Open banking

Answer

Open banking is an initiative aimed at increasing competition and transparency in the financial services market. The original deadline to implement open banking – under both the Second Payment Services Directive (PSD2) and the Retail Banking Market Investigation Order – was January 2018. Additional requirements were also included in the European Commission’s Regulatory Technical Standards on Strong Customer Authentication and Common and Secure Standards of Communication, which took effect on 14 September 2019. This article looks back at the origins of open banking, some of the benefits and challenges for consumers and financial services firms and what to expect going forward.

Background

To understand open banking, it is necessary to appreciate the context in which it came about. For some time, the government had been concerned about a lack of competition in the financial services market, where the way in which consumers interacted with banking services has become increasingly mobile and digital.

In 2011 the Department for Business, Energy and Industrial Strategy launched the midata initiative, whereby banks provided customers with a one-off snapshot of their data that they could download and then upload to price comparison sites. It was rolled out in 2015 with limited success due to the limitations of the data set and the complexity of the process. In 2014 Her Majesty’s Treasury commissioned research into opportunities to improve UK banking and the idea of using common application programme interfaces (APIs) was proposed as a way of enabling secure and effective data sharing.

In late 2014 the Competition and Markets Authority (CMA) launched an investigation into the supply of retail banking services in the United Kingdom to see if any factors were having an adverse effect on competition. The CMA considered the following:

• whether a lack of engagement with the industry or barriers to switching were reducing the incentive for banks to compete on price or quality or innovate;
• whether barriers to entry and expansion were preventing newcomers from entering the market; and
• whether the level of concentration of banks was adversely affecting customers.

The CMA published its findings in 2016 and, although it found evidence of innovation and variation in quality and price in the personal current account market, it found that those banks offering on average the lowest prices and better quality had been slow to gain a market share. Given that customers could make substantial gains by switching, the CMA concluded that the markets were functioning poorly. As part of this report, the CMA proposed several remedies, including those which led to:

• the seven-day current account switch service;
• the review of high-cost credit; and
• the open banking standard.

The Open Banking Implementation Entity (OBIE) was established to deliver open banking in the United Kingdom.

Simultaneously, the European Commission was working on PSD2 to address inadequacies in the existing legal framework for payment services and the fragmented approach to payment services across the European Union. Developments in payment services since the first Payment Services Directive had created legal uncertainty in the existing framework, security risks in the payment journey and a need to improve consumer protection. In terms of open banking, PSD2 requires banks to facilitate the sharing of their customer data on payment accounts with third parties to enable new market entrants to access data and create an integrated payments system. PSD2 also introduced the Strong Customer Authentication (SCA) rules, which require two independent factors of validation for payment initiation and are aimed at increasing security and reducing fraud when authenticating whether a customer has made the payment instruction. The SCA rules came into effect on 14 September 2019, but the Financial Conduct Authority (FCA) recently agreed to a phased implementation period for the United Kingdom, ending on 14 March 2020.

What is open banking?

Open banking is a technology-driven initiative aimed at increasing competition in the financial services sector by giving consumers more control over their banking data and requiring banks to facilitate the sharing of that data with third-party providers (TPPs). 

PSD2 introduced the legal concepts of the following new TPPs (or entities) that can receive or access customer data in this way:

• account information service providers (AISPs); and
• payment initiation service providers (PISPs). 

AISPs provide account aggregation services, which means that they enable users to see their financial information or account activity for one or more of their bank accounts in one place. PISPs provide payment initiation services, which means that they can request payments on the users’ behalf from their platform (for one or multiple banks) rather than the user having to log into their bank’s platform.

These new TPPs can access an individual’s banking data (with permission) through APIs. The API is the software interface that enables the exchange of data or information from a bank’s systems to the TPP. The top nine financial service firms in the United Kingdom were required to adopt the standard API (as part of the open banking standard introduced by the CMA) to ensure that there was consistency for TPPs when developing their services and apps, thereby removing barriers for new entrants to the market. The result for users is that they are in control of their banking data and no longer need rely on their bank’s apps or mobile sites to see their account information or make a payment. Instead, they can choose to use a TPP. 

What are the practical benefits and drawbacks?

Before open banking, third-party companies would use unregulated screen scraping technology to lift a customer’s banking data. This involved the customer passing log-in details to third parties (which naturally created a security risk). Open banking does not require customers to give up any security information to a TPP, as the open banking journey redirects them to their bank’s secure space to enter their security credentials. The TPP can then access their account details through APIs. Open banking also has the benefit of requiring TPPs to be authorised by the regulator (the FCA in the United Kingdom). Despite these measures, consumers have been wary of open banking. Given that financial transactions contain a vast amount of information about our daily lives and data has been increasingly prominent in the press (including the GDPR and large-scale data breaches) it is unsurprising that consumers are reluctant to share their information with unestablished third parties. 

Despite this, open banking does have the potential to transform the way in which the population banks. For individuals, aggregation services and apps can provide better oversight of accounts – enabling users to view account information for multiple banks in one place or simply provide a better platform for viewing an account than the incumbent banks. For example, personal finance app Money Dashboard allows users to see all of their accounts on one platform, set budgets for spending and plan their future finances. Open banking also provides opportunities for banks to partner with fintech companies and expand their service offering or develop more sophisticated APIs. For example, Santander has partnered with Moneybox, an app that allows users to invest the spare change from their transactions into certain individual savings accounts. 

If TPPs have access to an individual’s complete banking data, there is scope to provide personalised recommendations based on how that individual uses their account, which could result in more suitable products being recommended. There is naturally a risk with personalised recommendations that platforms may appear independent when in fact they are promoting sponsored products. However, if more emphasis is placed on the product in the market, this could begin to disrupt brand loyalty and customer inertia, and TPPs could enable visibility of products across all providers. In turn, this could lead banks to innovate and invest more in their products and services, which would ultimately open up the market to challenger banks and new entrants, as consumers will be more likely to look for the best product over a well-known brand. This is already happening with digital-only banks such as Monzo and Starling, which have attractive positions on non-sterling transaction fees and allow users to automatically divert savings into money pots.

One driver behind the open banking reforms is the increased use of mobile and digital banking services and the need to regulate the way in which people are now accessing financial services. However, there are still individuals who are not online and do not use mobile or digital means of banking. If open banking persists, there is a risk of financial exclusion if providers direct their efforts towards apps and TPP services; individuals who do not want to share their data could lose out on the best products and some could have no access at all. 

Where are we now?

Open banking was introduced on 13 January 2018 and there was a phased implementation period until September 2019 (although open banking will inevitably continue to develop past this deadline). Open banking is still in its infancy 18 months on, as its take up will involve a change in banking behaviour and the way in which people think about their financial data. However, as open banking matures and is invested in, security and regulation will improve and this in turn will increase its appeal.

OBIE has published three iterations of the open banking standards since 2018, each time adapting the requirements based on user feedback, to improve the user experience. Feedback from other stakeholders has highlighted areas for improvement going forward, as outlined in OBIE’s recent paper Open Banking: Preparing for Lift Off. These areas include:

• improving the payment capabilities via the APIs (currently refunds and pre-approved payments cannot be made);
• improving consumer protection; and
• applying the principles of open banking to the broader spectrum of retail products (ie, savings, mortgages, pensions and insurance).  

The FCA has recently established an Advisory Group on Open Finance, which will look at extending the open banking principles to other products; this will no doubt have positive effects for consumers in terms of increased competition, greater control and better prices. This will likely create more opportunities for TPPs and require the established financial services providers to implement the infrastructure or mechanisms necessary to facilitate any new requirements.

Open banking is just the beginning and although its full effect is unknown, it is a significant step towards challenging the financial services status quo. If open banking makes banks think about how they market and design products and enables new and innovative providers and services to come to market, it will only be a positive development for consumers.

Roslyn Jackson is a trainee solicitor at Burges Salmon.