Will open banking live up to its promise?

Of all the forces predicted to challenge and disrupt banking and financial services, open banking has proven to have a staying power that stretches beyond the initial hype. The remaining question is whether this paradigm holds up when it comes to producing tangible results.

In its simplest form, open banking is about the exchange of data and services through standardized technical interfaces, so-called APIs. These three letters describe the way different IT systems interact based on standardized formats. This is an acronym that has long been reserved for the IT department, but the commercial use of APIs will create new opportunities for those who dare to explore and think outside existing organizational boundaries.

Even though the term open banking have versed enough to become a household term in the financial industry, the true potential of open banking is still out for debate. This is largely due to the fact that in order to master open banking, it requires knowledge and expertise in a number of disciplines to fully understand the scope of opportunities as well as potential limitations. As a result, some of the initial promises made by open banking are falsified, while future opportunities are still open to those who dare to venture further along the open banking path.

More on open banking.

In order to understand the potential of open banking, it is imperative to understand how digital ecosystems grow and evolve, thus taking lessons from Facebook, Google, Apple, and Amazon as well as their Chinese counterparts Tencent and Alibaba. Although they come from a vastly different starting point, they all share a clear commonality: they all succeed in creating a well-functioning digital ecosystem around their core products and services.

More on the nature of digital ecosystems.

A majority of the digital services that act as the embodiment of the digital economy would never have taken place without the use of open interfaces. Without Facebook’s APIs, we would not have had Tinder, and without Google Maps’ interface, we would not have had Uber.

The ability to leverage an open platform to your own benefit has proven to be a winning formula. The famous iPhone moment that disrupted the mobile phone market was not the launch of the iPhone, but the launch of the App Store. It was not Apple that killed Nokia, but access to third-party services in the App Store.

This is a useful reminder for the banking industry, as what is considered as one of the catalysts for open banking is the revised payment service directive, also known as PSD2. Even though PSD2 has already been introduced in the EU, the impact on consumer behavior has been insignificant.

It should come as a surprise to no-one that account aggregation in its simplest form does not provide enough customer value to shift consumer behavior. In addition, the implementation of SCA (Strong Customer Authentication) is far from frictionless for third parties wishing to access banking APIs to initiate payments. Even though the immediate effect of PSD2 is absent, it is what lies beyond that keeps me excited.

So far, we are witnessing how banks testing the waters in an exploratory phase with small-scale experiments and integrations along the fringes of the core business, and a least common denominator approach to account aggregation. All with the looming threat of losing the battle for the customer interface as a common foe.  

According to a report by Tink, open banking investments have become central to the digital transformation of the industry itself. For financial institutions in Europe, the median spend on open banking is 50-100 MEUR and is expected to grow in the years to come.

However, massive investments without a tangible plan for returns is rarely a winning formula, and this is where I expect to witness the biggest distance between leaders and laggards. If there is no potential business model ahead, open banking investments will likely just increase the operational cost and is better left undone.

An example of potential commercial use cases for open banking is in the business banking segment, where open banking could not only provide a better overall user experience for customers through integrating accounting software to banking APIs but could also generate off-balance revenues through subscription plans as well as offering financial products directly through ERP vendor interfaces. Not only does this extend customer reach, but front-end development is costly, and is perhaps better left to the accounting software providers, providing an opportunity to API-only banks like Aprila.  

COVID-19 has also provided some proof of the real power of open banking with the implementation of The Business Compensation Scheme that provides financial compensation for enterprises with large income loss resulting from the virus outbreak in Norway. The solution is based on already existing digital infrastructure and available APIs from both the financial services industry as well as government services and was developed and deployed in three weeks.

However, the main benefactors from open banking and PSD2 so far are API aggregator and middleware providers like Nets, Tink, Plaid, Nordic API Gateway, Neonomics, Yapily, Konsentus, Nordigen and many more. As bank investments in open banking increase, so does both revenues and valuations of the API aggregators. Proving the statement that you want to get rich during a gold rush, make sure you sell mining equipment.

Even though it has been the talk of (the banking) town for e couple of years now, open banking is still in its infancy. Those who wish to benefit from open banking must be willing to give up control of the entire customer value chain and choose where to excel. Attempting to control everything will at best result in mediocracy when facing specialized contenders.

With this in mind, banks should rapidly transition from an exploratory case and downright fixate on revenue-generating activities to compensate for past, present, and future investments needed to stay ahead in the open banking game. It is important to note that banks have been operating a platform business ever since the birth of modern banking in renaissance Italy, making a profit by balancing deposits and loans, and incumbent banks, despite the rumors of being slow-moving dinosaurs incapable of change should be on their home turf in this area.