PSE will be discussing Open Banking along with all things payments and acceptance at our November Conference.
If you would like to hear more from Tony he will be talking about Open banking at Sibos in London at the end of September.
Fintechs are the intended beneficiaries of open banking, but many are struggling with the variable quality of bank APIs and clunky Strong Customer Authentication (SCA) mechanisms. Merchants want better methods of payment, but it remains to be seen whether open banking can deliver a true alternative to card rails – at this moment there are too many gaps. If things go well then open banking could become a boon for fintechs, merchants and also banks, but that will require a mind-set shift from financial institutions.
Banks are ill advised to approach open banking as a compliance project. Open banking is really about financial services in the ‘World of Platforms’. There is a McKinsey study that talks about $60 trillion of economic activity resolving into B2C and B2B platforms by 2025 and the question is: who is going to provide the financial services that will be embedded within those platforms? There is a race between fintechs, banks and the platforms themselves to see who will provide the financial layer. The true question about Open Banking is whether banks will step up and deliver the full range of retail and wholesale banking services through API that are required by digital platforms.
We are entering this hyper-connected era when the digital economy will be powered by APIs. Banks need to realise that their presence on the information superhighway is going to be expressed primarily through APIs, rather than focusing on this as a regulatory exercise.
We need to move open banking out of the regulatory mandatory stage and banks must publish the full range of retail and wholesale banking services through standardised APIs.
We are seeing API standards develop the national level and then countries inexactly copying each other, but in this world of platforms – which is fundamentally a global world – we need to have global standards for financial service APIs.
So if banks want to win the race to be the financial layer of the digital economy, there are some big changes to be made. Fintechs may appear to be out in front at the moment, but bigtech is coming.
Consumers will notice that financial services will be seamlessly embedded into their favourite digital platforms. There is one grand battle between the platforms giants and the nimble disruptors for the customer interface by creating sticky experiences and compelling customer journeys. Wherever the consumer or business chooses to transact digitally – their favourite ride sharing application, marketplace or travel aggregator – there will be tightly integrated financial services as part of the customer journey.
This is why we are seeing the growth of point of purchase lending propositions. There is a moment in the online buying decision when the consumer is choosing what flat screen TV to choose where the availability of finance will also be a factor in the decision making. .The traditional card based ways that banks deliver balance sheet to consumers is easily intercepted in the digital world by a nimble, tech savvy lender who can insert a dynamic offer before and during checkout.
The most fundamental change that can happen is when fintechs or bigtechs begin to take on what might be considered the core functions of banking, meaning the provision of balance sheet. In this first wave of Open Banking that is limited to account information and payment initiation there will be Personal Financial Management (PFM) apps that aggregate across different banks, but to be honest this is a minority sport.
Banks are fundamentally balance sheets and the different lines of business – current accounts, car loans, mortgages, savings, business banking or whatever – are just mechanisms for generating liabilities and assets. So the question is whether that core business of running balance sheets will be disrupted. Obviously that is a licensed activity but we are already seeing players like AfterPay in Australia, Klarna in Europe and Affirm in the United States who are starting to disintermediate traditional banks from lending. Some of these players have or will become banks themselves but there are two significant differences – they are ‘API first’ in their approach and they leverage modern technology to do better than credit reference agencies when making instant lending decisions.
Banks urgently need to think about how they deliver core banking services into the digital economy through API. This will require true transformation from front to back. Many banks talk about it but a bank has not undertaken digital transformation until it can do its core business through API in real time. Banks need to be able to do lending through API instantaneously to both existing and new customers – to both businesses and consumers.
That will be a tremendous challenge for most banks because their loan systems and underwriting processes will not be as responsive But it will become a minimum requirement to deliver core services like lending instantly through APIs into digital platforms.
Until there is a shift in mindset that this is purely a regulatory exercise, we will see slow progress made. There needs to be a realization that the digital economy will have a financial layer and that banks don’t have divine right to provide it.
The financial layer to the digital economy will be delivered into marketplaces and digital ecosystems through API so we need to get to grips with the emerging reality of the platform economy. There is a classic quote from Marc Andreessen that ‘software is eating the world’ but it may be more accurate to say that ‘platforms are eating the world’.
All platforms have three parts: a middle and two sides. On one side of the platform is the supply side: that could be a ride sharing driver, a short term rental host, a freelancer in the gig economy or a seller on a digital marketplace. The supply side of any platform has a range of financial needs, for example, to be paid promptly in the currency of their choice and to be able to borrow against their platform earnings.
On the demand side is the ride sharing passenger, the vacationer, the small business tapping into a global pool of labour, or a buyer of the flat screen TV we talked about before. The demand side of the platform has a range of financial needs, for example, to pay in their currency and payment instrument of choice, to ‘pay later’ for large purchases, to obtain product insurance and have the ability to earn rewards for loyal purchases.
In the middle is the platform operator itself and they also have a set of financial needs to be able to intermediate between their supply sides and demand sides. This means a potentially global transaction banking structure that enables the platforms to pay and receive money, conduct foreign exchange, safeguard client funds and manage everything from a centralised treasury operation.
One model for how the world of platforms might develop is China. In the Alibaba ecosystem, the financial services are provided by Ant financial, so this is the model where bigtech does the financial layer itself. Not much room for fintechs or banks. Ant Financial practice what I call ‘total financial intermediation’ of the financial preferences of the buy side and sell side of the Alibaba platform.
This model has proven to be extraordinary successful and we are seeing early indications that West Coast bigtechs are gradually waking up to the opportunity of financial intermediation. To be successful, they will have to overcome a prevailing mind-set that financial intermediation is only an adjacency or an enabler rather than a line of business by itself.
The Bank of International Settlements recently issued a report on bigtech’s potential role in financial intermediation where they demonstrate that adding financing to the seller side of a marketplace is like adding gas to the engine. In the year after adding financing to a marketplace, sellers sell around 75% more SKUs and increase sales by around 75%. So it is apparent that injecting financial services is a way of accelerating the flywheel of platform economics.
There will be a growing realisation from the platform providers that they need to incorporate financial services into their customer journeys. If the banks leave a vacuum – if they don’t provide these services through API to the buy side and sell side – it will be filled by the fintechs or by the platforms themselves and banks may wonder why their business has disappeared.
It is highly possible that platforms develop their own financial ecosystems. There will be space for a plurality of providers of financial services into the ecosystem but quite a lot of activity could remain the system. We are at an early point of time in the development of these platforms. There is an argument to say that the minimum efficient scale of platforms is global and the logical of the digital economy is a winner takes all environment dominated by few players.
As these platforms become global and embed financial services, some of these platforms may seek to develop their own private currencies. If platforms develop currencies as if they are countries there will be enormous questions around national sovereignty and there is a potential regulatory vacuum in terms of the treatment of instruments like cryptographic stablecoins.
We have not even reached the foothills of these developments and banks need to think about what role they are going to play in a world of global platforms.