The Challenge of Open Banking for Reluctant Innovators

by Johnny Wyld, Director, Business Consultancy, EPAM

June 27, 2017

The revised Payment Services Directive (PSD2) in Europe is diverse and broad-ranging, and the highest profile headlines concern its requirement for banks to open up their accounts via APIs.

PSD2 is not the only driver for the Open Banking revolution, though. There are other regulatory initiatives around the world pushing in the same direction, as well as a new generation of banks voluntarily adopting APIs as a go-to-market strategy. Furthermore, and perhaps most alarmingly for the incumbents, there are a variety of disruptive business models from new players who are offering similar services to those achievable through open APIs, but delivering them through other innovative technologies such as tokenization, prepaid wallets, and screen scraping.

Despite their visionary statements and marketing campaigns, banks traditionally were not very good at demonstrating innovation in technology, channels, products, or service. Protected by high regulatory barriers to entry, they were relatively immune to major challenge, although onerous regulatory compliance also acted as a barrier to innovation and agility. As a result, regulators, banks, and, to a large extent, customers were happy to embrace a status quo in which banks focused on fine-tuning risk and profit margins on a very limited set of standardized products.

Open Banking is the latest, and most significant, driver which is changing this picture dramatically. Pushed by regulators as a way of driving innovation and competition, it’s understandable that many incumbents may see few redeeming features in PSD2 and other regulations. Fair enough: they’re the ones who will be saddled with the costs of implementation, the increased compliance implications of dealing with a new breed of intermediaries, and unquantifiable risks around settlement and reputational damage.

Four Broad, Strategic Responses to Open Banking

At a high level, there are four broad, strategic options available to banks, ranging from head-in-the-sand denial and obstruction to embracing the opportunities for growth that open APIs can offer:

  • Resist, obstruct, and obfuscate: It will be relatively easy for banks to comply with the letter of the law while making it very difficult in practice for third parties to use their supposedly open APIs. Restrictive authentication requirements, obscure protocols, constant non-backwardly compatible interface upgrades, and a highly sensitive approach to fraud detection can all be deployed to thwart the open market, especially when coupled with aggressive marketing of in-house equivalent services, as per the closed ecosystem strategy.
  • Create a closed ecosystem: Some banks will want to create an enclosed ecosystem of apps built on their own banking platform. Providers wishing to join in must abide by the bank’s rules and afford their customers exclusivity. Although not PSD2-compliant, this strategy can be deployed in parallel with a more open approach to give selected partners greater access in exchange for control of data, financial or commercial reward, or to give customers more choice than they’d get elsewhere.
  • Compete in the open market: In the spirit of openness, banks will allow third parties to build services on APIs with minimal control as defined by regulation. These third parties can use other banks’ APIs as well to create an intermediary layer as per the regulators’ vision. A bank can compete in this market by having the best products when compared directly alongside their competitors’, and could risk losing customers by failing to meet the same minimum standards.
  • Become a service enabler: In this approach, the bank becomes a service enabler for third parties. These third parties can then worry about owning the customer relationship and delivering a superior experience, without their customers even necessarily being aware that a bank is involved. Customers don’t need to shop around for banking products, because that is all done for them as part of delivering a great service.

Different Approaches for Different Scenarios

Unfortunately (or fortunately, depending how you look at it), there is no one-size-fits-all solution for banks.   All of these strategies could deliver benefits, and a well-thought-out approach will see each bank using all of these over time in different scenarios based on products, geographies, target markets, and growth strategy.

Now, 18 months after the announcement of Open Banking under PSD2, banks, the ever-reluctant innovators, will have the next 18 months to show they have the vision and technical ability to really embrace the opportunities that lie before them.