Authors

Giorgio Barba Navaretti^[1]University of Milan., Giacomo Calzolari^[2]European University Institute. and Alberto Franco Pozzolo^[3]Roma Tre University.

 

1. Introduction

Information is the main character in open banking (OB), which is about opening to third parties the access to information that is otherwise captive in a bilateral relationship between the incumbent provider of financial services and the client. With the words of Rivero and Vives in this issue, OB “refers to those actions that allow third-party firms, either regulated banks or non-bank entities, to have access under customer consent to their data through application programming interfaces (API)”.

Specifically, open banking aims at creating a market for customers’ transaction data, obtained (mostly although not only) from payment information. Traditionally, these data were accessible only by the financial intermediary performing the transaction and they were rather cumbersome to transfer. This gave banks the possibility to leverage on the data and extract higher rents from the interactions with their customers. OB allows customers to easily, swiftly and freely transfer their own payment information to any authorized third party of their choice, thus changing the conditions for transactions with their financial intermediaries.

Where does OB come from? The kick start comes from regulation. In the European Union, the starting point was the approval in 2015 of PSD2, the revision of the Payment Services Directive by the European Commission,^[4]Directive (EU) 2015/2366, known as PSD2, see the Institutions section below. which requires that financial institutions open up they data in favour of account service information providers (AISP), payment initiation service providers (PISP), and card-based payment instrument issuers (CBPII). In UK, PSD2 was transposed into legislation with The Payment Services Regulation of 2017, leading to the foundation in the same year of the Open Banking Implementation Entity (OBIE), an independent organisation of the 9 largest retail banks in Britain and Northern Ireland aiming to implement open banking. Similar legislations were implemented for example in South Korea and Australia, favouring the diffusion of open banking.^[5]See the Institutions and Numbers sections below. Also the market itself and the entry of new fintechs can give incentives to customers to share their financial information to obtain better services, in domains beyond payments, like loans, private banking, and so on.

In general terms, the reasons for opening access to information to third parties are three. First, enhancing competition. New third-party firms can use the information about the client to offer targeted services at better terms than the incumbent. Second, to favour inclusion. Because of a decline in costs, otherwise unbanked, unfinanced individuals may have access to financial services (see Bianco and Vangelisti in this issue). Third, to foster innovation. Competition and the focus on big data and programming interfaces is expected to favor the development of new tools, apps and services.

More specifically, the preamble of PSD2 emphasized the importance of increasing competition and guaranteeing free entry and a level playing field among incumbents and new participants.^[6]Paragraph (4) of the preamble recites: “(…) equivalent operating conditions should be guaranteed, to existing and new players on the market, enabling new means of payment to reach a broader … Continue reading However, and remarkably, the Directive focused almost exclusively on data about payment services. In fact, AISPs are guaranteed access only to data of payment accounts, i.e., accounts “held in the name of one or more payment service users which is used for the execution of payment transactions”. All the same, it became increasingly clear to the industry that granting access to customers’ payment information would have also eased the provision of other banking and financial services and the development of a range of innovative products. These developments were also judged positively by regulators. In this regard, it is illuminating that EBA, in reply to a question raised by the Bank of Ireland on the interpretation of the Directive, on 13 September 2019 stated that an AISP is not limited to providing the consolidated information on the different account positions to the payment service user, but with the user’s consent it can also make this information available to third parties.

This evolution towards an even broader OB is envisaged to have the potential to change financial intermediation radically. But for this to happen, two key factors must be present: first, consumers must be willing to share their data, and second, the technology must be in place to ensure seamless data access through the use of APIs and cloud computing. If these conditions are met, OB is expected to change the way financial intermediation occurs.

Yet, there are considerable limits to the diffusion of financial information and to the use of such information for the purposes of enhancing competition, inclusion and innovation. Open banking is essentially about enabling transfers of data and information to some third parties, but not making it generally available. Key to the understanding of the potential impact of this innovation with respect to the three objectives above is therefore the assessment of how information will in fact be spread and used. If we take this perspective, we believe that the scope and the aims of open banking, although potentially groundbreaking, may sometimes be overstated, and its desirable implications cannot be taken for granted.

Information, in principle, is a public good: non rival and spreadable at no (marginal) cost. It gains private value precisely when different forms of protection privacy rules), or property rights (patents and copyright) prevent it from being used as a public good. Even in the case of open banking, information has value, be it for the incumbent or for other third parties, only if it can keep being privatized, at least partly. This creates inherent limits to its complete diffusion and disclosure.

These limitations are relevant for both the supply and the demand of information. On the supply side, OB does not open information concerning a given client to everybody. The owner of the information, the client, decides whether to make it available to well-identified counterparts. Whatever the source of open banking, rules or markets, the starting point is that the client remains the sole owner of the data and information on her or his transactions. This causes an issue of selection. How many potential counterparts are clients willing to disclose their private transactions to? Possibly a small number, because of privacy and because of reluctance to disclose sensitive information. Hence the supply of information will likely be limited.

As for demand, entry of third parties in a given segment of the financial markets will be enhanced by OB only if entrants have some way of preserving at least part of the value of the information. If it were not at least partly privatized by the new third party, the information would have limited value and there would be no demand for it and, ultimately, no entry in the market. Of course, even in a world where information is fully disclosed, capable providers can leverage on freely accessible information to offer highly differentiated products, not fully in competition one with the other, and create value for themselves anyway. Yet, inevitably the value of information declines with its diffusion. Again, this sets, from the demand side, a limit to how extensively information would be spread out.

An additional issue is how the information can be effectively used, and we will discuss this extensively in the third part of this editorial. One option, as argued above, is that the information is granted by the customer to a limited number of selected counterparts. Even opening up the information to a single new provider can be beneficial to the client: compared to the incumbent, the entrant may offer new services or the same services at better conditions. Of course, as argued by several contributions in this issue, things are different if the new entrant is an established bank or a Bigtech i.e., the big digital platforms with strong and entrenched market power in (non-financial) digital markets, rather than a fintech. Still, the ability to offer new services would anyway have a positive impact on competition and innovation, and possibly, through a reduction in the cost of services, to inclusion.

A different scenario could emerge if the data were transferred to a platform, which brokers numbers of potential suppliers of financial services. The platform matches clients with services, and the information likely stays with the platform, i.e., it is not necessarily transferred to the providers of the financial services. This because the platform is the intermediary in a two-sided market and has the technology to use the information for efficient matching. The client can therefore be better off. However, as we will argue below, the platform would enjoy monopoly power and information rents.

Network externalities would also be another distinctive element of this scenario. Only platforms with a very large client base and a large number of potential suppliers can effectively use clients’ data to offer efficiently targeted services. In other words, services based on the use of data and clients’ information generate network externalities which create new monopolistic power and limit the diffusion of information, even if it is used to broker the services of many potential suppliers. The market power built on relationship-based financial intermediation with restricted data access, would be replaced by a new network-based market power with open data. We will discuss the implications of OB for competition extensively in the third part of the introduction. In the following one we first examine which type of financial services can be affected by OB.

 

2. Open banking’s products

Which financial products will be mostly affected by open banking? A distinction is to be made between the existing financial products and the new ones that may be created.

Since open banking is mostly based on sharing payment information, an obvious starting point is to look at payment services. In this respect, payment initiation service providers (PISP) – newly allowed by PSD2 – may compete with existing intermediaries to become the originators of customers’ transactions, favouring a reduction in the costs and an increase in the speed and security of payment transactions. Customers, for example, may authorize a PISP to directly charge their bank current account after their purchases on internet, while simultaneously giving the seller the guarantee that the payment is successful. Since internet purchases are typically regulated through rather expensive credit-card transactions, the benefits of having PISPs is in this case evident

However, focusing on payment services only gives a narrow perspective on how open banking can enhance competition in the market for existing financial products. The possibility of accessing customers’ transaction data will likely impact all markets where this information has value for the provision of targeted services (Fama, 1985). An obvious example is the loan market. Convincing empirical evidence shows that there are significant complementarities between offering the same client a deposit account and a loan (Mester et al. 2002). In fact, it is a common practice for banks to require clients to open a checking account when they are granted a loan. Indeed, information on incoming and outgoing financial flows can be extremely valuable to assess ex-ante the level of a borrower’s riskiness and monitor ex-post its evolution. Financial intermediaries that can access these data have, therefore, a competitive advantage with respect to their competitors, leading to a bundling of the markets for deposits and loans. With open banking, each customer can allow an AISP (account information service provider) to access his transaction data and use them to choose what it considers the best potential lender. If authorized by the payment account holder, an AISP can also make the information available to any third party of his choice. A competing bank could therefore either act as an AISP or obtain information from an AISP on the customer’s transaction data. Clearly, this would whiten the competitive advantage that banks have when granting loans to their deposit holders. The product that would benefit from increased competition made possible by open banking would in this case be traditional bank loans.

Another practice that is rather common among banks is to offer investment products to their deposit holders when they see that their balances on the checking account exceeds levels consistent with normal operativity. In this case, the customer only receives an alert on his liquidity position, and she is free to invest in products other than those offered by the bank where she holds her checking account. However, the bank that has access to the customer’s transaction data still holds a first-mover advantage with respect to potential competitors, and it also has a comprehensive view of the time evolution of the liquidity position of the customer and of its average liquidity needs. Once again, with open banking, a customer can choose to make all this information available to any provider of saving products through an AISP, therefore reducing the competitive advantage of the bank where she holds the checking account.

A parallel issue, emphasized by Redondo and Vives in this issue, is the sharing of information on other financial positions of a customer regarding his saving and investment accounts or his loans and mortgages. While this is not yet a central part of the debate on open banking, there appears to be no reason why the logic applied to transaction data should not be expanded to information on other financial positions.

But open banking is not only expected to increase competition in the markets for existing financial services but also to foster the creation and supply of new financial services. This may open the door to an entirely new business model, where banks become platforms between customers willing to make their data available and sellers of financial services and financial intermediaries willing to offer them products that are specifically targeted to their individual characteristics. While the implications of this potential revolution on the banking industry will be discussed in more detail below, new products are being developed and it is to be expected that a wide range of additional ones will be made available in the future.

At the moment, the fastest growing services seems to be those helping to connect different accounts – e.g., bank, credit cards, and investment accounts – to provide a comprehensive view of the financial position of an individual or a firm. Providers such as Emma (https://emma-app.com/), Tink (https://tink.com/) and TrueLayer (https://truelayer.com) already offer these services, and are extending their line of business in new directions. For example, some providers already offer contemporaneous access to investment platforms, including those allowing to acquire crypto assets, while others offer secure authentication for the access to all different accounts. Other services already available include those that alert customers (and possibly their authorized connections, e.g., parents of minors) when a payment is required that exceeds a given amount or a regular pattern of purchases, helping detect scams and frauds.

As discussed by Bianco and Vangelisti in this issue, an interesting set of services are those targeted to less skilled individuals to manage their finances better, helping them to avoid recurring to credit card loans when cheaper bank loans are available as alternative or alerting them when outflows are exceeding the sustainable pattern that can be foreseen based on past evolution. Indeed, if directed by adequate policies, open banking can be a powerful tool to improve financial awareness and inclusion.

The next steps are difficult to foresee, but they will likely depend on the amount of information that can be extracted from payment data. Detailed information not only on the inflows and outflows of money from an account but also on their origin and destination might allow to reconstruct the pattern of purchase of an individual, making the step towards targeted product advertisement very short. Clearly, this once again opens the Pandora box of the role of Bigtechs such as Amazon or Alibaba, that already collect this information from a different angle. The role of policy and regulation will therefore be crucial in shaping future developments.

The possible uneasiness of many customers to share information with unknown new players gives a strong advantage to incumbents. And while this may be contrasted by enacting regulations that limit access to customers’ information only to reliable and possibly supervised entities, such regulations may not be easy to implement since open banking services are offered through the Internet and may therefore come from entities based all over the world, including countries with loose or non-existent financial regulations on open banking and data protection. Indeed, an adequate balance between limitations imposed by regulation and the need to allow market access to innovative entrants is yet to be found, but certainly necessary.

The market is in rapid evolution. Emma, for example, was founded in 2010 by two computer scientists and has still managed to survive being privately owned. Tink, founded in 2012 by two independent entrepreneurs, has been fully acquired by VISA in 2022, likely planning to leverage its huge customer base. Instead, Yolt, an open banking personal finance management application offered by the Dutch bank ING that started operating in 2017, has already closed its activities.

 

3. The impact on the industry

As discussed above, the actual implications of OB, though, depend on the availability of adequate data flows. If financial customers are not interested in sharing their data or have concerns about privacy, the entire chain of consequences may not materialize. The more mature digital markets provide useful lessons, showing how platform companies successfully convinced users to give up and share their data. Many digital markets offer “freebies”, or zero-price services, such as search engines and recommendations, with monetization taking place on other sides of the market, such as advertising to digital users. This business model has pushed users to embrace the idea, consciously or not, of providing personal information in exchange for services. This could serve as a model for financial markets too, but it will require the development of a platform-based business model that, as illustrated above, would allow retaining the information with the platform intermediary, a model still to come in financial markets.

Assuming that financial consumers are convinced to share data, the question is who are the other financial operators that will receive them. Rivera and Vives, in this issue, convincingly note that if data flow reaches other incumbent operators, like traditional banks, then even if potentially competing, we may not expect significant impacts of data, with additional risks. We know that data availability may induce a “winners-takes-all” condition when companies offer multiple products and services. Again digital markets are an example with their strategies that rely on the reusability of personal data for multiple purposes and services, with an envelopment effect on customers. A realistic outcome of this data flow is a possible increase of market concentration in the hands of fewer traditional financial intermediaries, uniquely placed to offer bundles of services. They are unlikely to be challenged by platforms also offering several products and services, as they are yet to be seen in markets.

Clearly, as argued above, the flow of data mobilized by OB can also reach new players offering specialized and unbundled services, such as payment systems or lending services. Although in this case data could activate new tech players in financial markets such as Fintech, the implications on market structure and outcomes are, again, ambiguous and may not materialize quickly.

In fact, some recent papers in the academic literature (e.g. Parlour et al. (2022) on payments services and He et al. (2023) on lending) have highlighted that empowering Fintech players creates competitive pressure for traditional banks but, at the same time, can produce countervailing effects in terms of price and product discrimination and reduction of consumers’ surplus. Information is a peculiar input in financial intermediation. If the technology used by the new players to manage and elaborate information is significantly better than that of traditional players, this would enable them to segment the market and acquire the surplus of consumers of financial services. In other words, the unique nature of information as an input for financial activities can quickly generate excessive informational advantages for new entrants in terms of new services and better surplus appropriation.

Another risk could emerge when the data flow on financial transactions reaches mostly BigTech firms. These companies may extend their business envelopment and begin offering financial services (some already are, such as in China). On the one hand, this would increase competition, thus benefitting consumers of financial services. On the other hand, the strong envelopment tendency of a platform-business model should not be underestimated. We know from digital markets that these firms leverage detailed users’ information to capture users in several markets, with reinforcing feedback effect induced by even more data from the many services and products they offer. These are the consequences of strong complementarities between services and products (or indirect network externalities), reusability of data for several purposes and products, and specific properties of Artificial Intelligence algorithms employed to process these data.^[7]Calzolari et al. (2023) discuss “Scale and Scope” properties of Machine Learning tools that rely on the amount of data and the diversity of data-sources and also study the implications for the … Continue reading Digital platforms have also prospered thanks to a feedback-loop mechanism where more users provide more data, allowing for better algorithms, predictions, and services, thus attracting even more users. OB has thus the potential to favor BigTech companies disproportionally and reinforce their business model with the inclusion and mutual reinforcement of financial services in their ecosystems. Interestingly, BigTech may value the flow of data originated by OB more than traditional banks for the same mechanisms described above and may be quicker and more effective in convincing financial market customers to share data with them.

Will platform-based financial operators able to bundle a variety of services emerge? It is difficult to say at this stage. They may materialize from a transformation of traditional incumbent companies, such as banks, or from BigTech entering the financial market. However, whatever the origin of this development, this could become a radically new scenario with platforms operating as matchmakers between customers of financial services and financial service providers . As a first step, the relevant data might possible refer to payments and deposits, as discussed above, possibly merging this type of information from different banking relationships. So traditional banks and AISPs are currently better placed to become financial platforms at an initial stage. However, the envelopment effects of Bigtechs should not be underestimated. In addition, “Banking as a Service” may further evolve, again under the impulse of regulation, markets and technology, into broader future developments, as it could very much involve many other financial services not only those typically related to banking. The properties of such a market configuration with broad gatekeepers are not necessarily very competitive, as the digital markets have shown and as discussed above.

Padoan, in this issue, indicates what could be effective strategies for traditional banks. Rather than insisting on traditional approaches, the quicker way into the innovation flow for traditional banks seems to be collaborating with new players (or acquiring them). However, we think this will not suffice if the platform model prevails. The changes needed for banks to transform themselves into platform operators and benefit from the network externalities that, if large, they already enjoy, are anyway deep. Offering fintech services in parallel is just one step in creating an enveloping “ecosystem” for their own products or for those of partners.

These long-run effects of OB are challenging to predict at this stage, as they combine several elements, in particular innovative technologies with consequences on screening and matching, flows of data, and business models that are new to financial markets.

In this uncertain and evolving environment, regulation should play a key role. For example, currently, in Europe, the Payment Service Directive “PSD2” only refers to data flowing to payment service providers but not to providers of other financial services, such as saving accounts, credit cards, mortgages, pensions, or insurance. Because of the implications of data flow discussed above, this limited first step into OB could be considered a wise approach. However, this is leaving much of the potential of OB untapped, and, as Dalmasso elaborates in this issue, the limited span of the directive may in itself constrain the potential broader benefits of OB. Regulation should continue to lead the development that OB will have on financial markets, also because increased competition and shifts in profitability will affect financial operators’ charter values, thus inducing increased risk-taking appetite with perilous implications for financial stability.

Currently, the promise of innovative banking platforms remains unfulfilled, as new entrants primarily focus on creating effective application interfaces rather than offering truly ground-breaking financial services. As previously discussed, the impact of OB may remain limited. However, once OB reaches full potential, it will undoubtedly reshape the financial landscape. And it will be essential to guide this process to prevent market tipping and concentrations similar to those seen in digital markets. Historically, policymakers believed that ex-post interventions would suffice to address market power issues in digital markets. However, as we have learned from experience, this is not the case, and regulators have had to catch-up with new regulations like the Digital Market Act (DMA) and the Digital Service Act (DSA). In the case of financial markets, proactive regulation will be crucial to avoid a similar scenario of late intervention. To achieve this, it will be useful to learn from the lessons of digital markets while creating regulations tailored to the unique characteristics of the financial industry. The challenge will be to strike a balance between regulations like DMA and DSA, coexisting with those designed explicitly for financial markets.

 

References

Calzolari G., Cheysson, A., and R. Rovatti (2023) “Machine Data: Market and Analytics”. SSRN, CEPT and European University Institute working paper.

Fama, E. F. (1985). “What’s different about banks?”. Journal of monetary economics, 15(1), 29-39.

He, Z., Huang, J., and Zhou, J. (2023). “Open banking: credit market competition when borrowers own the data”. Journal of Financial Economics, 147, 449-474.

Mester, L. J., Nakamura, L. I., and Renault, M. (2007). “Transactions accounts and loan monitoring”. The Review of Financial Studies, 20(3), 529-556.

Parlour, C. A., Rajan, U., and Zhu, H. (2022). “When Fintech competes for payment flows”. The Review of Financial Studies, 35, 4985-5024.

 

Authors

José Manuel Mansilla-Fernández^[1]Public University of Navarre (UPNA) and Institute for Advanced Research in Business and Economics (INARBE).

 

Characteristics of Open Banking^[2]We wish to thank Platformable for making their data available for our research.

Figure 1. APIs development by banks.

Notes: Own elaboration on Platformable and world Bank data. The figure reports the first 30 countries ordered by the ratio of the number of APIs developed by banks in the Platformable sample and the total number of banks in the country.

 

Figure 2a. APIs development by banks in different world regions.

 

Figure 2b. APIs development by banks in Europe.

Notes: Own elaboration on Platformable database. The vertical axis represents the average number of APIs developed by each bank of the sample. The whiskers represent the maximum and the minimum of the distribution. The box is divided into two parts by the median, i.e., the 50 percent of the distribution. The upper (lower) box represents the 25 percent of the sample greater (lower) than the median, i.e., the upper (lower) quartile. The mean of the distribution is represented by ×.

 

Figure 3: APIs development and bank size.

Notes: Own elaboration on Platformable database. Correlation between banks’ size measured as the natural logarithm of bank’s i total assets (Ln(Total assets)) in 2022Q3, which is represented in the horizontal axis, and the number of APIs in 2022Q3, which is represented in the vertical axis. The sample includes banks from Austria, Denmark, France, Greece, Ireland, Italy, The Netherlands, Spain, and the United Kingdom.

 

On FinTech companies

Figure 4: Use of FinTech-provided services.

Notes: Own elaboration on Platformable database. The vertical axis represents the different FinTech categories by functions. The horizontal axis represents the share of the number of FinTech companies included in Platformable by category. The sample includes FinTech companies from Europe, The United Kingdom, and the United States.

 

Figure 5: Users of FinTech-provided services.

Notes: Own elaboration on Platformable database. The horizontal axis represents different users of banking services provided by FinTech companies. The vertical axis the share of each users. The sample includes FinTech companies from Europe, The United Kingdom, and the United States.

Authors

José Manuel Mansilla-Fernández

 

Open banking frameworks

Open banking is defined as the “sharing of customers’ permissioned information held by banks with so-called ‘third-party’ developers, who can use them to build applications and services comprising payments, synthetic information for account holders, and other marketing and cross-selling opportunities” (BIS, 2019).^[1]The term ‘third party’ can be defined as ‘legal entities’, rather than supervised banks. More precisely, ‘third parties’ can be supervised banks and / or regulated companies, sellers, and … Continue reading

Many authorities are planning to take actions to regulate Open Banking in their jurisdictions. A large part is following a prescriptive approach, which mandates banks to share customers’ information with the aforementioned ‘third parties’ willing to access, as long as they are included in a register established by regulatory authorities. Other jurisdictions are instead adopting a facilitating approach, avoiding explicit requirements to make data available to ‘third parties’ but providing guidelines or recommendations, as well as suggesting common standards for the application programming interfaces (API) used to access the data, that the whole industry is invited to adopt. Lastly, other authorities are following a market-driven approach, setting no specific rules the sharing of customers’ information between banks and ‘third parties’ (BIS, 2019). ^[2]The European Union countries follow the prescriptive approach. Japan, Hong Kong, Singapore, and Republic of Korea adopted the facilitative approach. Argentina, the US and China follow the … Continue reading Overall, the regulatory framework is still embryonic in many jurisdictions, and activities by regulators, banks and market developers are still in at the initial stage (OECD, 2023).

A thorough Open Banking framework can include rules, standards and practices aimed at solving the many issues that are likely to emerge from such a pervasive data-sharing environment. Most jurisdictions take the perspective of customer protection from possible problems caused by allowing access to bank customer-permissioned data to unregulated third (and possibly fourth, if data are further transmitted to other corporations) parties (Bains et al., 2022). From this perspective, a range of different authorities are involved in regulating open banking, including: i) bank supervisors, in their traditional role of with respect to the activities of regulated banks (that are the producers of customer data); ii) technical standards setting bodies, that establish standards for automated access to customer permissioned data through API, with a special focus on security and standardization, requiring all involved entities to comply with them; iii) competition authorities, that monitor, encourage and take actions to ensure the well-functioning of markets; iv) data privacy authorities, responsible of ensuring the protection customer data; v) alternative dispute resolution mechanisms, responsible of mediating disputes between consumers and financial service providers (BIS, 2019).

 

The regulatory framework in the European Union

The revised PSD2 (Directive (EU) 2015/2366), adopted from January 13th 2018, standardizes payment services across the European Union (EU hereafter), and is the reference framework for the regulation of the payment sector.

Among other seminal provisions – e.g., detailed security transactions for electronic payments – the PSD2 also establishes the key concepts for the definition of Open Banking, by including in the regulation the Payment Initiation Services (PIS) and the Account Information Services (AIS). In this regard, the Directive clarify that the ‘competition-enhancing objective’ by regulating services operating as competitors to main banks.^[3]Art. 108 of The Directive foresees reporting on the application of PSD2 to the European regulatory institutions, i.e., the European Parliament and the Council, the European Central Bank and the … Continue reading An important step in this direction was the reply by EBA to a question raised by the Bank of Ireland on the interpretation of the Directive, stating that an AISP is not limited to providing the consolidated information on the different account positions to the payment service user, but with the user’s consent it can also make this information available to third parties (EBA, 2021).

Despite the innovative content of PSD2, a recent document by EBA (2022) assessing the impact of PSD2 came to the conclusion that significant areas are still to be addressed so as to achieve the objectives to enhance competition, facilitate innovation, increase security of payment transactions, ensure the neutrality of the business model, and build a ‘single EU retail payment market’. In particular, the EBA proposes detailed interventions in four areas: 1) the prudential framework on licencing payment companies under the PSD2 regulation; 2) the responsibility of funds transferred by ‘third-parties’;^[4]In particular, EBA proposes for the Directive: (i) not to take into consideration maximum limits for the amount to block payers’ accounts if the transaction is known, but introducing some … Continue reading 3) the application of Secured Customer Authentication (SCA), especially regarding the regulation of the merchant-inititaled transactions; 4) the need to address social engineering fraud risk by introducing requirements on educational and awareness campaigns, incentivising Payment Service Providers (PSP hereafter) to invest in monitoring mechanisms and sharing information among PSPs related to possible cases of fraud or fraudsters. Interestingly, regarding the need for ensuring the maximum degree of ‘financial inclusion’, the EBA suggests that the Directive introduces a general provision taking into account vulnerability of customers. The EBA also suggests enhancing attention and training on authentication procedures.

 

The British regulatory framework

The United Kingdom’s (UK) Open Banking Initiative constitutes a reference worldwide. The Open Banking Working Group (OBWG hereafter) was created in September 2015 by HM Treasury to assess whether bank data sharing may benefit the whole sector. The group consists of representatives of financial institutions, open data groups such as the Open Data Institute (ODI hereafter), as well as consumers’ associations and representatives of ‘third-party’ corporations. The following year, the Group suggested that standardized APIs would be a useful step to facilitate the sharing of information. In addition, it argued that a decentralised system of Open Banking would be safer than a single, centralised system.

The crucial year for Open Banking in UK is 2017. The PSD2 was transposed into legislation with The Payment Services Regulation and the Competition and Markets Authority (CMA) conducted a ‘Retail Banking Market Investigation’, that reached the conclusion that “older and larger banks do not have to compete hard enough for customers’ business, and smaller and newer banks find it difficult to grow. This means that many people are paying more than they should and are not benefiting from new services” (CMA, 2016). As a result, the CMA introduced a major open banking initiative aimed at enhancing innovation and competition within the banking sector, requiring the nine largest banks to “give their personal and business customers the ability to access and share their account data on an ongoing basis with an authorised [by the government] third parties” (see Taylor-Kerr, 2020). Here, the term ‘third party’ refers to banks and FinTechs. Furthermore, the aforementioned banks were required to enable third parties to make payment services authorised by customers’ banks, the so-called payment initiation. Importantly, the access to the data must be free to the petitioner (under customers’ permission), and banks are mandated to allow it (Babina et al., 2022).

In allowing banks to access customers’ information, regulators intend to create an environment where financial might propose new or improved financial services for customers and enhancing competing environment.

Lastly, the Open Banking Implementation Entity’s (OBIE hereafter), which was created in May 2020 after a thorough consultation process, adjusted the ‘Roadmap’. The process was conducted in two steps of consultation: i) open workshops, and ii) the assessment over 75 pieces of feedback from representative stakeholders, including the banks, third party suppliers, and user representatives.

 

Regulatory framework in other jurisdictions

As argued above, the regulatory framework of open banking is still embryonic in many jurisdictions. This section describes briefly the situation and perspectives of Open banking around the World.

The Australian government introduced the Consumer Data Right (CDR hereafter) legislation in 2017. The CDR applies to a broad range of customers’ data, including banking, energy, telecommunication data information, which are aimed at generating interoperability across sectors. Furthermore, the Australian Open Banking application is exclusively dealing with data, but not on payments. Additionally, the Australian Competition Consumer Commission (ACCC hereafter) assumes the supervisory role, which is equivalent to that of the CMA in the UK, while operating along the Australian Payments Network. In this regards, Andi White, CEO of the Australian Payments Network, stated that “the regulatory stance is about a balance of stability and innovation but there is a desire for good competition with the rise of challenger banks” (ACCC, 2023).

In Canada, a consultation was announced in 2017 to analyse the capabilities of Open Banking for their banking sector. In particular, an ‘Advisory Committee on Open Banking’ was appointed to conduct the analysis, along with a secretariat within the Department of Finance. In June 2019, the ‘Standing Senate Committee on Banking, Trade and Commerce’ launched a report entitled “Open Banking: What It Means For You”, which deals with a number of recommendations aimed at consolidating the Open Banking in Canada (World Bank, 2022).

The Hong Kong Monetary Authority (HKMA) released the “Open API Framework for the Hong Kong Banking Sector” in July 2018. The HKMA is intended to allow their banking industry to set their own criteria without making it a regulatory requirement (HKMA, 2018).

India released the Unified Payment Interface (UPI) in 2016, which is developed by the National Payments Corporation of India (NPCI). The UPI allows data transfer among financial institutions using a strong API environment that includes a digital identity solution which is still missing in most European and US jurisdictions/markets. Importantly, a new category of entities called Account Aggregators act as data fiduciary managing data requests from institutions that have a legitimate interest and the providers of information, and the consent of the data subject. The model is a clear representation of the regulatory approach. Importantly, it does not pre-judge the type of services the data receivers will offer, and allows all institutions regulated by any of the financial sector regulators in India and the Department of Revenue, Government of India to be able to participate as data receivers (see Natarajan, in this issue).

In Japan, the Amended Banking Act introduces a system for TPPs and establishes the environment for the banks-TPPs collaborations, in addition to other voluntary partnerships among banks to release ‘digital payments initiatives’. However, the activities of adopting ‘third parties’ are still in a preliminary phase, partly because of the difficulty in negotiating contracts between banks and FinTechs.

Mexico has implemented a model similar to the British one, but considering ‘premium’ versions for APIs. In March 2018, Mexico passed the ‘Financial Technology Institutions Law’ (The FinTech Law) aimed at regulating the FinTech and the Open Banking companies. The Mexican government is now finalising its implementation. The National Banking and Securities Commission will be the Open Banking regulatory framework, which is also intended to enhance innovation and financial inclusion (Greenberg and Traurig, 2020).

New Zealand implemented a model of Open Banking similar to the British one. The similarity results from the tight collaboration between both jurisdictions, conducted under the administration of the local payments associations, namely PaymentsNZ. Furthermore, New Zealand’s programme includes information about customers’ accounts and their payments (World Bank, 2022).

In Nigeria, the ‘Open Technology Foundation’ launched the Open Banking Nigeria (OBN hereafter) in 2018, which was aimed at fostering innovation in the Nigerian banking sector. OBN was intended to standardize open APIs as well as foster financial institutions and FinTechs to open their APIs protocols. Unlike other Open Banking jurisdictions, OBN regards excessive the British standards for the Nigerian purposes. Hopefully, Nigeria is designing suitable standards for the needs of their banking sector, and for other West African countries. The OBN’s API framework is expected to reduce the cost of innovation and to provide a good customer experience (Kassab and Laplante, 2022; ODI, 2020).

In Singapore, banks are encouraged to adopt APIs to accelerate the implementation of Open Banking. The Monetary Authority of Singapore (MAS hereafter) is not directly intervening, but together with the Association of Banks in Singapore has released an API typescript to encourage financial institutions to take part in the programme. As a result, several banks are launching their own API portals (e.g., Citibank, DBS, Standard Chartered, among others).

In the US, the so-called “NACHA’s API standardisation programme”, which was announced in 2017, focusses on three areas: i) fraud; ii) customers’ information sharing; iii) access to payment services. Additionally, the Consumer Financial Protection Bureau’s principles advice banks to include APIs for customers’ information sharing.

 

References

Australian Competition and Consumer Commission (ACCC) (2023). The consumer data rights. Available at: https://www.accc.gov.au/focus-areas/the-consumer-data-right (Accessed on 23 March 2023).

Babina, T., Buchak, G. and Gornall, W. (2022). Customer Data Access and Fintech Entry: Early Evidence from Open Banking. Mimeo.

Bains, P., Sugimoto, N., and Wilson, C. (2022). BigTech in Financial Services: Regulatory Approaches and Architecture, FinTech Notes. Available at: https://www.elibrary.imf.org/view/journals/063/2022/002/article-A001-en.xml (Accessed on 22 March 2023).
Badour, A., and Presta, D. (2018). Open Banking: Canadian and international developments. Banking & finance law review, 34(1): 41-47.

BIS (2019). Report on open banking and application programming interfaces. Basel Committee on Banking Supervision. Available at: https://www.bis.org/bcbs/publ/d486.pdf (Accessed on 15 February 2023).

Competition and Markets Authority (CMA) (2022). Retail banking market investigation. Avaulable at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1048212/Final_revised_Agreed_Arrangements_190122.pdf (Accessed on 22 March 2023).

Competition and Markets Authority (CMA) (2016). CMA paves the way for Open Banking revolution. Available at: https://www.gov.uk/government/news/cma-paves-the-way-for-open-banking-revolution (Accessed on 22 March 2023).

EBA (2022). Opinion of the European Banking Authority onitstechnicaladvice on thereview of Directive(EU) 2015/2366onpayment services in the internal market (PSD2). Available at: https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Opinions/2022/Opinion%20od%20PSD2%20review%20%28EBA-Op-2022-06%29/1036016/EBA%27s%20response%20to%20the%20Call%20for%20advice%20on%20the%20review%20of%20PSD2.pdf (Accessed on 15 February 2023).

EBA (2021). Guidelines on customer due diligence and the factors credit and financial institutions should consider when assessing the money laundering and terrorist financing risk associated with individual business relationships and occasional transactions (‘The ML/TF Risk Factors Guidelines’) under Articles 17 and 18(4) of Directive (EU) 2015/849. (Accessed on 22 March 2023). Available at: https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Guidelines/2021/963637/Final%20Report%20on%20Guidelines%20on%20revised%20ML%20TF%20Risk%20Factors.pdf

GreenbergTraurig (2020). New Open Banking Regulation in Mexico. Alert – Financial Regulatory & Compliance. Available at: https://www.gtlaw.com/en/insights/2020/6/open-banking-en-mexico-nueva-regulacion (Accessed on 23 March 2023).

Hong Kong Monetary Authority (2018). Open API Framework for the Hong Kong Banking Sector. Available at: https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2018/20180718e5a2.pdf (Accessed on 22 March 2023).

Kassab, M., and Laplante, P.A. (2022). Open Banking: What It Is, Where It’s at, and Where It’s Going. Computer, 55: 53-63 DOI: 10.1109/MC.2021.3108402.

Leong, E., and Gardner, J. (2022). Open Banking in the UK and Singapore: Open Possibilities for Enhancing Financial Inclusion. Journal of Business Law, 5: 424-453. DOI: http://dx.doi.org/10.2139/ssrn.4194256.

Natarajan, H. (2022). Regulatory Aspects of Open Banking: The Experience thus Far. European Economy. Banks Regulation, and the real Sector, this issue.

Open Data Institute (ODI) (2020). Open Banking preparing for lift off. Purpose, Progress & Potential. Available at: https://www.openbanking.org.uk/wp-content/uploads/open-banking-report-150719.pdf (Accessed on 23 March 2023).

OECD (2023). Data portability in open banking: Privacy and other cross-cutting issues. OECD Digital Economy Papers, No. 348, OECD Publishing, Paris, DOI: https://doi.org/10.1787/6c872949-en.

Parliament of Canada (2019). Open Banking: What it means for you. Senate, Ottawa, Ontario, Canada, K1A 0A4. Available at: https://sencanada.ca/content/sen/committee/421/BANC/reports/BANC_SS-11_Report_Final_E.pdf (Accessed on 2 March 2023).

Taylor-Kerr, A. J. (2020). Adopting Open Banking in Canada: An Analysis of Current Global Frameworks (Unpublished master’s project). University of Calgary, Calgary, AB. URI: http://hdl.handle.net/1880/114213

World Bank (2022). Technical Note on Open Banking. Comparative Study on Regulatory Approaches. Available at: https://elibrary.worldbank.org/doi/abs/10.1596/37483 (Accessed on 2 March 2023).

Legislation cited

The CDR Treasury Laws Amendment (Consumer Data Right) Act 2019. Available at: https://www.oaic.gov.au/consumer-data-right/cdr-legislation (Accessed on 15 February 2023).

Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC (Text with EEA relevance).

Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC.

Hong Kong Monetary Authority (2018). Open API Framework for the Hong Kong Banking Sector. Available at: https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2018/20180718e5a2.pdf (Accessed on 15 February 2023).

Japan. Act No. 59 of 1981, as amended (Banking Act). Available at: https://uk.practicallaw.thomsonreuters.com/w-007-5339?transitionType=Default&contextData=(sc.Default)&firstPage=true (Accessed on 15 February 2023).

Mexico. DECRETO por el que se expide la Ley para Regular las Instituciones de Tecnología Financiera y se reforman y adicionan diversas disposiciones de la Ley de Instituciones de Crédito, de la Ley del Mercado de Valores, de la Ley General de Organizaciones y Actividades Auxiliares del Crédito, de la Ley para la Transparencia y Ordenamiento de los Servicios Financieros, de la Ley para Regular las Sociedades de Información Crediticia, de la Ley de Protección y Defensa al Usuario de Servicios Financieros, de la Ley para Regular las Agrupaciones Financieras, de la Ley de la Comisión Nacional Bancaria y de Valores y, de la Ley Federal para la Prevención e Identificación de Operaciones con Recursos de Procedencia Ilícita. Available at: https://www.dof.gob.mx/nota_detalle.php?codigo=5515623&fecha=09/03/2018#gsc.tab=0 (Accessed on 15 February 2023).

Authors

José Manuel Mansilla-Fernández

 

This journal section indicates a few briefly commented references that a non-expert reader might want to cover to obtain a first informed and broad view of the theme discussed in the current issue. These references are meant to provide an extensive, though not exhaustive, insight into the main topics of the debate. More detailed and specific references are available in each article published in the current issue.

 

On the functioning of Open Banking

Banking institutions allow access to their data through application programming interfaces (APIs hereafter) to third-party services providers (TSPs hereafter) to create new services, analytics, and financial products to improve customers’ services. In this regard, Open Banking is thought to support customer requirements and TSPs innovation to identify further customers’ needs and accelerate financial inclusion. The critical point is to preserve the privacy of depositors, borrowers, investors, and other types of personal information (PI). When disclosing APIs to TSPs, financial institutions might be afraid due to possible attacks to their customers by malicious software (Liao et al., 2022).

Notably, APIs can be defined as mechanisms through which computers communicate with each other using common languages. Software systems operate among themselves through standardized protocols and standard interfaces (Cowhey et al., 2009). In this regard, APIs enable such interfaces to communicate with one another, making information and contents approachable (Bodle, 2011). Furthermore, APIs technologies reduce abstraction and complexity, allowing API-consuming systems to communicate without previous conditions regarding the origin of the applications (Zachariadis and Ozcan, 2017).

Interestingly, the banking industry is experiencing a process of platformization, in which technology is used to connect people, organisations and resources in an interactive ecosystem (Parker et al, 2016; Van Dijck et al., 2014, 2018). Formally speaking, Open Banking, has been expanded worldwide, and it has become one of the most prominent strengths of the banking industry (Brackert et al., 2019; Ziegler, 2021). The cornerstone of Open Banking is to ensure sharing, provided there is consent. Interestingly, despite this simple process, data-sharing rights might be the main limitation for fostering the revolution of the banking industry from the conventional business models to ‘open platforms’, as happened in other industries such as the telecommunication sector (Babina et al., 2022; Westermeier, 2020). Indeed, platform-business models might have repercussions on competition since they rely on network externalities, as further discussed in the next section (Barba Navaretti et al., this issue).

Open Banking encourages innovation between financial institutions and TSPs. Consequently, customers’ account transactions are regarded as ‘banks’ assets’, but Open Banking allows customers to share their information with other TSPs through APIs (Almehrej, et al., 2020). Interestingly, the Open Banking Implementation Entity (OBIE) aimed to develop APIs standards for Open Banking in the UK. The OBIE requires British banks to verify TSPs (consent) access to users’ data. Liao et al. (2022: 451) identify the following three phases to implementing Open Banking:

1. Requiring public information about time deposit interests, currency exchange, and mortgage interest rates. This information, which banks must post, must be verifiable by users.
2. TSPs will access users’ data to supply integrated account services. This phase focuses on customers’ information, e.g., their deposits, credit, and investments for multiple banks integrated into a single set.
3. Lastly, users can link payments and funds among different sources via ATP-providers Apps. This phase focuses on transaction information about loan repayments, authorisations, and several types of transactions.

An essential issue in Open Banking is that of security and data protection. Interestingly, blockchains which distribute digital blocks containing cryptographic linking information, can help protect customers’ privacy, ensure the safety of transactions, and provide safe scenarios, particularly for third parties (Chen et al., 2016; Chiu et al., 2021).^[1]An example is Ethereum blockchain platform is an example of smart-contact (SC hereafter), which might improve control over customers’ changes of authorisations (Liao et al., 2022). Wang et al. (2020) assess methodologies employed to classify data privacy and ‘disclosure schemes’ for protecting customers’ privacy, which must concord with possible deficiencies in Open Banking blockchain, e.g., privacy-preserving granularity, over-complexities of banking subsystems, or hierarchical data management. Mukhopadhyay and Ghosh (2021), based on a systematic customer consent management analysis, set up a TPST classification to facilitate customers making consent decisions. Noting that private information has higher standards of authentication and requirements, Xu et al. (2020) built a considerable data-sharing model to ease banks and customers access to TSP information. Based on an analysis of security risks, Zhang et al. (2019) propose a data-sharing scheme and API agreement to safeguard APIs from malware. Likewise, Dong et al. (2020) describe that a blockchain-based SSI model wbhci might be able to address data privacy issues, involving registry and controlling contracts to enhance user identity changes.

 

The impact of Open Banking on competition

Economic literature usually compares traditional banks and FinTech companies when competing.

He et al. (2022a,b,) develop a model in which Open Banking may enhance credit competition between banks and FinTech companies by augmenting banks’ and FinTechs’ efficiency in screening borrowers. Accordingly, customers with higher creditworthiness will have better access to credit than those relatively worse classified. A key element of Open Banking is that customers keep control of the data they are willing to share with third-parties, which can reveal information about their creditworthiness. Lastly, Open Banking can disclose non-financial information about (FinTech) lenders. Nonetheless, little is known about how FinTechs can make relatively more targeted credit offers which can impact competition.

The irruption of FinTech (e.g., Vives, 2019) changed the sources of information production and diffusion.^[2]The term Open Banking refers to data sharing of customers’ information that banks possess with the so-called ‘third-party’ (See Instititution in this issue), whereas the concept of FinTech … Continue reading Berg et al. (2020, 2021) show that digital footprints – which refers to the trail of data that a person leaves on the Internet, including visits to websites, emails, etc. – might be a valuable tool to predict consumers’ default and it might be a complementary source to traditional credit agencies. Similarly, Fuster et al. (2019) assess the mortgage credit market and show that FinTech lenders’ advantages from technology augment their origination efficiencies. Remarkably, Di Maggio and Yao (2021) show that FinTech lenders grant to borrowers of relatively better creditworthiness by financing consumer credit, who later on default ex post more frequently than similar borrowers applying to other lenders. Di Maggio et al. (2022) suggest that some borrowers wishing immediate consumption apply to FinTechs, thus exacerbating their self-control issue over overborrow.

Focusing explicitly on Open Banking, Parlour et al. (2022) investigate the case of a bank operating in both payments and credit markets. The authors assume that the bank is a monopolist in the credit market but competing with another stand-alone FinTech on payment services. A crucial assumption is that customers’ payment services provide information about their creditworthiness. Within this framework, customers might anticipate that changing their payment service to FinTech might impact their credit service. Notwithstanding, there is no implication on the equilibrium of credit quality.

On the empirical side, Buchak et al. (2018) investigates the mortgage market and explain that advances in banking regulation significantly contributed to growing FinTechs. Besides, Tang (2019) introduces a regulatory ‘shock’ that shortens bank credit to find that peer-to-peer (P2P) platforms can substitute banks in the consumer credit segment. On th supply side, Feyen et al. (2022c) conducted a survey that reveals that banks and Fintechs do not see each other as competitors. Likewise, Fintech firms expect to compete with their counterparts like BigTechs, platforms, or aggregators; whereas banks see neo-banks as their competitors. However, economies of scale and network economies are expected to consolidate large multi-product institutions, e.g., large banks, FinTechs, and BigTechs (Feyen et al., 2022a,b).

Babina et al. (2022) recently studied open banking using a handful of data sources, including hand-collected data. Their findings show little effect of open banking on competition in the banking sector. They provide two main explanations of this result. First, the phenomenon of OB is still embryonic and data are not entirely reliable. Second, real effects can take a while to be visible substantially. Interestingly, they find that Open Banking might reduce adverse selection against new entrants and augment formers’ product quality. Consequently, Open Banking fosters innovation. These results suggest two interesting areas for policymakers. First, Open Banking diminishes banks’ incentives to generate value by capturing customers’ data. Secondly, ‘data sharing’ hurt customers who opt-out from sharing might be harmed since they might be perceived as credit-worthless borrowers, i.e., they are sending negative signals to the market. Consequently, the effects can be unpredictable because Open Banking data can be used to screen potential renters and customers who are unwilling to share information about their levels of risk, thus being removed from ‘basic housing markets’.

 

Financial inclusion and consumer protection

Financial inclusion can be defined as a measure of the degree to which individuals and companies can access financial services. The maintained assumption is that financial inclusion can substantially improve people’s well-being. Digital financial services might offer important opportunities for inclusion and resilience. In this regard, financial literacy and digital skills play an important role in correctly managing the aforementioned financial applications from a young age (Bianco et al., 2022).

The economic literature suggests that the market equilibrium depends on the context of consumer privacy preferences. Jones and Tonetti’s (2020) theoretical model shows that consumers’ data ownership frequently leads to broader data management than firm ownership, thus enhancing welfare due to the non-rivalry of such usage. Likewise, Ichihashi (2020) shows that sellers might use consumers’ information, particularly when revealing their preferences, to recommend specific products and implement price discrimination, the so-called multi-product monopoly. More precisely, they show that the seller is incentivized not to discriminate consumers in price to encourage consumers to share their information, but it harms consumers in equilibrium since firms might set constant prices anticipating the clearing of the market. Similarly, Ali et al. (2022) find that sharing information about preferences with firms might amplify price competition and benefit consumers. Interestingly, Liu et al. (2020) analyze the implications of consumers’ privacy when introducing a ‘consumption good’ and a ‘temptation good’. Data sharing might manipulate consumers’ behaviour, improving the efficiency of the ‘consumption good’, but inducing behaviorally biased consumption towards the ‘temptation good’. In particular, Ali et al. (2022) emphasize differences between the EU consumer privacy regulation, namely General Data Protection Regulation (preferred opt-out choice), and the California Consumer Privacy Act (opt-in preferred choice) (see also Kshetri and Voas, 2020).

 

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