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Open banking, and what it means for European fintechs and consumers – Part 1

Open banking is a global trend that is here to stay. Its development in Europe has been taken by the rest of the world as a lighthouse for other continents’ regulations, and it is expected that through it, fintechs will be able to offer more services that traditional banks can’t.

Open banking primarily revolves around sharing a client’s banking and financial data over third party service providers’ secure channels, usually by fintechs and data aggregators.

A much higher level of customisation and personalised services can be provided when an open banking framework is in place, at a much lower cost – or no cost at all. Apps notifying you about all of your bank accounts, cards and credit, latest transactions and new possibilities at the lowest possible costs are becoming popular and we are only in the beginning of this movement.

Some markets, led by the EU and the UK, followed by Australia, have already taken the lead by creating and passing their own open banking regulations. Other markets, such as Canada, New Zealand, Mexico, Argentina, Brazil, Nigeria, Hong Kong, Japan and Taiwan, for example, are creating norms to enable that to happen as well. In a number of other markets, even without regulation, open banking is beginning to flourish and forcing governments and traditional banks to adapt.

Having been pushed by regulation since January 2018, banks and financial service suppliers in Europe and the UK are testing prototypes and beta versions of their new operating models, and some of them already have entire sets of open banking solutions, especially in regards to Application Program Interfaces (APIs).

Comparison services, programmed savings towards an objective and credit portability are on the brink of a much faster and easier implementation by banks, fintechs and consumers – typically by someone using a Personal Financial Manager (PFM), or a small to medium enterprise (SME) using a Business Financial Manager (BFM) app.

We can expect financial literacy to grow as consumers are given real-time information about their financial standpoint, along with some alternatives to traditional and expensive services, leading to better financial decisions. Instead of having partial visuals of their finances, consumers can use bank account aggregator apps where they can see all their balances and transactions in one screen, seamlessly and effortlessly, instead of having to open three to four different apps or browsers to check each of their separate bank and credit cards accounts.

How safe is it?

Open banking is as safe as online banking, at least. A strong customer authentication is used to move customer data around through APIs in a procedure which allows the payment service provider to verify the identity of both the user and the service.

What are the motivations behind the Open Banking framework in the UK and PSD2, or the Second Payment Services Directive, in Europe?

The motivations are basically the same: to foster competition and innovation in the retail financial services market, to increase market efficiency, and to create a more inclusive environment for the unbanked and the newly banked, without losing sight of the financial system stability and consumers’ rights protection.

Consumers and SMEs have been paying for overdrafts in their current accounts, as well as not earning interest on their money in most accounts, and having their money being eaten away by ‘monthly administrative fees’ – even when they aren’t making transactions or even using the account – are some of the issues that financial authorities wanted to address, especially when banks make so much money out of consumer’s money.

What is the difference between open banking and PSD2?

In the UK, the Competition and Markets Authority (CMA) brought in Open Banking (an NGO) in order to intensify competition and innovation in the market in January 2018. Open banking also forms a part of the new European legislation known as the second Payment Services Directive, or PSD2.

Although people often think they are the same thing, there is a small difference: while PSD2 mandates that banks open their data to third parties, open banking specifies that banks do so in a standardised format.

On September 14th, 2019, PSD2 will take effect, and new requirements for the authentication of online payments will be officially introduced in Europe, although most countries announced in August an expected delay in their national implementations of the SCA, or Strong Customer Authentication. This requirement of the EU PSD2 on payment service providers within the European Economic Area ensures that electronic payments are conducted with multi-factor authentication.

What are the main trends being brought by open banking and PSD2?

1. Payments simplification

Open banking and PSD2 will bring simplicity to payments by allowing a direct payment between your bank account and an online shop, for instance, without intermediaries. Your payments should therefore become cheaper, faster and safer. The bank will be able to authenticate the purchase without having to rely on ‘acquirers’ such as Global Payments and WorldPay, among others.

As it is today, when you buy a ticket through a travel platform, the online retailer has to call or contact an acquirer, which in turn calls or contacts VISA, MasterCard, Amex, DinersClub or another credit card company. Otherwise, the payment cannot leave your account.

2. Aggregation, or all accounts information in one screen

As mentioned earlier, one of the biggest headaches for bank and credit card clients and for SMEs is juggling several apps and taking a long time to understand your overall balance, having to open a few apps and browsers one after another. Open banking will let you see them simultaneously, which makes it a breeze to manage different banks, cards, payables and receivables on one screen or dashboard.

ING’s Yolt got a head start as an app providing aggregation services (launched in April 2018). ‘HSBC Beta’ app from HSBC UK was then turned into Connected Money app in May 2018, after more than six months beta testing period. Those are examples of banks leveraging their position as early adopters and staying ahead of the competition. In those apps you can see your incoming and outgoing amounts in several bank accounts, not only the app’s provider current account.

Aggregators using bank and card APIs are facilitating access to cost comparisons and increasing the competition between financial service providers, traditional and non-traditional alike.

Right now, banks and credit card companies hold the history of our revenues and expenses, from water utility bills to cell phone bills to mortgages, to how many times we go to the supermarket monthly. That data could provide advantages for the clients producing it, in the form of cheaper services and promotions, as well as financial advice.

Open banking and PSD2 enable this information to be passed on to third parties, who can use it to create new services and approaches to existing financial issues, like a mortgage that has become too expensive and could be renegotiated online, instead of wasting time at bank branch queues.

3. Borrowing made easier for SMEs and consumers

The amount of time and money wasted by most SMEs in receivables and payables compilation and consolidation is absurd. Many companies today still have to scan bank statements and enter values into spreadsheets or systems that are often incompatible.

There are fintechs addressing this already, using information taken from the company’s bank account directly to an online platform that categorises and consolidates its expenses and revenues on a periodic basis, and on this basis forecasts and gives advice about near future and long-term financial planning. This is already helping lenders to make faster and more assertive decisions on whether a person or company is fit to receive credit.

What’s in it for fintech startups?

On the financial service providers side, a significant number of new challenger banks and fintech startups are targeting a better consumer experience as their value-added differentiation.

There are six ecosystem pillars that specialists agree are the base of an innovative and efficient open banking framework:

  1. Secure APIs
  2. Digital IDs
  3. Remote customer onboarding and authentication
  4. Access and open data consent management
  5. Better, faster and a more automated user experience
  6. Partnerships between traditional financial service providers and new entrants

These six pillars can be explored by fintech startups and technology departments of traditional banks as new business opportunities.

Three types of specialised fintech startups will have more chances of surviving in the new open banking environment, due to having less maintenance costs than digital infrastructure companies:

Front-end specialists: Through their user-friendly dashboards and customer experience – on and offline – these players focus on giving access to various banks and third-party services – often to a specific segment of potential customers. Through data enrichment, account aggregation and transaction categorisation, ‘super-aggregation and access’ apps will become a part of everybody’s lives, as banks are today.

Integration specialists: In this case, not only the front-end but its integration with the back-end of systems used by financial players will count a lot. These companies must have a deep understanding of how the front-end platform algorithms work and how the back-end systems are working before transferring data through the APIs, to ensure a pipeline of products that keep the user interested in consulting them again and again.

Non-traditional credit analysis specialists: the way traditional credit bureaus make a person’s credit score and history are inflexible. Today, fintechs exploring this niche are relying on consumer behaviour, social network behaviour, financial statements and other inputs to give a credit score and likelihood for that person pay their bills and loans on time, with more accuracy than bureaus that use only traditional approaches and financial information.

Financial inclusion in the age of the cloud

As to the financial inclusion debate, transaction costs should be reasonable for everyone, while continuing to generate revenue for financial services providers. Fintechs can help in this inclusion effort, and the accolades for new entrants can be the size of the unbanked inhabitants of the world, or the size of the banked but unhappy clients of the traditional banking institutions.

Cloud technology is essential for fintechs and therefore for open banking success. Safeguards that exceed on-premises security, faster go-to-market speed, real time feedback, blockchain, chatbots, AI, and machine learning are only a few features enabling the cloud platform to have a lower TOC (Total Cost of Ownership) for fintechs, than having to build whole infrastructures and mainframes as banks had to do decades ago.

To be continued…

Bernardo Arnaud
Bernardo Arnaud
Bernardo lives in Vienna and has been consulting and advising companies for 18 years in fintech, commodities trading, telecom assets management, messaging, jobs marketplaces, agribusiness, luxury, e-commerce and SaaS. He founded a few companies throughout his entrepreneurial journey.

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