From paper ledgers, through automated teller machines (“ATM”) and online banking, to Open Banking platforms, the staid world of banking has changed dramatically in just a generation. It is now the age of mobile digital banking. Although these changes only started in the recent past, they are proving to be a force to be reckoned with. Digitalisation of banking services generally reduces risk, allows clients to deposit and withdraw money, apply for loans, make payments online or on their smartphone and more.
All this is in line with the revised Payment Services Directive (“PSD2”), which updated and enhanced the EU rules that were put in place by the initial PSD in 2007 and was transposed into national law by all EU member states including the UK. PSD2 also brings the much-improved security of two-factor authentication on payments, usually through the receipt of a text message code to the customer’s mobile phone.
Regulated banks in the UK are required to let customers share their transaction data (such as spending habits and regular payments) with authorised third-party providers (“TPP”) offering other services – if the customer has given permission. This is done in a secure manner using Application Programming Interfaces (“API”), which provide TPP with access to banking systems and customer databases.
Many financial services providers have launched their own Open Banking platforms. These platforms enable access to various banks in different countries through a secure, single API. All TPP wishing to connect to bank API must be authorised by the UK’s financial regulator, the Financial Conduct Authority (“FCA”).
This introduction of “Open Banking” in Britain has arguably started to revolutionise banking. Change may take time, but it is undeniable that its wheels are in motion. We can liken this to how contactless cards are now an essential component of payments, yet they were only initially introduced in 2007. Customers have the option to share information about how they manage their bank accounts with organisations that work to deliver an enhanced banking experience, for example by offering comparison and switching services to help customers pinpoint the best financial products for them.
The crucial advantage Open Banking platforms bring to the field is the capacity to allow clients to take charge of their finances by enhancing their potential to discover new products and providing clarity over their finances and, in so doing, returning the focus back to client needs.
Open Banking means that clients will be able to access all financial services in one place – whether they are looking for a loan, a mortgage, or to pay their bills.
Some specific benefits include:
- Opportunities to cater to under-served segments: SME have particularly benefited. When it comes to businesses, they are typically heavily reliant on accountants for money management. But both challenger and incumbent banks alike are starting to offer services that reduce the need for expensive accountants. Examples include Starling’s marketplace and the purchase of the FreeAgent online accounting platform by RBS.
- Debt management: is one area of financial management that consumers continue to struggle with, as banking providers do not typically offer easily accessible services. This is starting to change thanks to Open Banking. Start-ups such as Tully are using the regulation and associated technology to improve debt management. Big banks are seeing the value of such services, as evidenced by incumbent Nationwide partnering with Tully as part of its “Open Banking for Good” initiative.
- Lending: The introduction of Open Banking gives lenders access to a much bigger range of data which was traditionally impossible, and this permits lending recommendations for a larger pool of clients, necessarily transforming this sector. For example, Peer to Peer (“P2P”) lending platforms such as Rate Setter, Zopa, and Growth Street, which are designed for both business organisations and Individuals, provide borrowers with novel ways to access facilitated loans and finance worth nearly £3 billion during 2018.With regards to SME Lending, Open Banking has allowed a variety of remedies to tackle various SME’s working capital pain points. Platforms such as Freedom Finance and Funding Options use Open Banking data to discern how an SME is performing and the probability of a default in payments based on characteristics like its cash flows and other factors. After the assessment, the SME is offered a pool of lenders best suited to meet their needs. The lenders can consider the SME’s business performance and not just credit score. This is important as SME cash flow is typically variable, which affects the firm’s overall credit score and in turn, limits access to working capital. It is therefore faster and less risky for the lenders to lend to SMEs.
- Streamlining loan application processes by partnering with credit agencies: Zopa for example launched its own verification tool in partnership with TrueLayer, that eliminated the need for borrowers to upload documents manually. The lender reports that over half of its customers select this Open Banking-powered verification option, a sign that consumers are responding positively to the tools and services enabled by this new regulation.
- Account aggregation: This is a service which many customers are benefiting from. Those that have adopted it find that the pros of keeping track of many different bank products in one place far outweigh the hesitation to share their data.
- Personal Finance Management (“PFM”): Historically, banks have done well at providing basic payments functionality and infrastructure but arguably have performed poorly at assisting clients to successfully control their spending. PFM tools assist by furnishing insights into spending habits and offering suggestions around budgeting and savings they can collect from accessing transactions. HSBC was the first UK incumbent bank to offer PFM tools via its Connected Money app, which lets clients view their accounts at up to 21 different banks.
Open Banking comes as a revolution with a myriad of opportunities for all. However, ultimately for it to be completely successful, there must be reassurance about the security of client data. With the rise in cyber threats and crime and especially when software or applications are available for free, customers first check the authenticity of the software before allowing it to connect to their banking information. The UK was the first country to develop Open Banking standards and remains the leader in this field. With Open Banking, financial institutions will have so much more to offer to their customers and keep them satisfied. Customers can gain up to £12bn a year from Open Banking enabled services, while the potential value for SME is £6bn according to research from the Open Banking Implementation Entity (“OBIE”) formed by the Competition and Markets Authority (“CMA”).
Lorna Ndungu & Nick Harriss