Exploring the open banking industry in the United States
Open banking in the USA is growing in adoption every day, and the Consumer Financial Protection Bureau’s preliminary timeline for upcoming regulation creates a new urgency to embrace open banking for those who remain on the fence.
The open banking movement may have started with the banking industry, but it will soon expand to Open Everything: open finance, open government, open healthcare, as well as other industries — a global phenomenon driven by consumers, but not only, who want to control where, when, and how their personal data is shared and manage it from one place.
Driving open banking in the USA
In the USA, unlike in Europe, where it has been driven by the PSD2 regulation (soon to be PSD3), open banking took a late start, but it is becoming a central topic of discussion for the largest banks due to the upcoming regulation in early 2024 by the CFPB and the Dodd-Frank Section 1033 rulemaking. The first step will be the elimination of unsecured screen scraping historically used by account aggregators and fintechs.
Many are now seriously committing resources to their open banking efforts by putting an organization in charge of formulating a strategy.
The Financial Data Exchange (FDX) is a nonprofit organization dedicated to unifying the financial industry around a common, interoperable, and royalty-free standard for the secure access of user permissioned financial data.
Its FDX API has become the de facto standard for North America.
Traditionally, open banking started on the retail side, enabling consumers to conveniently access their data across multiple institutions to manage their money.
Of course, it has evolved significantly since then, as we now see the commercial side of the banks, driven by the movement towards real-time (with real-time payments, real-time forecasting, and so on) aiming to provide the corporate treasurer with faster and more convenient access to cash management.
The last economic driver is the emergence of business ecosystems through the connection of banks, third-party providers, fintechs, and customers, all sharing a common interest and where each player transparently owns a piece of the joint value proposition.
Recently, Farouk Ferchichi – Group President of Envestnet, one of the leading account aggregators – made the case of open banking for small banks and credit unions, highlighting how it will facilitate the access to credit, the role of financial advisers.
Open banking indications of future growth
For consumers, being able to manage their full financial assets in one place and freely compare financial institutions’ fees and interest is an exciting proposition; however, one that might not be so attractive for banks, at least on the surface.
On top of that, cybersecurity’s concern is high on both sides and might even be an inhibitor for wary consumers in fear of seeing their accounts being hacked.
Strategy for financial institutions
For the banking industry, the core benefit of open banking is to:
- Create a digital profile of the bank’s customers by understanding how they bank outside of their institutions. Armed with this new actionable intelligence, the bank can better upsell and cross-sell their customers.
- Capture new customers that they wouldn’t have access to otherwise by changing their business model to participate in entirely new ecosystems.
Let’s take Uber, which we all know well, as an example. Uber’s model is called a two-sided platform that matches drivers and customers seeking transportation services. As the number of drivers on the Uber platform increases, the better service customers can get because pickup times are reduced, and prices are more competitive.
This attracts even more customers on the platform, which in turn, attracts more drivers. This “virtuous cycle” driven by positive network effects is a fundamental characteristic of platform strategy and increases the advantage of the entire ecosystem.
We already see a lot of partnerships with fintech and industry players providing differentiated value. To date, the value propositions being created are fairly simple.
For example, a bank is partnering with a solar panel vendor to offer loans through the vendor’s website, with an appeal to customers who already have a mortgage with that bank and can therefore be offered better rates.
All of this is being done in real-time and transparently via APIs, all for the convenience of the consumer who doesn’t have to leave the vendor’s website.
A good example of such a platform strategy has been executed by one of the largest Indonesian banks: Permata Bank. Using APIs, Permata achieved a more than four-fold increase in accounts opened in FY2019 compared to FY2016.
They worked with payment gateways, online gaming providers, rideshare, and travel services to create a payment ecosystem process that has seen the bank increase its annual transaction processing volume by 88%, boosting its processing fee revenue while keeping headcount and operating costs flat.
Who said banking apps could only be used to manage money? Anyone who has traveled in China and used the so-called “Super Apps” can testify to that paradigm shift; however, it still remains a dream in North America.
In these new ecosystems, whether it’s with fintech startups adding intelligence, mobile delivered services that require a financial processing component, other banks at different tier levels, or even established companies in other industries, all these players can deliver benefits such as:
- New acquisition channels and account creation increases.
- Fee increases in transaction processing volume.
- Fee income from premium data-related services.
- Community feedback on partner APIs to improve the ecosystem.
- Improve the effectiveness of internal APIs to drive efficiency within the bank.
Such business strategy supposes that a financial institution has mastered the process of API product creation and the usage of a modern digital storefront, where API products are published and consumed by fintech or commercial partners within the ecosystem.
PSD2 released data that had been historically buried inside banks through regulation and payment laws that protected consumers from their financial data being used for anything.
Even the banks couldn’t use the data they held, and many banks have retained that mindset, that they can’t use the data in the advisory of their customers. But PSD2 and GDPR changed all that.
There is no reason North American consumers will feel differently than their European peers. Progress in the technologies surrounding API security, identity, and consent is making these exchanges much more secure than just a few years ago and the benefits will ultimately outsmart the fear of privacy loss by a wide margin.
The future is open… embrace the challenge or stay behind?
In the case of PSD2, the emphasis was broadly on creating a more level, competitive playing field for non-banks to enter the value chain, while by comparison the UK’s open banking project was triggered more by a desire to stimulate competition between banks.
According to a report by Polaris Market Research, the global open banking market size was valued at $16.14 billion in 2021 and is projected to reach $128.12 billion by 2030, growing at a CAGR of 26.8% during the forecasted period.
Many countries around the world are catching up:
- India with their United Payments Interface initiative;
- The Monetary Authority of Singapore and the Association of Banks in Singapore launched their Open Banking Playbook in 2017, with a clear focus on driving innovation;
- In Australia, open banking forms part of a much more ambitious plan by the government to give consumers control of their data across the whole economy;
- Brazil has their own open banking regulation;
- and the movement is now being caught up in the Middle East and throughout the African continent.
Beyond open banking, governments around the world are expanding the scope to other segments of the economy. For instance, the Consumer Data Right (CDR) in Australia mentioned above saw the energy sector follow banking, with telecommunications still to come, enabling customers to access and share data with trusted parties — data which they now legally own.
There is no turning back. Open banking and ultimately Open Everything is happening. Ultimately, banks must come to view APIs not as a side initiative to the wider organization, but as an entirely new form of distribution channel built on new business models, where developers are now a new kind of customer.
Competing in this new ecosystem will require banks to make strategic investments in several areas. Ensuring rapid access to the data in core systems and high API availability are only pieces of the puzzle; the capabilities to design rapidly, build, test, and deploy new API-based services will be fundamental.
Alongside these areas, microservices architecture, security (including managing customer consent), governance, and analysis of performance will also be essential components of an effective API strategy.
Banks focused on deploying commercial APIs (i.e., those that can be revenue-generating, either directly or indirectly) must also invest in the developer experience to ensure that innovative new propositions are built for their customers.
In addition to easy-to-use developer portals and wider support services, consideration must be given to how and when pricing and formal contractual arrangements are put in place, as developers move from test towards launch and commercialization.
Open banking is poised to redraw the competitive landscape of the future. Those banks that invest in their capabilities will position themselves well to remain as strong consumer-facing brands.
There will be those that choose an alternative path and aim to act as a supplier to third-party players — both of these are viable strategies. The pain will be felt by those banks that do not change at all; just as there will be winners from open banking, there will also be those that lose.
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