Open banking – the next phase

September 2023  |  COVER STORY | BANKING & FINANCE

Financier Worldwide Magazine

September 2023 Issue

From its origins in Germany in the 1980s to today, open banking has contributed to a shift in attitudes toward the way people bank, move money and use financial services in the modern world. Expanding access to critical banking data has given impetus to innovation. Open banking has brought about a wave of FinTech ideas that deliver greater transparency, improved services, more personalised products and multiple other benefits to customers.

In 2020, the global open banking market was valued at $13.9bn, according to Allied Market Research. It is predicted to reach over $43bn by 2026 and $123.7bn by 2031 – a compound annual growth rate of 22.3 percent from 2022 to 2031. According to a recent report from Coalition for a Digital Economy (Coadec), more than 4800 people work in open banking in the UK alone, and the industry raised over £886m last year.

The market has been on an upward growth trend, boosted by the coronavirus (COVID-19) pandemic. Changes to consumer behaviour during the pandemic fuelled growth. Across the globe there was a marked shift to mobile banking, and with it, open banking.

In the UK, the number of open banking users more than doubled over a six-month period. According to Open Banking Limited (OBL), one in every five adults began using open banking apps during the COVID-19 lockdown period. Money management apps soared in popularity as users looked to better manage their finances amid economic challenges. Thanks to open banking, third-party apps could build a unified snapshot of an individual’s finances across multiple banks and financial providers.

“Although we have seen great progress in open banking we should not forget that it is still very much a nascent technology, albeit with growing confidence across certain use cases,” points out Siamac Rezaiezadeh, vice president of product marketing and insights at GoCardless. “There is evidence of compelling benefits in areas such as sharing bank account information across consumer apps, using account information to improve risk decision making for lenders, and making certain types of payments like depositing money into a savings account or paying tax bills.

“There is still a long way to go to solve for more use cases and other types of payments,” he continues. “But the fundamentals around fast, low-cost payments are strong, and that will encourage applicability across a variety of scenarios. Paying regular utility bills and insurance premiums will gain traction, as will e-commerce transactions for online purchases. Now it is a case of building both consumer and merchant trust. Regulation will go a long way toward developing this trust, especially when it comes to consumer protection and fraud reduction.”

With open banking taking hold and spreading to new jurisdictions, the industry will continue to evolve. “We are starting to see open banking evolve to encompass new types of payments,” concurs Mr Rezaiezadeh. “The advances toward variable recurring payments (VRPs) are very welcome and seeing this being applied to ‘sweeping’ use cases, such as moving money to and from accounts owned by the same person, is a positive first step.”

Opportunity knocks in the UK

The rapid development of open banking has placed a spotlight on regulation of the space. In early June, the UK Financial Conduct Authority (FCA), via the Joint Regulatory Oversight Committee’s (JROC’s) strategic roadmap, set out a number of recommendations on the future of open banking. JROC’s report focuses on actions identified as key to achieving the committee’s vision, including transitioning oversight of open banking to a future entity. It provides the committee’s latest thinking on the role and design of the future entity and the next steps to refine these views.

The report also includes a phased roadmap, comprising of five themes of activities to be delivered over the next two years. Those five themes are: (i) the levelling up of availability and performance; (ii) mitigating the risks of financial crime; (iii) ensuring effective consumer protection if something goes wrong; (iv) improving information flows to third-party providers and end users; and (v) promoting additional services, using non-sweeping variable recurring payments as a pilot. These themes will, the FCA hopes, enable open banking to develop further in a safe, scalable and economically sustainable way over the next two years.

In addition, the JROC report includes an update on the government’s thinking on a long-term regulatory framework once the foundations for the next phase of open banking are in place. The committee plans to publish a progress update in Q4 2023.

For Tom Burton, director of external affairs and public policy at GoCardless, JROC’s report balances ambition with pragmatism. “In the run up to its publication, there were growing calls for current issues with open banking to be fixed before focusing on the future,” he notes. “The JROC report fundamentally says this, while providing a clear roadmap for developing open banking in the UK. Issues like tackling financial crime, consumer protection and the delivery of non-sweeping VRPs are all covered.

“There is a need for the government, regulatory authorities and industry participants to work together to achieve the vision JROC has laid out. Having a strong entity to oversee and, where necessary, enforce this will be key to success. The onus is on all stakeholders to work together toward this common vision that will ultimately help to improve people’s financial health,” he adds.

According to Andy Thornley, head of financial services at techUK, the importance of the JROC roadmap was underlined by the industry’s concerned reaction to the delay of its publication. “There was a period of over a year following the establishment of JROC where the industry was awaiting direction and clarity in terms of what the future of open banking would be following the completion of the implementation stage. Now we have the roadmap – a north star around which the industry can coalesce, and a goal against which to assess whether progress is being made toward clearly defined success outcomes.

“A clearly defined goal is important: the reason open banking was implemented through the Competition and Markets Authority (CMA) order was to facilitate the switching of retail bank accounts,” he continues. “That had moderate success, but the star of the show has actually been the suite of products and services that have been delivered using the initiative. JROC, through its roadmap, appears to have taken this on board and is basing its success measures on the number of services offered and levels of industry participation. This outcome is an important one for policymakers and the public alike.”

In Mr Thornley’s view, however, the roadmap gives rise to some questions that still need to be answered. The most notable of these issues concerns the actions and timelines for interdependencies such as open data and open finance. “Despite this, the core purpose – moving from implementation to a future phase for open banking seems to be catered for in this paper,” he says. “Now we have to get on and deliver it.”

Indeed, as Mr Rezaiezadeh notes, ‘levelling up’ the overall availability and performance of open banking is one of JROC’s recommendations. “Banks have an opportunity to strengthen the early foundations of open banking, with the best quality, highest performing application programming interfaces (APIs), that will set the standard and help the UK retain its position as a leading FinTech hub,” he says.

With the UK at the forefront of the open banking movement, all eyes are on how the country’s approach continues to develop. For Mr Burton, the existence of a single open banking standard has arguably been the most important driver allowing open banking to flourish in the UK. “The statistics we are now seeing published by OBL are impressive,” he points out. “Over 7 million active open banking users, with payments trebling in 2022 compared to 2021, is significant. Other countries like Brazil are now being called the global leader, but most of the 60-something countries with open banking initiatives still look to the UK to learn from our experience. They will no doubt be watching how JROC’s roadmap progresses.

“Executing against that roadmap, on time, should produce indicators of ‘market’ success like new products, lower prices, growth of the open banking ecosystem and consumer uptake. The EU’s experience has not been so positive, but we are excited to see what the EU Commission announces for the Third Payment Services Directive (PSD3). We are expecting evolution, not revolution, and no change in scope but a real focus on improving the ‘baseline’ service that banks provide to FinTechs,” he adds.

To be sure, uncertainty still surrounds the EU’s PSD3. Whether it will be merely an update to PSD2 or completely replace the older directive remains to be seen. PSD2 paved the way for an open payments ecosystem that encouraged collaboration between previously untapped banks and financial institutions. This led to the creation of new products and services. Though PSD2 was well received, there are a number of areas for improvement, such as crypto payments, the emergence of ‘buy now, pay later’ (BNPL) products and embedded finance.

The financial services sector keenly awaits future announcements regarding the scope of PSD3. There is hope that it will, for example, offer more support for institutions in the EU financial landscape. PSD3 is likely to focus on providing better protection against fraud, promoting innovative payment services, improving rights for users, reducing friction in online payments, tackling unregulated market activities, and increasing transparency for cross-border payments and fees.

Open finance – the next phase

Hot on the heels of open banking is the emergence of open finance. As an extension or branch of open banking, open finance, according to GoCardless, involves the use of open APIs that enable third-party developers to build applications and services for a wide variety of financial institutions. It goes beyond the scope of data and services available at banks, and can cover an entire financial footprint. With a customer’s consent, financial data related to pensions, tax and insurance could all be accessed by a trusted third party under an open finance scheme. Advocates believe this would lead to better-tailored consumer services for payments as well as other financial products.

But for Mr Thornley, though there are difficulties in delivering open banking, its path may be easier than for open finance. “Banking, at its heart, is essentially a ledger with payments being the movement of money between one ledger and another,” he explains. “Compare this to insurance, which is essentially a legal contract between one party and an insurer, with the product being the perils and insurable interests contained within that contract. Typically, the only time finance comes into the equation is when you pay a premium or if you are unfortunate enough to make a claim against that contract – a very different proposition.

“Therefore, it is likely that open finance will need to be iterative, claiming the low hanging fruit where wins can be made while progress is made in other areas,” he continues. “Perhaps some areas, such as insurance, may need to focus on particular aspects where digitalisation can help – for example smart contracts for claims – rather than more complex areas such as auto-switching of policies.”

Despite the challenges involved, progress is already being made. “It is exciting to see the HM Treasury-backed Centre for Finance, Innovation and Technology (CFIT) choose open finance as the problem statements for its first coalitions – with SME finance and consumer credit files the first areas being considered,” says Mr Thornley. “Through these time-limited projects, these use cases can be proved, demonstrating to government, regulators and industry alike that not only can the challenges be overcome, but the initiative can help deliver new products, services and innovations that make life better for the customers we serve.”

Future imperatives

Open banking is, however, vulnerable to malicious actors. Some retail banking channels have already experienced sizeable fraud losses. For instance, between June and August 2020, one UK bank observed 77.8 fraud loss basis points from its open banking channel compared with an overall fraud loss of 2.5 basis points. This 31-fold larger fraud incidence rate demonstrates an urgent need for improvements in open banking fraud detection.

Going forward, Mr Rezaiezadeh suggests, the industry needs to address a number of areas before it can really take advantage of the opportunity that open banking has to offer. “This includes growing consumer confidence, making meaningful progress on the technology and increasing the number of applicable use cases for VRPs,” he says. “Having ‘hero’ use cases to drive awareness and adoption – something similar to the impact that Transport For London had on contactless payment adoption – would make a big difference, as will improvements to the overall availability and performance of services. If we can do these things, we will see open banking, and open banking payments in particular, go from strength to strength.”

Beyond that, the industry needs to hone in on meeting people’s needs. “Despite the fact we in financial services spend many hours talking about and working on mechanisms and solutions, it is what they facilitate which matters most to the public,” opines Mr Thornley. “The public does not want a financing agreement, they just want the car; they do not want the mortgage, just the house. By focusing on this, we as an industry can use data and technology to improve people’s lives – and hopefully make a good business out of it at the same time.”

Looking ahead, banks and the wider financial services sector must continue to embrace innovation and work on progressive solutions. This will leave them better prepared for market changes and new directions as open banking becomes more widespread.

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Richard Summerfield