you’re able to orchestrate good third-party products and services as well as your own,” McIntyre observes. These have to be good products and services, of course, and not just things you get paid to push, he adds.
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5 Ways Open Banking Can Benefit Banking Providers
Some executives in the financial industry will struggle seeing how it’s in their institution’s interest to promote open banking, since they have to “give away” valuable data to third-party providers. In some scenarios that might be true, but adopting open banking could be a defensive strategy to (1) fight the onslaught of fintechs, neo-banks and other disruptive challengers, while (2) remaining competitive with other institutions that have embraced it.
Nevertheless, opening up your banking platform does afford some significant benefits and opportunities.
1. Expanded portfolio of products and services. As described by Mobey Forum, banks and credit unions can take the role of “producer”, “distributor” or both. As producers, they would offer their own products through third-party channels. As distributors, they would give consumers access to other companies’ financial products. Either way, this gives the institution a more complete portfolio, and exposure to a wider range of potential customers — what some call the “network effect.”
2. Greater personalization. Increased transparency and data-driven tools will assist consumers in managing their financial lives. MX points out how that, in turn, improves relationships and profitability of the financial institutions that provide them. To accomplish this, banks and credit unions can use third parties’ customer knowledge to improve their own understanding of the segments they serve.
3. Generate alternative revenue streams. McIntyre and others say payment transaction fees are a diminishing stream, and that data-access fees in an open banking model can help offset that. BBVA is one bank already charging micropayments for data access, McIntyre says.
4. Eliminate “screen scraping.” In the past, screen scraping allowed third parties to access financial data by logging into digital portals on behalf of a financial institutions’ customers. It typically involves creating a mirrored login page, which looks and feels similar to the institution’s online login page. The customer enters their login details and passwords so the third party can use its screen scraping tools to copy available data to an external database. The practice is generally hated by banking institutions for security and customer control reasons. Open banking does away with the need because under most regimes, third parties must meet security requirements to qualify for access. As for control of customer data, however, that horse is out of the barn. Increasingly consumers are exerting control over their data.
5. Stealing business. Canadian banker Lionel Pimpin, SVP/Digital Channels at National Bank of Canada, says open banking is a two-way street. National created a digital hub where business clients can display both in-house [on-us] and external [on-others] accounts. That’s not only convenient for the business customer, it’s an opportunity for National to steal some business, as long as the client grants permission to view the data that they have imported from rival institutions.