The modern banking system has existed in much the same essential form since the first banks were opened up for customers to deposit money and valuable items centuries ago. Although there have been a number of significant, even transformative technological developments since then, including paper currency, cheques, plastic payment cards, telephone and online banking, none of this has really disrupted the fundamental two-way relationship between customers and banks. That may be about to change with the rise of open banking.

What is open banking?

At its core, open banking is about consumers providing financial providers with secure access to their financial information, and enabling the growth of a new ecosystem around bank accounts to provide consumers with more innovative, streamlined products.

Banks are sitting on a goldmine of data about their customers and whilst historically the banking relationship has been a very closed and private relationship between banker and customer, open banking challenges that model. It promotes the sharing of the customer's transactional banking data with trusted third parties. The consequence is that customers will have more choices about who to share their information with and what data they want to share.

This information can, for example, be used to make highly accurate assessments of the user's credit risk (even if they have no credit history), to help customers manage their money better or switch accounts to a more appropriate product, to help with digital identity verification or even to make risk assessments for insurance products.

Introducing a third party into any relationship is highly disruptive, however, and open banking is no different. 

Key practical considerations for role players revolve around the need to evidence customer consent, authenticate the customer, and ensure the security of the shared information.

The most fundamental issue for open banking enthusiasts, however, is that of 'ownership' of the data. Historical banking practices have tended to lead banks to consider account data as belonging to the provider, meaning that it is jealously guarded and only grudgingly shared. In contrast, the open banking movement is predicated on the basis that the data belongs to the customer and that the customer should have control over how it is used and with whom it is shared.

Disruption as a force for good

Open banking is not just disruption for the sake of it though. The four key potential benefits of open banking are increased choice, competition, innovation, and financial inclusion.

Open banking allows third party providers to access financial data where a customer chooses to allow access. This in turn gives customers (where permitted by their bank or the law) the opportunity to engage with a potentially huge number of third party providers. Customers are no longer restricted by the sometimes limited additional services that their own bank offers, but can access more efficient and effective services offered by third party providers without having to change banks. Not only will customers have access to more banking services and products but, by giving access to their financial information, customers can find other financial products that are more tailored to their financial situation.  

This increased choice can encourage competition on several levels. Where access is opened up through a standardised open banking framework, third party providers will find it easier to access customers and more products and services will appear. This in turn should encourage banks to provide a better service to their customers by either developing their own competing services or by partnering with (or acquiring) popular third party providers.

As payment service providers (both new and old) become more competitive and are able to reach new markets, innovation is likely to increase to help participants stay relevant and competitive. With the lower costs of digital innovation (compared to the costs of traditional 'bricks and mortar' branch-based banking), more entrants will join the market with competing products, and as the market broadens, new customers and needs will be identified.

Increased access and deeper market penetration can help promote financial inclusion by providing products that are more tailored to those who are currently unbanked or under-banked. 

This virtuous circle can feed itself. As competition increases, more markets are reached, more innovation occurs, more choices are offered, and competition increases further. 

Fintechs vs. incumbents

Open banking may be seen as a threat by some incumbent banks but it also presents great opportunities for innovative banks, new providers, and customers. For example, data from the Boston Consulting Group (BCG) shows that open banking has the potential to add or erode retail-banking revenues by 15% to 25%. Although it is often the disruptive potential of fintechs that is highlighted in relation to open banking, according to BCG the real disruptive force will be generated by incumbents that seize the potential of open banking ecosystems to create long-term differentiation and growth.

Inevitably, like the banks themselves, the law around the world is also reacting to these developments. So far, there is no standard image of what open banking looks like, nor is there a 'typical' approach of governments and regulators to the question of whether it should be mandated or enabled, but in time we may see greater consistency across different jurisdictions. 

For banking regulators the challenge is to allow open banking to flourish in a controlled manner that does not undermine the regulator's overriding objectives of stability and security. In some jurisdictions (notably in Europe), open banking is imposed by regulation, but in others, banks are doing it voluntarily.

For legislators, the burning question is whether – in the long term – the aims of open banking are better achieved through 'enabling' legislation that removes obstacles and then relies on competitive forces to make it a success, or through mandatory legislation that may result in more activity sooner, but may also result in a narrower and more restricted end product.

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