As Canada continues its march into the Digital Economy, technology is quickly becoming the great equalizer. Firms are digitizing their processes, as well as the ways they reach and interact with customers. Digitization has given rise to an abundance of data, and in today’s world, this data has enormous value. Companies are now measured by the wealth of their data sets, their ability to build core competencies around data and leveraging the insights to inform their strategic directions. However, digitization doesn’t escape controversy: customers are growing more concerned about the use of their data, its security and who they’re willing to share it with.
Banks have historically been the foremost custodians of data; customers have trusted them with their most sensitive information. Now, what if the sharing of such data surfaces new value for consumers and becomes much more prevalent? In this piece, I will examine the global movement towards Open Banking. I will also examine its implications for financial institutions (specifically banks), customers and Financial Technologies (Fintech), and the degrees to which Open Banking can serve as a conduit to fostering Financial Inclusion.
So why should we care?
In the 2018 Canadian Federal Budget, Minister of Finance Bill Morneau called for the establishment of a consultation group to ‘study the merits of Open Banking’. The series of consultations launched by the Federal Government aimed to explore whether Open Banking could serve to establish a “financial sector that is globally competitive and promotes consumer choice.”
Open Banking legislation has the potential to fundamentally change how banking services are delivered. It leverages Application Programming Interface (API) as the underlying technology to provide a framework that enables the ‘democratization of data’ which were historically held by the banks, making them available to regulated third parties, but only with the customer’s consent. Open Banking will likely usher in a new era of meaningful partnerships between Fintechs and Banks to deliver breakthrough innovations and financial products. Open Banking legislation should also bring to bear increased levels of customer choice, competition and transparency within the financial services ecosystem.
The trend towards Open Banking, or at least how it is being positioned by some of its champions, is fueled by the idea that customers should have stewardship over the data they generate, how it is used
and with whom it is shared. Canada is not alone in thinking about Open Banking, in many respects it is the laggard. The UK and the EU have both passed legislation around Open Banking and started implementing Open Banking standards in January of 2018. Australia has also followed up with its own set of frameworks in July of 2019. Legislation won’t come easy as there will be resistance from incumbents and customers alike. Anecdotally, incumbents fear revenue erosion while customers are wary over data security and a loss of privacy. Some proponents of Open Banking in Canada are championing a novel approach to Open Banking, a market led solution that convenes the different stakeholders, including the regulator, to bring financial data sharing a step closer to reality.
How did we get here?
In the wake of the 2008 Financial Crisis, a combination of volatile financial markets, new regulatory requirements and continued bleeding from losses owing to Mortgage-Backed Securities resulted in a meaningful contraction in bank profits. Regulations like the Dodd Frank Act and Basel III were introduced to curb excessive risk-taking by financial institutions. They did so by elevating the level of capital and liquidity that banks were required to hold, limiting their ability to lend.
Bank IT spend prioritized the maintenance of legacy infrastructure for business continuity versus product and systems innovation. Maintenance and support measures proved to be a high cost burden on the banks and significantly reduced their ability to allocate capital towards innovation projects. The dramatically different operating environment for banks and incumbents gave rise to Fintech companies aspiring to modernize the way banking services were delivered and consumed, eliminating the friction inherent in today’s banking system. Unlike traditional financial institutions, Fintechs are closer to the customer. Fintechs tend to operate with greater agility and face far less regulatory constraints. Fintechs prioritize design thinking in their processes, which according to Ideo, a renowned Design and Consulting firm based out of Palo Alto, is a practice that impresses upon organizations the need “to focus on the people they’re creating for” to deliver improved solutions, processes and product offerings. Where banks beget bureaucracy, Fintechs emphasize efficiency.
The global push towards Open Banking was born out of necessity; the need to innovate, coupled with the need to make financial products more accessible to clients. Among the key intentions of the Open Banking movement is fostering more effective and collaborative partnerships with the Fintech Community in order to benefit the end customer. Banks possess a treasure trove of critically sensitive data on their clients, data that can be very valuable to Fintechs and other TPPs. Banks have transaction and payment related data that illustrate employment history, income, account and transaction information.
Historically banks have enjoyed a very captive network of customers. In its current form, it is cumbersome for customers to change banks; banking clients tend to be ‘sticky’. Banks have generally resisted the push towards Open Banking since it may conceivably threaten aspects of their business and put downward pressure on two of the bank’s primary revenue streams: Fee-based and Net Interest Incomes. The threat to banking profits could be meaningful, which is why their resistance is understandable. Per a survey jointly conducted by Bain & Co, Salesforce and MaritzCX of 4000 UK banking customers, roughly 15-20% of banking customers tend to be ‘high risk’. The survey finds that 65% of this group of customers tend to be younger, more affluent and represent approximately 45% of banking profits. They demonstrate openness to sharing their data with third party providers, in exchange for better or cheaper products or services. Bain & Company estimates that as much “10% to 20% of banking profits could be at risk of disruption”.
Strategically, how can banks compete given this paradigm shift?
Open Banking does not need to spell the end for the banks. The vast majority of Fintech companies are non-account holding and do not have the regulatory approvals necessary to carry deposits, nor is it a goal. Fintechs merely operate as an intermediary to facilitate improved delivery of banking services that have historically been neglected or deprioritized by the banks.
In examining many of Canada’s Fintechs, it becomes clear that among the biggest hurdles to a Fintech’s growth in Canada is the lack of access to customers and markets. This challenge is exacerbated in an operating environment where the ‘Big Five’ Canadian banks collectively dominate over 90% of the domestic market. The prevailing lack of access to customers limits any meaningful revenue traction that Fintechs require, in order to attract VC investments and grow.
The growth of the Fintech ecosystem in Canada is driven by access to markets, it should not be stymied by it. Where Canadian banks account for three of the largest twenty global banks by market cap, Canadian Fintechs still have a long road ahead. Increased partnerships between Incumbents and Fintechs is one way to shrink the gap. Among the chief concerns of Canadian banks with respect to Fintechs is the risk of disruption that they pose. While the narrative may resonate in other more fragmented markets, it is an argument that is challenging to reconcile with reality. There is unlikely to be
any material disruption when the odds are stacked so disproportionately in favor of the banks. Fintechs lack the needed market access and the necessary scale to challenge the status-quo.
Open Banking as an Opportunity?
The greatest opportunity with Open Banking results from the potential risk it curtails. Independent interviews with senior executives at large European financials revealed that the biggest benefit from Open Banking was to curb, or stave off, the looming threat from mega cap technology companies (Big Tech). Big Tech is best in class at building for customer experience: they enjoy unencumbered access to customers, they have the expertise and the scale to deploy solutions and grow them exponentially. They also have growing balance sheets with billions in cash and marketable securities, ready to be allocated into profitable opportunities across financial products and services. Banks will need to work with Fintechs just as much as Fintechs will need to work with Banks.
Not long ago the banks were viewed as the primary trusted custodians of customers’ personal data, not anymore. In fact, erosion of customer trust extends back to the financial crisis, and in some respect, is the one hangover that continues to affect the banks, almost universally. As a result, banks now lag behind manufactures of tech (Apple and Samsung), and Online eCommerce giant Amazon as platforms that customers trust most to safeguard personal data. The changing landscape, as it relates to trust, serves to underscore the importance of Open Banking and why it is critical to the continued growth and longevity of Canadian banks. The introduction of Open Banking standards will initially present opportunities for Incumbent banks to capture some low hanging-fruit, these include: improved operational efficiencies, faster payments and superior product and service curations for clients.
Tech migration into financial services is gaining traction, and in the process, they are making financial products more customer friendly across their different lines of business. Banking services layered on technology platforms are no longer a foreign concept, but a natural evolution of their businesses. During its most recent holiday quarter of 2018, the volume of Apple Pay transactions eclipsed 1.8b unique transactions. Apple also recently announced a partnership with Goldman Sachs to begin issuing a technology powered (cashback, no fee, low interest rate) credit card dubbed Apple Card. Unlike nascent Fintechs, Apple has the ability to rapidly scale its credit solution to the near 1b active installed devices globally, of whom, approximately 16m reside in Canada, accounting for 43.3% of the country’s population. Moreover, online eCommerce players like Amazon and Shopify lead with lending across
Merchant and POS financing and are growing them exponentially. Amazon, though not a bank, has incredible line of sight into customer transactions and could layer a wide array of relevant banking services on top of what they already know about their customer. The absence of Open Banking is an advantage Amazon currently enjoys over Canadian Banks and Fintechs.
It is Big Tech and not Fintech, who are best positioned to materially disrupt the banks, and they have the resources needed to scale, almost immediately. Open Banking is emerging as the most feasible conduit for banks to preserve and grow revenue, accelerate product innovation and compete on customer experience.
Open Banking to Grow Revenue
SMBs are likely to hold multiple accounts within one institution, or even across multiple financial services firms. As such, managing these oft distinct relationships is labor intensive, costly and time consuming for small companies. API-enabled account aggregation that is made possible through Open Banking allows for deeper client engagement benefiting both the bank, and its SMB client. SMBs will be better positioned to interact with their primary bank, or banking relationship, through API-enabled account aggregation. Banks could further develop monetizable APIs to enable SMB to: access commercial banking solutions; curb FX risk or even acquire treasury and trade services. Banks stand to benefit as they become increasingly more entrenched in their client’s operations. Better visibility into a banking relationship enables the bank to better service its clients with the relevant services.
Open Banking legislation in the UK initially mandated the nine largest banks (dubbed CMA9) to begin sharing data with accredited Fintechs and TPPs, who would layer their technology onto the data they stood to acquire. One of the aims of Open Banking is to support the emergence of Fintech, and their increasingly more prominent role in the financial system. Open Banking is a conduit to achieving deeper collaboration with banks that would allow Fintechs to better target customers with more relevant financial products, eliminate the inefficiencies and multi-day lag that exist in payments, and augment the account information that banks hold on customers with other services designed to produce more personalized, holistic and useful financial products.
The introduction of Open Banking legislation injected transparency to an otherwise opaque system. Banks were required “to disclose performance and fee data”, as well as product satisfaction scores, allowing customers to effortlessly comparison shop across the different institutions. The customer flight risk for the banks could be significant, as clients would be empowered to engage the bank they deem most appropriate for their needs, or require their primary bank to share their data, where feasible, with a third-party provider. In an Open Banking world, customers control the fate of their data, where it is shared and how it is used.
In the absence of legislation, and in an attempt to be proactive, banks like Citigroup in the US are jumping ahead of regulations to gain a market advantage. To that end, Citigroup launched a Global API Developer hub, setting up its own innovation sandbox, to facilitate collaboration with fintechs and create compelling new solutions for their clients. Through the use of private APIs, Citigroup allows approved Fintechs and TPPs to gain access to real customer transaction data, but strictly with the permission of the end user.
What does Leadership in Open Banking mean for Canadian banks?
Open Banking presents Canadian financial institutions with the opportunity to build a North American leadership position in financial services. The US is critical to the continued growth of the Big Five Canadian banks, who on average, derive approximately a fifth of their earnings from their US operations. The US also presents a much larger and more fragmented market opportunity to capture. In contrast to their Canadian peers, the Big Five banks in the US control only 35% of their domestic market. Armed with Open Banking enabled technologies and partnerships, Canadian banks could leverage their learnings in Canada to more effectively compete, grow and deploy innovative offerings in the US, simultaneously upselling existing clients while acquiring new ones.
Open Banking legislation in the UK, which was introduced by the Competition and Markets Authority (CMA), required the CMA9 to begin sharing data with TPPs and Fintechs in a secure and standardised way, vis-à-vis public APIs. This evolving regulatory environment is forcing legacy financial institutions to rethink their business models and the way they create value for customers.
Regulatory changes such as Open Banking in the UK afford global British Banks the opportunity to leapfrog the competition in different parts of the world. For instance, HSBC and Barclays have operations in jurisdictions around the world where the conversations around Open Banking are just beginning. Banks operating under Open Banking should develop an overarching Open Banking strategy that works to guide their business forward. Bare minimum compliance with the new standards present peer banks the opportunity to gain an enduring edge, especially as transparency becomes the name of the game. Big British Banks like HSBC and Barclays may look to deploy some of their newly piloted products and acquired knowledge (with Open Banking) into the Canadian markets. Such contexts suggest that Open Banking is also a means for Canadian banks to fend off potential external disruptors looking at expanding, or growing further, into the Canadian market. The reality for the banks is that access to richer data gives incumbents a more holistic understanding of client needs. In an Open Banking world, Banks will be better able to compete by leveraging richer data and analytics to improve customer experience, innovate and grow.
How does Open Banking further innovation in the banking system?
Open Banking gives rise to two distinct types of third-party providers: Account Information Service Providers (AISP) and Payment Information Service Providers (PISP). They will be granted access to customer account data, but only with the client’s explicit permission. Financial advisors have a fiduciary duty to act in the best interests of their clients. With improved access to data, third party providers who emerge as AISPs could leverage the improved access to data to better deliver services to customers like Personal Financial Management.
Banks and Financial Institutions in Europe have struggled to keep pace with the rate of technological change and have failed to adequately modernize existing payment practices, which usually require three business days for funds to clear and become available for use. PISPs on the other hand gain access to account data in order to initiate transactions straight from a customer’s account, reducing the friction and length of time it takes for debit and credit payment transactions to clear, from three days down to minutes. The EU’s Payment Services Directive 2 (PSD2) goes a step further and builds on its predecessor to include international transactions that occur where only one party to the transaction is located in the jurisdiction of an EU member state.
Open access to banking data enables AISPs and PISPs to build comprehensive technology solutions around the customer. Increased visibility into the customer’s transaction data allows them to offer clients multiple payment options for bills and recurring obligations, as well as enhanced budgeting tools and products, embedded within financial management applications. The way payments could stand to evolve will also mean that merchants will be paid faster, the costs will be lower and clients more satisfied. Moreover, a core principle of Open Banking is reducing the occurrence of fraud and fraud liability. The transparency into account information will result in less fraudulent activities since the connections that are created within this newly emerging ecosystem, are facilitated through highly secure end-end APIs. APIs serve to safeguard customer data, ensuring their privacy, the integrity of the data and its visibility to institutions and regulated third-party providers.
Open Banking improves, and builds on, existing Know Your Customer (KYC) knowledge. KYC is employed by financial institutions to gain a better understanding of their clients, but also as a risk mitigation tool. With Open Banking, KYC information would be shared within the ecosystem. Financial institutions and service providers will have greater visibility over their customers and be better positioned to service them with more relevant offerings, while lowering the incidences of fraud throughout the system.
Open Banking to foster financial inclusion
Open Banking standards were conceived to act as a force for good, bolster competition, promote fairness, further financial innovation and foster financial inclusion. Open Banking emboldens customers, offering them greater choice when it comes to their financial health and allowing them to work with third party services without having to switch banks. Increased competition should make delivery of financial products/services better, more affordable and accessible to consumers, particularly within low-income, indigenous and other visible minority groups who are excluded due to account-associated fees.
PISPs stand to significantly help people in poor financial standing, they eliminate the lag in funds transfers and facilitate instant access to payroll deposits or other credits into a customer’s account. The fact is, many people live paycheck to paycheck and immediate access to funds will help those clients keep the lights on, put food on the table or even protect them from insolvency.
Open Banking helps improve customer financial literacy with respect to the products customers currently purchase. Increased transparency around solutions will improve customer knowledge regarding other products or services that they could acquire to service or support their current or future financial needs. Improved financial literacy among customers should increase adoption for financial planning tools.
Open Banking is expected to meaningfully benefit the underbanked, customers who don’t have access to a credit card or debt product. It stands to change the way companies assess customer credit worthiness. Credit bureaus like Equifax and TransUnion will be able to augment the customer’s credit history with transaction and account data from the client’s banking institution. This is very meaningful for newcomers and immigrants to Canada who are often excluded access to credit (credit cards, mortgages and other lending products) strictly due to limited, or no, domestic credit histories. Open Banking should also enable more customers to transact online and participate in e-commerce activities. PISPs could initiate a funds transfer directly from the client’s account and immediately deliver the funds to the merchant for the product/service rendered.
Open Banking enabled services has the potential to transform the way debt advisory is tailored and delivered. Access to richer information, layered with Artificial Intelligence (AI), could even predict the onset of financial deterioration in a customer, thus informing the advisor’s subsequent client interaction and future engagement. TPPs or Banks could recommend to ‘at risk clients’ areas to improve or mitigate their impending financial troubles. Access to transaction data allows fintechs and banks to help their clients budget better, even connecting them to personal financial management tools, debt products or other services more befitting of their needs and unique situations. Open Banking enabled tools could assist customers in dire financial standing take charge over their financial wellbeing and improve their outcomes. The benefit is two-fold as Open Banking would also help financial institutions, de-risk their client portfolios.
Canada should work with urgency to adopt Open Banking
Open Banking should radically change the way banking services are delivered. I do believe that Open Banking will ultimately be a force for good and help the Canadian Innovation Economy shine on the global stage. It is still early days to determine the success of European or British forays into Open Banking. However, should market forces fail to advance Open Banking in Canada, then I anticipate that regulatory forces will. If the US is an example, then leading innovative banks would look to get ahead of the Open Banking movement to differentiate. We live in a hyper-connected world where regulatory changes in Europe will soon cascade and affect businesses across the pond. Rather than fight the trend, Canada should embrace it, learn from other experiences and work to best pave the way for it.