The finance industry continues to evolve thanks to technological advancement, sustained innovation, market dynamics, and changing customer needs. This evolution has accelerated in the last two decades with the finance industry undergoing major upheaval and now ranks among the top most disrupted economic sectors. During this period, the financial sector has witnessed an influx of disruptive inventions from fintech startups, money transfer operators (MTOs), mobile banking by telcos, and even big tech like Apple, Google, and Facebook dabbling in financial services provision. These challengers compete with incumbent banks by offering less expensive, more convenient, and faster financial products and services.
Initially, most banks ignored these inventions seeing them as a passing fad and only began taking notice once these start-ups gained mainstream adoption. By then, they had become an unstoppable force, integral to the financial system. Subsequent rapid technological advancement coupled with global smartphone proliferation brought these innovations to the forefront and effectively put an end to legacy banking. Today, these inventions are core elements of the financial system having held their own against banks.
There are no signs that the disruption will stop or slow down. Rather, it is poised to gather pace and completely transform the financial sector as more novel and radical inventions such as blockchain technology are deployed.
The technology is expected to play a huge role as the disruptive wave is headed towards the next frontier: open banking.
What is open banking?
Open banking basically entails sharing of users’ financial information electronically through Application Program Interfaces (APIs) under preapproved conditions. This practice provides open access for consumer banking data to third parties such as other banks, non-bank financial institutions and other financial services providers.
Open banking enables networking and aggregation of users’ financial data across various institutions with the aim of providing customized services.
Financial institutions and third-party service providers can get a more accurate picture about the financial status of a consumer by examining the aggregated data. Such information can be used in determining each customer’s risk levels and terms for instance, when issuing loans.
On the other hand, consumers are made aware of their financial health, which can help in budgeting and decision making. For instance, a customer can use an open banking app to automatically calculate the kind of car or house they can afford using the information from their various accounts. This would be a more reliable assessment as compared to car dealerships or mortgage lending guidelines.
Open Banking adoption
Adoption in Europe and UK
The open banking concept has its roots in Europe and dates back to October 2015 when the European Parliament adopted a revised Payment Services Directive (PSD2). The PSD2 is a European Union (EU) directive for regulating payment services and their providers throughout the EU. The adoption of PSD2 was intended to spur competition in the payments sector and increase participation by non-banks by leveling the playing field. The directive has since been adopted by various EU nations, setting the stage for the creation and adoption of open standards and systems.
In August 2016, the United Kingdom became the first nation to adopt open banking by directing banks to grant licensed start-ups access to their customer data. The results were immediate with great strides made in the first year as seen in the infographic below.
Since then there has been substantial traction with 143 financial services providers joining the UK open banking initiative by September 2019. Interestingly, these financial apps provide a diverse range of services such as personal finance management, consumer credit, and small businesses support. This points to the accomplishment of the EU’s goal of increasing competition and participation.
Several other nations outside the EU are launching their open banking initiatives through either legislative changes (regulatory-driven) or collaborative industry efforts (market-driven).
Hong Kong and Australia have taken a regulatory-driven approach in deploying their open banking initiatives.
The Hong Kong Monetary Authority rolled out the national Open API Framework in July 2018 with 4 stages of implementation. Under this framework, banks will be able to share products and services information at the initial stage with the more sensitive customer transactional data reserved for the fourth stage. The directive also makes provisions for banks to control who they give access to the data.
In Australia, the open banking legislation is embedded in the nation’s Consumer Data Right Act (CDR). The CDR gives consumers control over their data and allows them to choose the third party they grant access to.
USA, India, Japan, Singapore, South Korea, and Nigeria open banking initiatives are market-driven. The banks, fintechs and other financial services providers in these nations are collaborating to establish the data-sharing frameworks in the absence of formal legislative guidelines. Each of these nations is taking own approaches to establish the standards for open banking adoption based on their market and policy objectives.
The Promise of open banking
To the banking industry
You may be tempted to ask, why would banks push for an initiative that definitely increases competition and even threatens to put them out of business? Whereas this is a valid question and a concern for banks, the upsides of open banking by far outweigh its downsides. Its adoption is of even greater importance considering how the economy is rapidly being digitalized. For banks to survive in a digital economy they need digital financial products and services. And open banking enables this. It levels the playing field for banks to compete directly with fintechs, big tech, startups, and other challengers in an open market for a slice of digital finance which is the future of banking.
Open banking grants banks access to huge amounts of data, including that held by competitors which broadens their potential customer base. It also facilitates the development of new products and services suitable for the digital financial ecosystem but not legacy banking platforms. For instance, they can pursue new avenues such as digital lending, retail investments, payments, mobile remittances, and other micro services.
Ideally, open banking opens up multiple opportunities for incumbents adding to their versatility and boosting their dynamism. As such the banking industry willingness to disrupt itself by pursuing the adoption of open banking is neither out of sheer goodwill nor is it a resignation to disruption. Rather, it is a testament to the initiative’s promise to transform their business, or at least keep them in it. Open banking provides the much needed lifeline for these institutions to remain relevant and competitive in a digital economy.
These observations were affirmed in a recent Accenture survey on bank executives at 100 large banks with 65 percent of them stating that they viewed open banking as an opportunity rather than a threat. 55 percent of them revealed that the initiative is a form of differentiation from their traditional competitors and 99 percent plan to make major investments in Open Banking initiatives by 2020. The bankers’ also acknowledge the opportunity to improve the speed and volume of instant payments by combining open banking with the Faster Payments Service (FPS). This is particularly important as instant payments volumes have grown rapidly since the FPS launch in 2008.
These observations not only show the importance of this initiative to banks but also explains the sense of urgency driving its adoption. Accordingly, banks currently have an upper hand in regards to customer trust with data security and privacy. However, this short-term advantage is eroding fast as consumers trust in third party service providers and other competitors is growing. Therefore, it is in the incumbent banks’ interest that open banking is adopted soon whilst they retain such advantages.
As things stand, open banking is inevitable and a necessity for the industry. The only other alternative is capitulation and failure.
Open banking will improve consumer access to financial services through ‘marketplace banking’ comprising multiple products and services from various providers via a single interface. This will raise competition among incumbent banks, fintechs, and other challengers leading to customization with institutions offering individual users tailored, good-value products and services. Customers will be able to choose what offers to take up from the marketplace. They will no longer be confined to what their bank offers but rather will be exposed to a host of propositions. Moreover, customers will be able to establish new relationships that prioritize convenience, transparency, speed and security.
The risk/threats of open banking
The risks of open banking are deeply entrenched in its innate nature. Open banking confers convenience to financial services by allowing third party access to customers’ financial data. Whereas this is a welcome benefit it poses severe risks to the users’ financial privacy as well as the security of their funds. The open access can lead to unlawful and unwarranted access to customer financial data by malicious third parties resulting in huge losses.
In the very extreme, such third parties or nefarious individuals running them could easily wipe out their balances. Whereas this is highly unlikely there are other omnipresent dangers that users may have to live with such as security breaches, publication of personal data, and insider threats among others. These are expected to increase as hacking and security lapses continue to become more widespread, especially for third party APIs with inadequate resources for data protection. This problem is amplified further as the burden of data security is shared among multiple institutions as opposed to a user’s bank of choice. This means that unrestricted access could result in financial and reputational liabilities for financial institutions as data and organisations become more interconnected.
Blockchain technology and open banking
The rising prominence of blockchain technology is no coincidence as it continues to establish itself as a dominant force in the fourth industrial revolution. As a matter of fact, the technology has transformed multiple industries leading the tech world to suggest that ‘blockchain fixes everything’. So, I believe I would not be overstepping by suggesting that blockchain will be a key enabler and the final piece of the open banking jigsaw.
Blockchain technology not only remedies the aforementioned issues but also provides a solid foundation for a new generation digital financial system.
The blockchain enables the creation of a new digital financial ecosystem by layering its distributed ledger technology on top of legacy banking APIs. This essentially creates a platform through which third parties can securely interact with banks and their data without directly accessing the core banking systems. Financial institutions can rely on the platform to transact securely among themselves in a trustless environment. They can also share information, connect teams, and build robust networks on a shared platform through collaborations and synergies. The blockchain based platform supports aggregation and storage of industry-wide data that can be relied upon to develop new products and services such as loans, investment packages, and pension plan etc. commensurate with the customers’ financial status.
Blockchain enhances data protection and security for banks which minimizes their risks and potential liabilities arising from breaches and hacking. The blockchain is a distributed ledger technology meaning it is transaction and records-based only. Data can be categorized and hierarchically managed in blockchains. For instance, it can be broken down to highly classified, private customer data, bank sensitive data, third party use data, and general public data. Access and disclosure for each category are then determined and programmed through smart contracts thus boosting data protection and minimizing security risks.
These unique blockchain features set it apart from other kinds of technologies while making it very suitable for open banking as it grants access only to the preapproved data in a non-intrusive manner. This improves trust and enables banks to share only the requisite information without compromising user privacy and data security. As such, the blockchain creates a robust yet agile digital platform that levels the playing field for incumbent banks, fintechs, Financial Services Institutions (FSIs), and any other new challengers.
Blockchain is also a powerful tool for solving the user privacy and data security issues. The technology can be used to provide users with a single digital ID for use when accessing the digital banking ecosystem, through their banks and without disclosing their personal details to third parties. This enables seamless access to all FSIs together with their products and services through familiar apps.
At the same time the blockchain enables customer data privacy disclosure schemes where user information usage situations for each party are set together with how it is to be used by different apps whilst ensuring the customer is aware of how their data is being used. Most importantly, the blockchain data privacy management enforces the users’ right over their data which is entrenched in the open banking policy. The customer thus retains control and the right to authorize access subject to given conditions for the use of their information. What’s more? Customers can have their conditions set out in smart contracts.
In order for us to predict the future, we must first look at the past and observe current trends.
Despite the great promise of open banking and the aggressive industry-driven push for policy, there is a shared lack of enthusiasm among customers. Some recent studies revealed there is little awareness and low adoption rates among customers. For instance, a study by the Unlimited Group found that 91% of UK bank customers did not know what open banking is. Another study by Challenger Bank found that only 6% of British adults had clear knowledge of open banking while 58% have never heard of the initiative. Most of the respondents stated that they were unlikely to use open banking with major reasons being unauthorized access to their data (31%), invasion of privacy (19%) and them not likely to benefit from the initiative (18%).
This pronounced scepticism surrounding open banking may be attributable to the increased fraud cases mostly resulting from digital payments. Mainstream media have also not done online banking many favours with adverse coverage of such incidents coupled with amplification of the risks associated with digital finance alternatives.
The current status should not be viewed as a deterrent to the adoption and growth of open banking. Rather, I prefer to view these as minor setbacks and teething problems that can be easily overcome through public awareness and customer education programs.
The low adoption rates and negative customer perceptions may also be simply because consumers have not seen enough to convince them of this open banking promise. FSIs are aware of this and are currently working overtime to develop new products and services for the markets. Thousands of startups and big tech like Amazon, Google, Apple, and Facebook are also dabbling in payments and financial services. These efforts continue to exacerbate the problems banks face. But from the consumers purview they enhance competition, accelerate the development pace, and enable new value propositions that were never expected. I believe it is this relentless building, inventing, and onboarding that will drive the future of open banking.
Available data from the UK suggests that relentless building is ongoing as third parties continue to leverage the available data to develop solutions.
Data calls made by APIs are growing rapidly since the launch of Open Banking Implementation Entity (OBIE). In October 2019 only over 180.6 million calls were made by third parties compared to 13.9 million made in October 2018. That’s 13x data calls made over the same period, only one year apart. Quite remarkable.
This data indicates a rapid growth in demand for financial data and signifies that institutions are viewing open banking as an opportunity rather than a threat. Imran Gulamhuseinwala OBE, Trustee of the OBIE, alluded to this stating:
Two years ago, open banking was regarded by many as a typical compliance exercise championed only by a handful of fintech — more tech spend driven by compliance rather than business case or customer need. This is no longer the case. Banks have very firmly moved from viewing open banking as a compliance exercise to an opportunity to compete and innovate.
This is quite visible with incumbent banks making strategic budgetary allocations and leveraging technology to reinvent their products and services in the future open banking era. For instance, J.P. Morgan is raising its technology budget to $11.5 billion, most of which is intended for exploring quantum computing and developing new retail products. Bank of America is setting aside a $10 billion technology budget, of which a third is slated for “new initiative investment spend.” Such bold spending by banks shows that they are not standing still waiting for disruption but rather intend to defend their business by exploring new opportunities.
Fintechs continue to develop new initiatives to disrupt the banking industry by leveraging open banking potential. In Asia big tech like Alibaba and Tencent are driving competition by creating super apps which have transformed how people interact with financial services. These tech giants are driving innovation through challenger banks such as MYbank and Webank providing digital financial services much to the chagrin of the incumbents.
These super apps are connected with more than 200 institutions, including over 100 banks, 60 insurers, and 40 wealth management companies and security brokerages. The new value propositions and possibilities that could be derived from such a powerful network in an open banking era are just unfathomable.
Open banking will help set up a robust data sharing infrastructure upon which a broad range of products and services can be anchored. This infrastructure built on blockchain technology will provide a transparent, secure, and reliable source for data that can be used by such super apps to develop new financial products and services.
Blockchain technology will come in handy as a tool for the creation of data architecture to support products and services development. The blockchain can be reliably used to create silos and permutations across a wide range of data to establish commonalities, patterns, and habits among customers. Such information can then be used by super apps, banks, and other third parties to bundle, unbundle, and rebundle their offerings as deemed fit.
Such possibilities are expected to increase competition in the financial services industry to the benefit of the consumers, albeit in the short term. In the long run, increased competitiveness is bound to have reverse effects as organizations seek to maintain and improve their profitability. Open banking lowers the barriers to entry and shifts the power to consumers. With the consumer financial data publicly available on the blockchain, third parties and any willing newcomers will have the ability to compete with incumbents on the open market by offering attractive products and services.
However, we do not expect banks and fintechs to sit idly by and watch their bottom line suffer. Rather, we are likely to witness more consolidation across the financial services sector as institutions fight to survive and thrive. There will be horizontal mergers between banks to leverage their economies of scale from big data and network effects. We are also going to witness vertical mergers between banks, other FSIs, fintechs, and cross-industry firms to create synergies and to leverage their unique but separate strengths.
Moreover, it is expected that these organizations will create closely related products for customer retention due to increased competition. This may eventually lead to the standardization of products and services thus killing the ‘marketplace banking’. Such practices may indeed counteract the intended goals of open banking such as product diversity and widespread access to financial services. So, whereas, open banking may cause a disruption of the banking sector, as is, there is a risk that it may revert to type. Ironically, due to consolidation induced by increased competition.
As open banking levels the playing field, I expect more collaborations and partnerships as opposed to aggressive competition. Therefore, there will be much more bundling, unbundling, and rebundling as organisations seek to evolve rather than to merely survive. Once again, blockchain is reinventing standards and subsequently its on its way to driving the financial ecosystem of the world.
About the writer
Edwin is a naturally curious person with a deep interest in new tech. He has been involved in multiple cryptocurrency projects providing blockchain know-how, technical, and marketing support. He co-founded coinweez, a website dedicated to creating awareness about blockchain technology in Africa.