Open banking is on the rise in Europe. A quick search on Google Trends shows how quickly interest in the term has exploded over the past five years. However, we are currently only witnessing the beginning of a phenomenon that will revolutionize financial services. There is wide speculation as to who will benefit most from open banking; My money is on the tech giants; here’s why.
When I founded Salt Edge in 2013, the company’s two products, an aggregation platform and a personal financial management tool, aggregated customer data through screen scraping. Open banking did not yet exist; it will be another five years before the revised Payment Services Directive (PSD2) comes into force. Until then, Salt Edge had no access to banks’ APIs or any idea how much open banking would change their business model, let alone the face of finance, over the next decade.
The impact of PSD2 on financial services
By requiring financial institutions to share data with third-party providers (TTPs), PSD2 aimed to increase competition and innovation in the financial services sector, which has traditionally been dominated by retail banks. Initially, TTPs appeared to have the most to gain from the new regulation, as banks were prohibited from monetizing their APIs and had relinquished sole control over valuable consumer data. Two types of TTPs subsequently emerged: Payment Initiation and Account Information Service Providers (AISPs and PISPs) and the number of use cases for financial solutions based on open banking increased.
The most innovative developments in payment initiation are currently underway, enabling customers to allow third parties to initiate payments directly from their bank account using transfer schemes such as Faster Payments, SEPA or Elixir Express. Cutting out the middleman is beneficial for both the customer and the merchant; the latter pays far fewer fees, while the former gains more security against fraud because they don’t need to provide their card details (which also saves the hassle of typing them in). Since bank transfers today take 10 seconds, instead of 10 days as before, card payments no longer have the speed advantage, putting their future in doubt.
Cards are technology from the 1960s and 1970s. Why carry around a piece of plastic when you can use your phone to authorize a payment?
Meanwhile, account information services continue to find new use cases. In the early days of Salt Edge, AISPs primarily targeted consumers, who benefited from better insight and control over their spending, borrowing and saving habits. Many of Salt Edge’s early customers tried to use data like account balances and transaction history to give customers access to all their financial data in one app. Today, AISPs are diversifying their customer bases to include groups such as private businesses, which enjoy real-time overview of their finances, and lenders, which can use personal financial data requested by consumers to lead to term transparent credit assessments.
Why open banking isn’t bad news for retail banks
Now that the industry has had time to adapt to PSD2, the benefits of open banking for retail banks have also become more apparent. With far greater resources than TTPs, banks can combine newly revealed customer data with the power of machine learning (ML). By mapping a single customer’s data to their entire anonymized customer base, retail banks can make highly accurate predictions, especially when they include additional data such as inflation and market changes in their calculations. Salaries provide a good example: if retail banks can predict how much a customer will earn in the future, they can use that information to suggest retirement or investment plans. The applications for ML are limitless, although good data management will determine the level of success of banks.
Retail banks are only scratching the surface when it comes to finding use cases for open banking. However, it is uncertain whether they will be the long-term winners.
How could the tech giants enter
Another stakeholder has even more influence than the banks: the tech giants. Although they have yet to successfully compete for important sections of the value chain, the tech giants are already driving retail banking forward. Apple recently acquired credit scoring startup Credit Kudos, which could allow Apple Pay to eliminate the need for credit cards and offer buy-now-pay-later services. I imagine it won’t be long before we can ask Siri for our bank balance or transfer money to our friends either.
Open banking will give financial institutions a much more accurate picture of people. On social media, it’s hard to predict what people are really like because they can manipulate their image and choose what information to share. With open banking, banks have access to data that represents the real, unedited lives of consumers; this is valuable data. Combine that with the power of companies like Google and the potential is huge.
In my view, the players who control the user interfaces have the most to gain from open banking, and those are likely to be the tech giants, not the banks. Bill Gates once said we need banking but we don’t need banks; as I see it, the advent of open banking marks the beginning of this transition. I think our money will always, or at least for a long time, be stored in banks, but consumers will interact and manage their funds through apps from the tech giants. With their digital expertise and focus on customer experience, combined with their sheer scale, the tech giants pose formidable competition.
Financial apps powered by tech giants would mean a better deal for consumers. Right now, consumers tend to rely on a single provider for most of their financial needs, hence the phrase “I bank with [insert bank name]”. While it would be much more efficient for consumers to pick and choose the most attractive products from different banks, supplier lock-in often prevents this. In the future, a tech giant like Google may have an open financial app powered by banking that selects the best checking account, savings account, retirement account or investment plan from different banks and offers them in a single solution. In this scenario, banks would likely compete with each other to partner with tech giants, which could lead them to specialize in specific solutions.
Open banking in the short term future
In the shorter term, the biggest change we will see in open banking is the evolution towards open finance, which will likely be part of PSD3. Open finance requires different types of entities (not just retail banks) to open up their data, which would give TTPs access to investment services, insurance companies, gig economy platforms and pension providers. From a business perspective, dealing with accounts like mortgages is logistically not that different from dealing with bank accounts, so the underlying technology will need to change little while still providing considerable benefits to the consumer.
How banks and TTPs can stay competitive
There are still challenges to overcome if retail banks and TTPs are to truly take advantage of developments in open banking. At payment initiation, there have been several situations with banks, either where they have authorized payments but the merchant has not received the funds, or where funds have been cleared into a merchant’s account that were not authorized by the customer Resolutions in these situations can be complicated. As TTPs have limited access to information, they can only rely on the payment status response from the bank’s API; the rest is a black box.
The good news is that these problems are not insurmountable. Problems with payments often arise due to problems with the bank’s API or its core banking and payment processing systems. In order to identify the causes of specific problems and minimize errors in the payment process, TTPs and banks should thoroughly test their applications with real financial accounts, payment instruments and device/OS combinations. By proliferating the number of institutions, service providers and accounts that can be combined, open banking has simultaneously proliferated the number of scenarios that banks and TTPs must test.
The stakes are high. In the age of open banking, companies that offer consumers the best digital experiences own the future of finance.
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