Consumers may not know what open banking is, but they sure like what it does. And the technology hasn’t even hit its stride yet.
From real-time account verification and money movement to apps that provide lenders and landlords an up-to-the-minute overview of an applicant’s credit history, open-banking technology is the engine that drives the modern payments ecosystem.
The power of open banking lies in the fact that it allows consumers to grant third parties access to their accounts and financial data through payment and financial-management apps—access these third parties can’t get through a bank. That capability has propelled several payments apps to the top of the charts. The list includes Chime Financial Inc., Square Inc., Stripe Inc., Venmo, and Zelle.
One reason such products have grown in popularity is they offer consumers what they want; whether it be choice, lower costs, or other benefits they can’t get from a bank. Another reason payments are a key part of the open-banking landscape is that open banking makes its easier, and faster, to pay for goods and services, and send money to friends and family, according to Plaid Inc.
Plaid is an open-banking services company that has built a data-transfer network that powers fintech and digital-finance products, and counts Chime and Venmo among its clients.
“Ultimately it is consumer expectations for more mobile-friendly and connected services that is driving the acceleration of digital finance overall,” says a Plaid spokesperson.
Yet, for as much as open banking is shaping the modern payments landscape, it remains a behind-the-scenes technology for most consumers. A 2021 survey by Axway Software, a provider of open-banking solutions, reveals that 50% of respondents have never heard of the term “open banking.”
Still, consumers do know that they like what it does—which is make available affordable, alternative payment and financial-management applications that give them control over their financial data, and deliver a better user experience.
The same survey by Axway reveals that 84% of respondents agree with the concept of having more control over their financial data. This desire for control goes to the heart of the open-banking movement, which is rooted in the idea of breaking down data silos within financial institutions to make consumer account and financial data more accessible, in a safe and controlled way, to the fintechs and other third-party partners that need it.
“Increasingly, consumers are turning to fintechs to round out their financial services and get access to those services on their terms,” says Sunil Sachev, head of fintech and growth for Fiserv Inc., which has partnered with several open-banking players, including MX Technologies Inc. “As a result, fintechs are working with financial institutions to build frictionless experiences for different slices of consumers.”
There are three primary forces driving adoption of open banking: the regulatory environment, increasing competition, and consumer acceptance of open-banking applications.
On the regulatory front, legislative bodies around the world are pushing for increased leeway for consumer and small and medium enterprises to control their data when it comes to third-party access, permissioning, and privacy, says Jess Turner, executive vice president, global open banking and API at Mastercard Inc.
While U.S. open-banking regulation lags that of other countries, federal policymakers such as the Consumer Financial Protection Bureau are developing standards to ensure data continuity and protection.
In Europe, a recently revised version of the PSD2 regulation includes security requirements for the initiation and processing of electronic payments and the protection of consumers’ financial data. The regulation is intended to make the banking industry more accessible to new players that are expected to develop and promote innovative products and services, while ensuring the protection of consumer data.
“Open banking is a technological shift that is still very much in its early innings. As it emerges and matures, federal policymakers play a meaningful role in the direction and pace of this transformation,” Turner says. “Providing clarity on data protection expectations, data-privacy requirements, and consumer-data rights will help shape a more secure, diverse, and inclusive financial market.”
Turner argues that the payments industry and regulatory bodies must ensure that consumers have data continuity, which enables the data from a consumer’s bank statements, paper checks, and online-banking apps to follow her into the realm of open banking and open finance.
“Sending information digitally is dramatically more secure than sharing papers, emailing information, or handing over a check at a cash register,” Turner adds. “For consumers and SMEs, continued access to their own data and the right to share it with other financial institutions or fintech companies will be transformational.”
Another driver of open banking has been the Covid-19 pandemic. “When stores and banks closed, people had to find new ways to do just about everything, and digital finance was there,” says the Plaid spokesperson.
“We’ve now reached a tipping point in consumer adoption, where more people now use fintech than social-media or streaming-video services like Netflix,” says the spokesperson. “In fact, between 2020 and 2021, the proportion of U.S. consumers using fintech grew from 58% to 88%.”
One way fintechs can use account data obtained through open banking is to create private-label debit cards that route transactions through the automated clearing house, as several companies such a Cumberland Farms have done for years. “Good account data is needed to facilitate payment of those transactions,” says Sarah Grotta, director of the debit and alternative products practice at Mercator Advisory Group.
Providers of buy now, pay later loans can leverage open banking to determine a consumer’s ability to repay the loan and determine how large a loan the consumer can qualify for to minimize its risk.
Another example of how open banking is powering innovation is TomoCredit, a San Francisco-based startup that helps immigrants and expatriates lacking a credit history demonstrate their creditworthiness by giving permissioned access to their financial accounts.
TomoCredit uses real-time data to improve risk assessment and decision-making with a more comprehensive picture of an applicant’s financial health. That helps give them access to a credit card, according to Mastercard.
“The more data available on a consumer’s financial life, the greater the benefits, because those leveraging open banking can identify who is likely to be interested in new products,” Grotta says.
“They can also see what consumers pay for certain products, which opens the door to offering a more competitively priced alternative,” she continues. “By understanding the customer data they can access, open-banking providers can craft more compelling offers.”
‘A Disruptive Force’
With open banking making it possible for fintechs to offer products and services that compete with those offered by traditional banks—as well as innovations that traditional banks can’t offer—it is on the verge of becoming a disruptive force for banks and the card networks to contend with, payments experts say.
“There are two kinds of banks in the United States, legacy banks that can’t adapt to open banking because of technological limits, and neobanks that are API-driven,” says Abhijit Chaudhary, chief product officer for Green Dot, a fintech payments provider and bank-holding company. “Our focus is on empowering our customers to use services they need; open banking goes a long way toward addressing those needs.”
That fintechs and neobanks not only see the value in open banking, but have the technology to support it, means it is not surprising they are initiating partnerships with banks rather than banks taking the intiative. “We are seeing a lot of fintechs, especially larger ones that have shared customers with banks, reaching out to financial institutions, but not the other way around,” Grotta says. “There are a lot of banks that share customers with fintechs.”
From a socio-demographic perspective, open banking provides financial institutions an opportunity to stay relevant to customers who also use fintech products, payment experts say.
“Financial institutions have the data that open banking needs, but they are not leveraging it, whereas fintechs use that data to understand the consumer at a micro-level,” says David Whitcomb, vice president of product for MX Technologies.
“With the data financial institutions have, they can see what products and services their customers are using outside their walls and leverage it to create competitive alternatives that solve problems for consumers,” Whitcomb adds. “When a problem can be solved, it creates opportunities for new revenue streams.”
Ways financial institutions can leverage open banking to serve their customers include offering loans, overdraft protection, and other services that don’t have high fees. They can even enable gig workers to set up auto-deposits from multiple employers with minimal friction, payments experts say.
But financial institutions are not the only legacy providers in the payment industry feeling the competitive heat from open banking. The card networks are, too. The threat here comes from the technology’s ability to verify account ownership and balances for account-to-account payments.
Real-time verification of account-to-account transfers can, in theory, render moot the use of credit and debit cards at the point of sale. With open banking, a consumer could pay a merchant directly from a designated account, and the merchant could instantly validate the account, the consumer, and that the consumer has the money to make the purchase.
But Visa and Mastercard are no strangers to open banking. Both have made acquisitions to ensure a beachhead in this technology. In June last year, Visa paid $2.15 billion for Tink AB, a Stockholm-based company with links to 3,400 financial institutions throughout Europe.
The deal was viewed as a consolation prize after the U.S. Department of Justice in 2020 objected to an attempt by Visa to buy Plaid. The DoJ argued the deal would hand Visa too much power over the debit business.
Mastercard, meanwhile, has been staking its own claim. In 2020, it acquired Finicity Corp., for $825 million. Later, it landed Aiia, a Copenhagen-based provider with connections to 2,700 banks and an account-to-account payment volume of more than 1 million transactions monthly. The price for Aiia was not disclosed.
Mastercard has wasted no time leveraging those acquisitions, announcing in March plans to launch two new payments tools that rely on the open banking and account-to-account transactions. One of the new tools, Payment Success Indicator, will enable the payment originator to check on the consumer’s account balance, as well as his or her historical payments behavior.
“We have always powered experiences that enable consumer choice, and in recent years, we have further differentiated Mastercard in the market by diversifying beyond the card,” says Mastercard’s Turner, who adds that open banking is a natural progression for Mastercard. “Open banking is yet another proof point of how we’re truly empowering consumers with flexibility and control.”
Visa did not respond to interview requests.
‘A Rising Tide’
Despite all of open banking’s promise, the trend is raising concerns about data protection. The Data Collaboration Alliance, a Toronto-based non-profit that helps consumers and organizations control their information, argues that, as open banking proliferates, fintechs and financial institutions need to build apps without copying data silos or screen scraping, a process that allows the gathering of customers’ financial transaction data from multiple sources.
“In today’s world, data has no boundaries, so we need to get away from such data-management practices as screen scraping and copying data silos, which do not always respect or preserve access and governance controls set by the rightful data owner,” says Chris McLellan, director of operations for the Alliance.
“One of the most important ways we can accelerate major breakthroughs in open banking is to embrace new data-management technologies, standards, and protocols that place data ownership at the forefront of digital design,” McLellan adds. “This way, data is managed as something with real value that shouldn’t be subject to unrestricted replication.”
The push for data protection aside, open banking is just hitting its stride, and that leaves lots of room for future innovation. “The appetite for these services is ever-growing around the world, and mainstream adoption of open banking is happening, with more than 80% of consumers in the U.S.—and 90% of younger consumers—already connecting their bank accounts to technology apps,” says Mastercard’s Turner.
“Now is the time to embrace the opportunity of open banking,” she adds. “It is truly a rising tide that will lift all boats.”