Can government intervention in banking actually encourage innovation rather than restrict it? That’s the question the U.K. government set out to answer with the implementation of its Open Banking directive.
This policy, which requires the country’s nine biggest banks to make customers’ financial data accessible by authorized third-party service providers, came into effect in January of 2018. Now, more than two years later, we’ve seen the results of this experiment first-hand, and the feedback has been quite positive overall. Furthermore, that success across the pond has given many U.S. banking leaders the confidence to start thinking about what similar regulation would look like here.
As a technologist who spends his days helping businesses modernize their IT infrastructures, I think this embrace (albeit cautious) of open banking is an extremely positive development. I’ve seen first-hand the benefits that open platforms can have in an industry, for customers and providers alike. That’s why I think it’s so important that business leaders at traditional banks understand just what open banking is. Because once they do, they’ll agree that open banking, whether it’s through government regulation or through their own action, is just what traditional banks need to stay competitive in our increasingly digital age.
What is open banking?
Let’s start with defining open banking. In short, it is the practice of opening up consumer financial data through APIs. A bank that embraces the open banking model will create APIs that define how a program can reliably and securely access its customers’ data. In addition, there are opportunities outside the scope of this article to also monetize said APIs. Creating entirely net new revenue streams.
By creating these specifications, open banking simplifies the process of building third-party apps that need access to consumer data. In fact, you’ve probably been the beneficiary of open banking if you’ve ever used apps such as Mint, Wealthfront, Venmo or TurboTax. Even if you’re wary of just handing over your bank account credentials to a third party, you probably have no problem with checking a box that allows only select data, like transactions, to be shared to authorized and properly vetted apps. And that, in a nutshell, is the power of open banking: it engenders the kind of trust that startup or niche third-party digital service providers need in order to gain traction.
What is the U.K. model?
What I’ve just given is the technical definition of open banking. But open banking is also a political, or more specifically a regulatory, concept. In the U.K., the Second Payment Services Directive (“PSD2” for short) requires the country’s largest banks, including HSBC, Barclay’s and Lloyd’s, to make certain customer data accessible through APIs. Some of the goals of the directive are to increase competition, counteract monopoly-like effects, and make banks work harder to get (and please and retain) customers.
Those are laudable and important goals for maintaining a robust liberal economic system, but perhaps the most salient aspect of the directive for British citizens will be how it encourages innovation in banking. The idea is that by lowering the barrier to entry for fintech startups, PSD2 will lead to the creation of new startups and products that benefit consumers.
Why should banks embrace open banking?
If open banking is so good for startups and other non-banks, what incentive do major banks in the U.S. have to implement open banking? Aren’t they just enabling their competition and digging their own graves?
The answer is “not really,” but before we get into that I should note that customers are already starting to expect open banking-like features from their banks. They want it to be easy and secure to set up Apple Pay or integrate their transaction data into Mint or TurboTax. Banks must keep up with consumer expectations if they want to retain customers.
Additionally, most of these apps don’t really represent competition for banks; in fact, these services tend to be complementary or adjacent to traditional banking services. If a bank’s core business is stowing customers’ money and giving out loans, then it has little to fear from a personal finance or tax app using its customers’ data. All sharing data can do in that case is make their customers more responsible with their money.
The security benefits of open banking shouldn’t be downplayed, either. Defining exactly how apps can gain access to just the data they need will reduce the practice of customers handing over their account credentials to get the digital services they want. That represents a huge reduction in risk for banks with comparatively little investment on their part.
Bringing Banking into the 21st century
Finally, let’s not forget that U.S. banks are already dabbling in open banking voluntarily — at least selectively. That suggests banking leaders must already agree to some extent that opening up data drives innovation. And innovation is something the banking industry could definitely use a dose of. While fintech startups have made splashes specializing in making just one aspect of the consumer financial experience better, banks have attempted to expand their services into every little corner of the banking-adjacent market. What that results in is bloated organizations and unprofitable units siphoning resources from making banking better.
Banks should be using their resources to develop better APIs and deeper data analytics to help them make better loan decisions or catch fraud — not trying to get into the mobile app business. It’s unlikely that big banks will ever become “lean” organizations, but embracing open banking can at last allow banks to offload non-core work and get back to the fundamental services that make them profitable.