Fintrends | The genesis of Open Banking

00:00:36 [Maya]

Bruno, to start, thank you for being with us.  You are the head of research at SBS, which means your mission is to identify, at an early stage, the areas to invest in and to shape SBS’s strategy and market positioning.  You’re passionate about how digital transformation is reshaping the economy, and you’re particularly fascinated by the potential that digital transformation can bring to the economy.  Data openness offers, notably in educating everyone about finance.  You’re actively involved in various organizations, such as the Global Competitiveness Cluster Finance Innovation, the standardization body Berlin Group, and within the European Commission.

So, today we summarize this economic transformation with a concept, open banking.  But what does that really entail?  What kind of lies beyond these words?  Is it ultimately just a buzzword?  Coined by marketing professionals?  Or is it something else?  To address these questions, I’d like to first kind of revisit the genesis of the concept of open banking with you.  We can get into the nitty gritty and see exactly what you think about the buzzword today.

My first question for you then is, how did the concept of open banking originate?  And what does it mean?

00:01:55 [Bruno]

The concept of open banking, or the foundational principles behind it, originated within the banking industry itself. It can be argued that the initial decade, spanning from approximately 25,000 years ago to 2010, marked a significant expansion phase for banks. This era laid the groundwork for what would eventually be recognized as open banking. The driving force behind this evolution was the burgeoning trend of web integration, characterized by the open exposure of banking transactions, content, and services. The term “banking” itself was coined by financial institutions, facilitating a new era where data could be extracted directly from bank interfaces—such as HTML code—enabling access to personal account information. This era saw the emergence of entities like Yodlee in the United States, spurred by the necessity for machine-readable banking data.

From a regulatory standpoint, this period was pivotal due to the increasing emphasis on data ownership by account holders. This concept was partially encapsulated in the Dodd-Frank Act in the US, specifically within Article 1033, marking the genesis of regulatory involvement in open banking. Concurrently, Europe witnessed the introduction of SEPA and the First Payment Services Directive (PSD1), which collectively standardized credit transfer processes and account identification across the European Union and the SEPA zone. These regulations laid the foundation for the Payment Services Directive, establishing a unified scheme for credit transfers managed by the European Payments Council (EPC).

This regulatory framework enabled service providers to utilize SEPA for facilitating credit transfers within the designated SEPA area, thus embedding the principles of open banking into the financial ecosystem. The advent of open banking was characterized by the ability of third-party providers to access banking data from outside the traditional banking system. The momentum for open banking surged around 2010, further accelerated by technological advancements such as smartphones and the introduction of ApplePay. This period also saw the rise of aggregation services, enabling consumers to consolidate account information across multiple banks on their smartphones, with companies like Yodlee leading the charge in account information consolidation, now widely known as aggregation services.

00:06:09 [Maya]

How did the banks react to the new unregulated access?

00:06:16 [Bruno]

The conversation surrounding open banking took a significant turn with concerns over third-party access to customer data, posing questions about data security and the initiation of transactions such as payments and credit transfers. Initially, banks were apprehensive, leading to restrictions on the ability for users to share their credentials with third parties. This led to a swift realization of the necessity for regulatory oversight, with demands for third-party providers to be regulated, accountable, and adequately insured.

The banks’ initial response to restrict access was quickly followed by regulatory interventions. One of the earliest formalizations of open banking regulations was by Her Majesty’s Treasury in the UK, which established an open banking framework in December 2014. This was a pioneering set of rules within the open banking domain. The movement for regulatory clarity and security also gained momentum in continental Europe with the introduction of PSD2, a revision of the Payment Services Directive that aimed to enhance security and foster innovation within the banking sector.

This regulatory evolution highlighted the banking industry’s shift towards demanding more stringent security measures and accountability for third-party providers. The recognition of the need for regulation was balanced with an acknowledgment of the innovation that third-party providers brought to the financial ecosystem, such as account aggregation services on smartphones.

The regulatory landscape evolved to accommodate these changes, with some regions opting for lighter regulations that simply authorized the sharing of personal financial information, while others implemented more prescriptive standards for data sharing, authentication, and supervision. This duality in regulatory approach aimed to create an innovation-friendly environment that encouraged competition while ensuring data security and consumer protection.

In summary, the banks’ initial protective stance against third-party data access led to a collaborative effort between the banking sector and regulators. This collaboration aimed to establish a secure, innovative open banking ecosystem that balanced the need for security with the potential for innovation, as exemplified by the PSD2 directive in the European Union.

00:10:22 [Maya]

Speaking of the regulators, what’s the status of data sharing regulation in Europe today, if you could sum it up for us?

00:10:30 [Bruno]

The regulatory landscape for open banking varies by country, with the UK being one of the pioneers by specifically targeting its nine largest banks for compliance. Initially, this alignment was in concert with the European Union’s standards, as the UK was a member at the time PSD2 was enacted. The focus was to ensure a broad compliance rate of at least 2% across all UK banks, mandating adherence to PSD2 regulations.

In contrast, the European Union has established socio-economic principles for the opening of payment accounts, emphasizing the secure initiation and processing of financial services, particularly payment initiation. This has led to a push for data standardization and the adoption of dedicated technological interfaces, notably through the use of RESTful JSON APIs, to facilitate secure data exchange. Various standards have emerged across Europe, with significant contributions from the UK and France, the latter through a collaborative effort among its six major banks to establish a unified API standard. The Berlin Group’s NextGen PSD2 standard has seen widespread adoption, extending beyond Europe to countries like Israel and Ukraine.

However, the essence of open banking extends beyond mere regulatory compliance and technical standardization. It encompasses the practical application of these frameworks to enhance financial services for individuals and businesses alike. Despite the infrastructure for payment initiation being in place as mandated by PSD2, its utilization remains limited. The broader vision for open banking includes a comprehensive suite of payment services that transcend traditional banking capabilities, such as deferred, split, and recurring payments, as well as innovative refund mechanisms for account-to-account transfers.

The European Payments Council (EPC) has been instrumental in advancing this vision through the SEPA Payment Account Access Scheme, which promises to enrich the open banking ecosystem with a variety of payment services. The continued development of these services, including the upcoming release of the V2 rulebook for the SPA, signifies ongoing progress in the realization of open banking’s full potential.

00:15:50 [Maya]

You talked about the professional advancements, but can you tell us a little bit more about some noteworthy technological advancements that it might be useful to tell our listeners?

00:16:02 [Bruno]

We find ourselves in an extraordinary era, particularly with the advent of open banking, encompassing regulations, frameworks, and standards. This era heralds a shift towards an ecosystem-centric approach, transcending traditional one-to-one business models like B2B and B2C. The current landscape necessitates a global, collaborative stance, embracing multilateral business engagements.

A crucial aspect of this transformation, particularly in B2C interactions, is the emphasis on security. In a multilateral ecosystem, authenticating the identities of both individuals and organizations becomes paramount. Fortunately, in Europe, we benefit from a cohesive regulatory environment that facilitates collaboration across the 27 member states, ensuring consistent authentication standards. This is largely thanks to the EIDAS regulations, and with the forthcoming EIDAS2, we anticipate even greater strides in authentication, extending to both organizations and individuals.

Reflecting on PSD2, it mandated robust customer authentication across all payment transactions, leading to a significant reduction in fraud, evidenced by a double-digit percentage decrease. This achievement underscores the foundational role of PSD2 in enhancing security, a principle set to be further advanced by EIDAS2. As we look to the future, it’s clear that technology will continue to play a pivotal role in shaping the open banking landscape, with more innovations and implementations on the horizon.

00:18:55 [Maya]

We are indeed living in a transformative era, marked by the evolution of open banking from the early 2000s to 2010, a period characterized by significant shifts in consumer behavior. This era heralded the entrance of innovative financial service providers into the market, particularly within the payments sector. The initial lack of regulation for these new entrants led to the development of regulatory frameworks aimed at securing operations and fostering legitimate competition, much to the chagrin of traditional banks.

In Europe, this regulatory landscape sought to balance the technical standards and operating rules among various payment actors, thereby promoting a fair and competitive environment. Technological advancements have also played a pivotal role, enhancing the security of transactions and facilitating real-time interactions within the financial ecosystem. These developments have emerged as key outcomes of the open banking evolution.

In our forthcoming episode, we will delve deeper into the ecosystems and explore the opportunities that real-time collaboration presents for banks and fintech companies. Bruno, with your extensive research in this field, I’m sure you’ll have insightful information to share with our audience.

00:20:30 [Bruno]

Thank you, Maya.