Open Finance is Coming, Are You Ready?

In this article, I aim to answer fundamental questions about Open Finance - namely, what it is, why financial institutions should pursue it, and its current state in the market.

What is Open Finance?

Open Finance refers to processes that enable users to share their financial data with other institutions (both banks and non-banks) in order to improve understanding of their financial situation and access new services. Until recent years, financial institutions were solely responsible for storing and processing financial data on behalf of their customers. Today, millions transact outside of their primary banking relationship, generating a trove of data that could be used to deliver value-added insights and new services, particularly once combined with data collected by financial institutions. According to a 2020 McKinsey survey, 42% of U.S. respondents used at least one fintech solution, up from 36% before the Covid-19 pandemic.

Why Should Financial Institutions Pursue Open Finance?

More pointedly, why should financial institutions throw open the doors of customer data to third parties? Simply put, doing so enables its services to be embedded within numerous third-party customer experiences, ones that keep the provider in the background and are seamless and frictionless for the user. Financial institutions of all types are facing long-term pressures on revenue. Embedded finance offers the opportunity to tap into far larger markets for new sources of revenue. A few use cases to keep in mind:

BaaS Use Case - Open data acts as the foundation for Banking-as-a-Service (BaaS), whereby financial institutions deliver services through non-banks, including fintechs and big technology providers. Such services could deliver new fee revenues, incremental transactions, or new deposits and loans. Gartner estimates that 50% of Tier 1 banks will launch a BaaS offering by 2025. According to Oliver Wyman, BaaS represents a scalable, agile opportunity to capture new revenue at a low cost.

Account Aggregation Use Case - Account aggregation dashboards are the most common use case though revenue models are still developing. Customers may ultimately decide to keep more of their accounts with a single provider

As showcased in the examples below, Open Finance also offers the opportunity to improve existing services and processes, resulting in lower costs and better customer experience:

• Mortgage lenders could reduce or eliminate the manual collection of application data with access to data in real-time, resulting in faster approvals. Third-party data could improve underwriting and collection results, reducing both fraud and credit losses.
• Marketing efficiency should rise as richer customer profiles result in better targeting of products and services.
• Automating data capture from third parties will reduce data errors, improving the quality of data analytics and insights.

When Should Financial Institutions Pursue Open Finance?

Revenue pressures are likely to persist in core business, a clear sign that financial institutions need to start preparing to deploy Open Finance applications, both the technology infrastructure and operational processes. As such, incumbents must innovate in order to reduce costs and add new revenue streams. Low interest rates and weak demand for credit may continue to weigh on banks and competition from non-banks will likely continue to increase.

Several jurisdictions have mandated Open Finance -- including the UK, EU, Australia, and Brazil -- though the rules continue to develop and complexities have slowed adoption.

As for the U.S., in July 2021 President Joe Biden issued an Executive Order which contains a section that encourages the Consumer Financial Protection Bureau (CFPB) to issue rules on consumer financial data portability. However, we have not heard from the CFPB on this issue since then.

In Canada, the Advisory Committee on Open Banking published a report in August 2021 indicating that banks operating in the country implement the initial phase of open banking by January of 2023. Specifically, by January 2023, Open Banking platforms must facilitate all products and services currently available via screen scraping. Second, Open Banking platforms should accommodate a wide range of data (account balance, transactions, consumer-provided, and publicly available).

The private sector isn’t standing idly by. The Financial Data Exchange (FDX), a consortium of nearly 200 major banks and technology companies, is working to develop Open Finance standards and protocols.

To that end, Fintech advisor FT Partners believes that Open Finance presents a substantial opportunity for early adopters who can drive widespread acceptance among consumers.

What is the Current State of Play for Open Finance in the U.S?

Application programming interfaces, or APIs, are being deployed as the preferred method of sharing data with third parties. FDX estimates that 25-40% of customer logins are actually “screen-scraping” sessions that are less secure and more error-prone than API interfaces. Fintechs have been laying the groundwork for Open Finance for years via API platforms. Examples include data aggregators such as Plaid and Finicity (now part of Mastercard) and Bank as a Service (BaaS) platforms such as Marqueta.

A wide range of data-sharing standards and protocols exist today, and with little consumer control, two issues the FDX consortium aims to address. In our view, data security and user-control issues must be solved before large financial institutions and consumers will be comfortable with widespread data sharing.

As a result, the Open Finance market will take time to evolve, particularly in markets that lack regulatory clarity. Much like transitioning to cloud infrastructure, deployment of Open Finance capabilities involves a complex evolution of technology and management practices, for the large incumbents in particular. On the consumer side, Digital ID is a long overdue security need and could be a key catalyst for Open Banking adoption.

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