A quick glance at the morning headlines is enough to notice that Open Banking is at the peak of the hype cycle right now. Traditional banks are being challenged by new, disruptive FinTech players, and with Big Tech giants increasingly moving into the financial services space -- e.g. Apple’s Card or Facebook’s Libra currency -- it seems inevitable that the banking landscape will change radically in the near future.
While it looks like 2019 could be the year that Open Banking takes hold, the conversation around it has been buzzing for some years now. But what is Open Banking exactly? And is it actually poised to change the face of financial services?
Looking back: A quick timeline of Open Banking (and PSD2) history
The economic crisis of 2007–2008 and the subsequent loss of trust in banks confirmed that the financial sector was in urgent need of a makeover.
The EU adopted the proposal for the Payment Services Directive (PSD) in 2007 in a bid to increase competition and choice for consumers in the financial services’ space. The directive obliged banks to give their customers more information about the payment services they offered, and it also introduced a new category of payment service providers other than banks, the so-called 'payment services'.
In 2015, the EU adopted a new directive on payment services (PSD2) to improve the existing rules and create safer and more innovative payment services. PSD2 became applicable on January 2018, although September 14th, 2019, is its final compliance deadline.
Meanwhile, the U.K.’s Competition and Markets Authority issued a report in 2016 in which it stated that small banks were finding it too hard to gain new customers, as a handful of big banks controlled most of the market share. In such an oligopolistic market, customers didn’t have much of a choice when selecting a financial services provider, nor full control over how their data was being managed.
The CMA ruled that something needed to be done in order to drive wider competition, transparency, and innovation in the financial sector. And so Open Banking –- the first enactment of PSD2 -– was born.
Open Banking and PSD2 are often used indistinctly, creating confusion between both concepts. Basically, the former is the U.K. version of the latter, which has a broader European scope. Other differences are that while the introduction of Open Banking standards only applies to the nine largest banks in the U.K., the rollout of PSD2 affects all payment account providers.
how does Open Banking work?
In general terms, Open Banking enables customers to access new financial services and products from regulated third party providers. For this to happen, banks have to open their application programming interfaces (APIs) and grant those third parties access to the customers' bank account data, to either collect transaction information or to make payments.
It is important to highlight that when authorizing third-party access, customers don’t have to reveal their login details to anyone other than their bank. Customers are always in control of what transaction data they choose to allow access to and they can stop access to their information at any time.
“Basically, you choose a provider you want to include in your banking app, you grant permission to your bank to securely access your data in that provider, and then the bank makes that data available to you via its applications,” says Luis Rodríguez, Chief Product and Innovation Officer at Strands.
For example, customers can give consent to a regulated app to round up every debit or credit card purchase and save the change toward one of their savings goals. Or SMEs can grant access to their transactions to a regulated FinTech platform to help them speed up a loan application process or facilitate business expense reporting.
“Depending on the third party you choose, different regulations apply about how long the permission you just granted last. The key is that, as a user, you need to be told explicitly and transparently which data will be used and for what purpose,” Rodríguez notes.
With great challenges come great opportunities
Open Banking and the ability to integrate APIs make it easier for customers and SMEs to compare accounts and adopt new services and products, which brings both new challenges and opportunities for banks.
Some FinTech startups are already kicking it out of the park by providing smart solutions that could potentially take customers away from traditional banks. In order to endure, banks must be able to deliver genuinely innovative, added-value services and gain a competitive edge.
In The Book on Open Banking, Landay Partners’ COO and former JP Morgan and Macquarrie Group executive Julian Cork says that “for the finance sector, as consumers become more precise in their demands for personalized service and more open to sampling the offering of innovative SMEs, established institutions, such as retail banks, must work harder to compete with more agile FinTech alternatives that rise to take advantage of this unique business opportunity.”
“Open Banking demands a truly customer-centric approach,” Strands’ Luis Rodríguez points out. “Individuals and companies can choose to give banks and third-party companies access to more of their data, but they will only do that in return for better products and services. That is the crux of the matter.”
As such, banks’ new products and services need to focus on improving a customer’s experience and overall financial life. By taking advantage of FinTech’s potential via APIs, banks can strengthen the relationship with their customers, open new customer segments and create new revenue streams. “It still remains to be seen if all this will work that way or if it will become just a data grabbing exercise, but in my opinion, this is the philosophy of PSD2,” Rodríguez concludes.