Open banking is ‘one of the biggest changes in financial services in a generation’, according to American Banker magazine. The changes enabled by open banking and comprehensive credit reporting will have a significant impact for customers, data privacy and financial crime, strategy and pricing, conduct and fairness, artificial intelligence, and application programming interfaces (APIs). Financial institutions that fail to align their actions in all of these areas ‘risk getting left in the dust.’
Retail banking globally is about to undergo what has the potential to be a seismic shift driven by changing consumer preferences, regulatory changes opening up bank data, and technology-enabled innovation. In the UK, the first nation to launch open banking, the new laws commenced on 13 January 2018. In Australia, the interim report on implementation of an open banking regime is likely to be released in January 2018. The review, being undertaken by Mr Scott Farrell, a partner with King & Wood Malleson (the Farrell Review), will provide recommendations on the design of the operating model and regulatory framework for the introduction of open banking in Australia. In addition, the interim report on competition in the Australian Financial System by the Productivity Commission will include comments on data availability and use and is expected to be released in early 2018. A component of open banking, Comprehensive Credit Reporting (CCR), has now been mandated and will be introduced on 1 July 2018.
Banks and other financial institutions have traditionally retained ownership of the customer relationship and, crucially, of what was perceived by them to be their customer data. Ownership has long provided incumbents with a significant competitive advantage in terms of pricing and risk scoring, compared to new entrants. And because the value of data grows exponentially, a larger bank has had a greater advantage than a smaller bank.
The evolution from a closed model, where each financial institution retains and controls the information it collects about its customers, to an open5t model, where customer data is shared, referred to as open banking, has the potential to change competition in the sector and see the creation of new products and services based on that data.
Data has changed the game
Customers provide financial institutions and banks in particular, almost literally, with a wealth of information. Demographic information about a person’s age, residence, employer and family. Financial information on a person’s assets, wealth, income and expenses. If a person has a credit card or transaction account, banks can gather information about what he or she spends their money on. Banks can glean behavioural insights from this expenditure data: Where and when do you shop? What do you buy at what time of day? How do you pay for these items?
Banks can also start to draw conclusions about your credit profile, or your likelihood to require financial products and services. For example, how the nature of your expenses influences the likelihood that you will miss a payment or default on a loan. They can even look at your employer’s cash flow and assess what that means for your likelihood of an unplanned loss of work.
As it becomes easier for customers to switch between current account providers and shop around for other products based on price, incumbents are at risk of losing market share and seeing reduced profit margins.
The competitive advantage they have experienced may now be eroded as customers take control of their data and data is shared with third parties. Moreover, third parties may be able to create new propositions that meet unmet needs, using data to give the customer tangible benefits. As a result, incumbents could lose the primary banking relationship if customers increasingly choose to manage their finances via a third-party interface.vi
Of particular concern for banks would be third-party interfaces that allow customers both to manage their finances and to switch providers via one app. In this scenario, incumbents risk losing both market share and the primary customer relationship.
Open banking will require a fundamental rethink of the traditional banking business model. Opening up bank data carries an inherent threat of commoditisation for incumbent banks. At the same time access to customer data will enable new entrants to be more competitive. Customers may see their primary relationship being with a fintech, a technology company (increasingly referred to as techfins), or a price-comparison website, with banks relegated to product manufacturers or payment infrastructure utilities. Open banking also has the potential to facilitate the creation of new, data-based, services.
Opening up customer transaction data is likely to lead to increased competition in retail banking and facilitate new customer propositions. This will just be the beginning. In the longer term, open banking is likely to facilitate a much more radical transformation of the sector, one that completely changes the dynamics of the retail banking landscape and the retail banking business model itself.
Financial institutions will need to learn to operate in a shared ecosystem, moving away from the currently closed environment to one where they need to work more closely with third parties.
Incumbent banks have much to consider if they are to thrive in this future landscape.
However, they cannot afford to stand still.
By improving their ability to optimise their use of data and embracing opportunities to automate, incumbent banks will be well positioned to maintain the customer relationship and, ultimately, to win in an ‘open banking’ world.
Partner | Financial Risk
Deloitte Risk Advisory Pty Ltd
Partner | Financial Risk