Open Banking: the landscape by 2025
In my recent blog, ‘What happens when the financial industry turns upside down?’, I explored the changes that we see happening in the Financial Services industry, with regard to new players in the market (let’s call them Fintechs), who are innovating the industry on top of the established infrastructure carefully built, maintained and guarded by the banks and legislators.
In this blog, let’s take a step back and look at the mechanics behind this change. Let’s have a look at Open Banking. Open Banking is the new banking business model, that came to be due to the activation of the Second Payment Services Directive (PSD2). Due to PSD2, banks are required to give any third party access to use payments data and launch transactions from a customer’s bank account, subject to the account holder’s permission naturally.
Getting the measure
Although the range of possibilities and changes around Open Banking may sometimes seem confusing, essentially, they fall into five key categories.
- Payments. PSD2 gives merchants direct access to consumers’ bank accounts to take payments, thereby diverting transaction fees (which can be up to 3%, or even more, of the cost of products) away from the chain of banks, credit-card companies and payment processors and onto the merchant’s bottom line (or passed onto the consumer). Merchants will start leveraging the benefits of this in the next two years, with some – such as ticket-sellers, online retailers, and transport operators – growing and diversifying what they choose to sell.
- Cash management. Given that most small- and medium-sized businesses hold accounts with at least two banks, these new services will offer to dynamically manage and optimize their cash flow between accounts – something that previously was only extended to corporate customers. So, if a business signs up with four or five banks, its money will be automatically moved between these accounts by one intermediary to avoid overdraft fees, maximize the benefits of interest rates and so on.
- Loans. Any business with money to invest will now be able to extend loans based on the ability to access the borrower’s bank account to assess risk and then regularly monitor cash flow. In exchange, lenders can offer more favorable interest rates. Perhaps the third most disruptive change, this could create new loans markets and push up competition.
- Personal financial management. This is one of the most commonly cited examples of Open Banking. Instead of having an app for each of our bank accounts, we will be able to use just one app to get an overview of all our finances, with useful graphs and trackers to monitor our spending, flag any potential problems, help us set goals, and offer us solutions, such as loans, to help us meet our goals a little faster. Instead of the incumbent bank, a new third party will own the direct relationship with the customer.
- Know your customer. This is about meeting regulatory requirements to vet customers, financial counter parties and others for credit rating and to fight crime, fraud and terrorist activity. Now, the vetting process is faster and easier – and enables financial institutions to offer this as a service to customers.
Rapid shifts and slower burns
So, how disruptive are these different types of service likely to be by 2025? On the one hand, the first two will clearly have major shorter term impacts as merchants and new players reinvent the value chain. On the other, it’s easy to see the potential for new lending and personal finance management facilities that extend consumers’ power and choice and give new players ownership of direct customer relationships. However, the success of these types of services will heavily depend on take-up.
Broadly speaking, when it comes to banking, consumers often stick to what they know – in fact, it is said that we’re more likely to change our life partner than we are to change our bank. It’s useful to look to the de-regulation of the energy market as an indicator. It took a few years for a critical mass of consumers to act, and a yearly saving of around £290 before people switched utility providers.
PSD2 does, however, go a long way to level the playing field. And with incumbents and new players all looking for similar ideas, collaboration is the best way to gain the edge. Smaller market entrants should look to develop white-labelled services that can be branded by governments or bigger institutions and seamlessly plugged into larger ecosystems. In turn, incumbents need to keep a close watch on the kind of differentiated services and innovations that FinTechs are devising. They also need to evaluate what is core, and what could be outsourced to reshape their organization and infrastructure to be agile enough to operate in a more open and dynamic environment.
After having dived a bit into the added value of Open Banking, we see how this new ability to engage and add value to consumers will no longer be just the preserve of banks, but will be shared with Fintechs, Retailers, software companies and other innovators. As such, PSD2 isn’t just the driver for Open Banking, it’s the prelude to ongoing disruption as regulators liberate other parts of banking into the market. Any institution needs to act now – not just to embrace PSD2, but to be ready for future directives.