Open banking: An introduction

The landscape for financial services is changing, and the jury is still out on how the endgame is going to play out. However, one of the concepts that is starting to stand out as inevitable  is open banking. This development emerges out of a perfect storm of shifting customer behavior, regulatory changes, the threat from digital ecosystems such as Google, Apple, Facebook and Amazon, and the quest for new business models are driving banks toward the open banking paradigm.

The coming European payment service directive, PSD2 is requiring banks to open up the payment infrastructure to third-party providers. New business models based on a platform economy is threatening existing revenue streams. As an example, the P2P lending industry is seeing significant growth, especially in developed countries with strong financial markets. In 2015, the alternative finance industry in the US  grew to $36.49 billion, a 212% annual increase from the $11.68 billion in 2014. Europe is also catching on, the total European alternative finance market, grew by 92% to reach €5.43 billion in 2015.

There is no need to ask what will be the Uber of banking. The Uber of banking is Uber. 30% of Uber drivers in the US have never had a bank account, but is instead allowing drivers to easily register for a bank account (through integration to a bank partner) or prepaid card when signing up to work for Uber, according to the documents. By doing so, drivers can get paid the same day they work instead of weekly or monthly. Effectively making Uber the fastest growing acquirer of small business accounts in the US.

This shows that industry boundaries are blurred in a digital world. The payment service M-Pesa by Vodaphone and Safaricom has 18 million customers and more than 80 000 agent outlets, financial services account for 9 percent of Telecom operator Telenor’s total revenue in Pakistan. Customer expectations shaped by digital ecosystems differs from the traditional approach to digital marketing where the dominating logic has been to bring customers to the company’s website or proprietary application platform. Citi research refers to this development contextual commerce, where a technology/platform enables a consumer to interact and transact with their chosen merchant/brands in the consumers preferred context or medium.

New technology if shifting the center of gravity for traditional core banking systems. A blockchain-based approach to core banking could act as a catalyst to fracture the monolithic and vertically integrated approach to core banking. A modular approach to lending, syndication, capital markets could utilize blockchain to tie it all together. All the other elements of transactions management, integrity of transactions, messaging, etc. are inherent features of blockchain. Banks can not afford to ignore the internet of things. When machines are able to perform transactions with machines in real-time at a marginal cost basis, the concept of payments will become obsolete in many use cases as transactions become automated and integrated into other platforms and services. As paying for a Uber today is hidden for the end-customer, the self-driving car of tomorrow could perform payments to the charging station on it’s own behalf.

These trends all sum up to the inevitability of open banking or banking as a platform.

However, open banking should be perceived as more than just a technical implementation. For banks to embrace open banking, incumbents need to also challenge internal culture and existing business models. Spanish bank BBVA has been a pioneer in this field together with Fidor, and banks like Capital One, ABN Amro and Nordea are all joining the open banking revolution. While open banking may not be the silver bullet for reinventing banking industry, it represents a catalyst for change.

APIs are at the heart of open banking. If executed correctly propose to increase innovation, foster collaboration, extend customer reach and lower costs compared to existing legacy systems. A key concept in the open banking paradigm is to use open source technologies to enable third-party developers to build financial applications on top of the banks’ exisiting infrastructure. This will most likely spark fears of becoming a commodity and giving away the customer interface for many bankers and may seem like the banks will be relegated to the back seat while third-party technology companies are driving the car.

When I started working in banking, my job was to prevent that from happening. Now I am strongly advocating that if the customer wants it, the back seat is probably the best place for banks as long as it is done willingly. After all, there is a vast difference between choosing to chill out in the back seat and being forced to.

With this I wish to go more in-depth of the key concepts of open banking in the next series of posts covering various topics related to open banking.