Lateral Thinking: Open Banking and Embedded Finance in Africa — Part 1

Samakab Hashi, Shreyas Mishra, and Njuguna Kamau.

Foreword

This 3 part series will examine the emergence of open banking and embedded finance across the globe and how ultimately it will impact the African fintech ecosystem.

Part 1 explores the trends and drivers that catalyzed the emergence of open banking and embedded finance. For readers that would like an overview of how open banking evolved across the world and what the drivers are for its adoption, read on.

Readers that have this context can skip straight to part 2 “The impact of open banking on banks” where we discuss the various business models banks can adopt and how ultimately the driving forces highlighted in part 1, opens the door to a world where every company is a fintech.

In the third post in the series, we will explore how the African fintech ecosystem participants (regulators, incumbent banks, digital banks, and fintechs) are responding to the changes.

Overview

Whilst banks have held up admirably during the Covid crisis, they continue to face a myriad of challenges including compressed interest rate margins, tighter capital controls, increased regulation around data protection, the emergence of digital banks unencumbered by physical infrastructure and the looming threat of a fresh wave of defaults.

Even before the Covid crisis, banking and insurance were two of the worst performing sectors worldwide. According to a recent report from McKinsey, the economic profit of the world’s top banks and insurance companies declined by $800bn and $300bn respectively between 2015 and 2018. Arguably the banking industry has still not recovered from the 2008 financial crisis.

Despite all these challenges the retail banking industry has been in a state of evolution not revolution, with banks focusing on incremental changes such as banking apps, electronic statements and electronic payments. However, the advent of open banking threatens to disrupt the structure of the industry by fundamentally transforming the relationship between banks, customers and data.

Open Banking essentially transfers ownership of a customer’s data away from the bank and back to the customer. Traditionally banks have had total control over all the customers data they collect allowing them to be the only source for traditional banking services such as lending and investment products. It is this moat that incentivizes banks to offer loss making services such as free accounts in order to capture the primary customer relationship.

Due to a combination of new regulation, technology and customer expectations, third party providers (TPP) will increasingly have access to banks customer data. Historically, a lack of data has been a major barrier to TPPs creating innovative value add services and challenging banks’ proprietary relationship with customers. Open Banking forces banks to share data with TPPs that can use the data to build innovative products and business models.

In a doomsday scenario for banks, slow moving incumbents could find themselves disintermediated by the tech giants, consumer facing brands and fintechs who make better use of the wealth of available customer data to usurp the primary customer relationship whilst leaving the retail banks operating as a low margin platform providing basic current account services.

Whilst the above challenges are real, we explore how open banking and subsequently embedded finance also presents an opportunity for incumbents to leverage their real advantages and build new partnerships and models. Banks have strong brands and a track record of being responsible custodians of customers capital, data and KYC info. If they can prove themselves nimble in how they manage and mine the data they have either by building in house capabilities or partnering with data API companies they will be in a good position to profit from the open banking and embedded finance opportunity which is estimated to rise to $3.6 trillion by 2030 in the US alone and $7.2 trillion globally. We believe that the embedded finance industry can truly deliver on the promise of making every company a fintech and will explore how companies in industries as diverse as software, energy, education and health care can partner with financial institutions and transform how customers undertake banking. The 1 billion API call question is, can African banks move quickly to efficiently utilize the mountain of data they manage to generate insights and provide bespoke products and services? Let’s explore the far reaching consequences that embedded finance will have on energy, education, healthcare etc.

Part 1: Open Banking — Driven by technology regulation and consumer expectations

“The only useful innovation in banking for the past 20 years had been the ATM.” _ Paul Volcker, former chairman of the U.S. Federal Reserve 2009

Banks today are sitting on a treasure trove of data about you, your lifestyle and your finances, everything from your salary, savings, spending habits and liabilities. However, historically banks have been poor at leveraging such data with consumer data sitting internally in silos. A dearth of analytics talent, high cost of data management, and a lack of strategic focus on big data are also major stumbling blocks to banks utilizing the data they hold.

If the above factors made it difficult for banks to use the data they hold on the consumer internally, moving customer data externally is even more fraught with difficulty. Without the ability to seamlessly share their data between financial institutions, customers’ ability to secure better rates on borrowing, foreign exchanges and savings is significantly impaired. Similarly, without easy portability of customer data, challenger banks and fintechs face significant barriers to creating innovative new products and challenging incumbent banks’ proprietary relationship with customers.

A UK report indicated that British bank customers were more likely to get divorced than to switch banks. So, to make changing banks easier, open banking was first introduced in the UK in 2018 and is being rolled out across the world including: Australia, Argentina, Brazil, Canada, Hong Kong, Japan, Mexico, Nigeria, Taiwan, as well as New Zealand.

“Data is the new oil, if you have access to data, then you have the ingredients to build better services.” _Linda Jeng, senior fellow at the Georgetown Institute of International Economic Law, former Federal Reserve official.

Open banking promises to fundamentally change the relationship between banks, customers and their data. Any consumer will be able to centrally manage all their banks and financial products and control all their finances from a central app. A simple but practical example of this is open banking’s potential to end the injustice of unexpected overdraft fees. Unauthorized overdraft fees can be punitive, even in cases where the consumer has balances elsewhere or has access to cheaper credit.

Open banking promises a world where a TPP seamlessly links a customer to a myriad of financial providers and steps in when you go into debt. Either by switching between accounts or automatically applying for credit at the lowest cost. A similar methodology could be applied to account management and sign up, real time savings and wealth management, credit cards and mortgages. In time it may also allow customers to easily access better deals in other sectors like energy, telecoms and insurance. Being able to compare offerings from different providers will allow consumers to choose to do business with the institutions they trust.

Drivers of open banking

The emergence of open banking is being driven by a combination of developments in technology, regulation and consumer expectations.

Across the UK, Europe, Latin America and Asia there has been a wave of regulation designed to break banks’ stranglehold by forcing them to share consumer data. Banks in markets with open banking regulations are forced to adopt common API standards to facilitate the free flow of data. An API is an interface that defines interactions between multiple software applications or mixed hardware-software intermediaries.

However, it would be a mistake to believe that open banking is only a by-product of regulation. Even in markets with little or no regulatory oversight at a national level like the US, there has been real movement towards the free flow of consumer data with companies like Plaid liberating customers data via screen scraping.

Consumer expectations are at least as great a driver of innovation as regulations are. In a world where consumers’ expectations are shaped by Apple, allowing the instant downloading of books, movies, music, news games and even on demand fitness classes at any time all from one interface, consumers are raising the bar on what they consider adequate service.

Previously banks would benchmark their capabilities against their peers, however today’s consumers’ expectations on what a customer centric experience should look like are set by the likes of Amazon or Expedia. A survey from Salesforce revealed that 73% of customers say that a single extraordinary experience with one company raises their expectations of other companies regardless of sector.

According to an Accenture 2019 Global Financial Services Consumer Study, of the consumers surveyed;

• 50% expect their financial providers to offer propositions addressing core needs — not only traditional financial services. An example of this would be allowing a complete “mobility proposition” for car buyers that includes different financing, renting and reselling options, as well as access to insurance, maintenance and ancillary services.
• 50% indicate an interest in personalized financial advice from banks that is shaped by their personal circumstances.
• 80% are willing to share their data with their providers

Driven by technology, regulation and changing consumer expectations banks are no longer isolated from the radically transforming expectations that have transformed the retail sector.

Click here for part 2 where we dive into the various approaches banks can adopt to respond to these changes as well as a look at the emergence of the embedded finance opportunity.