While Australia’s banks may be focussing their attention on an impending royal commission, another potential disruption looms. Open banking promises to set free customer data and invite a host of new financial players into an industry starved of competition.
It’s a system already gaining traction in the UK, Europe and parts of Asia. So exactly what is open banking, and can it live up to the hype?
According to an Australian Treasury issues paper on the topic, open banking “refers primarily to giving customers greater access to and control over their own banking data … Open banking enables the customer to direct that they, or third parties chosen by them, be provided with pre-determined parts of their banking data in a secure environment and in a prescribed way.”
In short, consumers get their data back from the banks, which they can use to shop around and switch financial providers more easily.
The issues paper is part of a review into open banking in Australia, following Treasurer Scott Morrison’s budget night announcement that the government will introduce an open banking regime. Morrison briefly elaborated on the regime in July.
“The Turnbull Government is committed to opening the door to new banking entrants and new financial products and services. This will mean more choice and cheaper and better options for consumers,” Morrison said.
Up until now banks have enjoyed exclusive access to consumer data. For the incumbents it’s a significant competitive advantage, while creating a barrier that arguably stymied innovation and competition from fintechs.
“The banks used [consumer data] for marketing and product design. That is, your data was used to increase their profits,” says UNSW Business School Senior lecturer, Dr Rob Nicholls.
In an open banking world, consumers could use that data themselves to find more appropriate products within an existing bank or compare offerings from the competition. They can also mandate for third parties to use the data, opening up the possibility of more financial tools and product aggregation. Importantly, open banking also removes many of the barriers to switching banks — currently a time-consuming and often confusing process.
Open banking encourages innovation and competition in financial services, according to its advocates.
But there are significant challenges and drawbacks to open banking too. Such a large scale reform requires clearly defined procedures and cooperation from regulators and consumers. The technology upgrades required are costly and just who pays for them is a contentious issue.
It means incumbents have tended to resist open banking, according to Nicholls.
Open banking potentially undermines the current banking industry — where customer retention costs are low and acquisition costs are high, Dr Nicholls said. Not a bad scenario if you only have three competitors.
According to the big four banks’ open banking review submissions they welcome open banking in Australia and are advocating for a consumer-focused approach.
NAB, EGM Digital & Innovation Jonathan Davey told Which-50, “We are focussed on delivering great experiences for our customers. An open banking regime done in the right way and with a strong emphasis on customers’ interests has the potential to deliver improved experiences for customers.
“This is a complex initiative with many details to be clarified. We have been an active participant in the process to date and looking forward to seeing the recommendations presented by [open banking review leader] Scott Farrell.”
Despite support for open banking, all four big banks highlight the challenges of cybersecurity and cost in their submissions.
Westpac flagged the potential investment required for open banking in its review submission, saying it would cost them approximately $25 million and require two years to implement a basic API platform. Getting that platform to a level that allowed third-party integration would cost at least another $150 million dollars in security upgrades, it said.
The Commonwealth Bank pointed to potential cost blowouts of open banking schemes like those experienced in the UK. According to the CBA, “Allowing for indirect costs, financial impact may run as high as GBP 500 million (AU885 million) for some participants.”
NAB has proposed charging a fee to access the data as part of a cost recovery model, “It is not commercially sustainable or equitable in the long term for the entire cost of implementing an open banking regime to be borne by the incumbent banking sector,” the NAB submission said.
But according to UNSW’s Nicholls, “As open banking becomes more of a norm in the UK and the European Union, the arguments for delay will fall away.”
“Just as the big four banks have accepted the inevitability of a Royal Commission, they will also accept open banking,” Nicholls told Which-50.
Just what they must accept remains unclear. Apart from the initial announcements, the government has remained relatively tight-lipped on the details of its open banking regime as it conducts its review.
Pumping the Brakes
A Treasury spokesman told Which-50, “The review is due to report to the treasurer by the end of 2017, consistent with its terms of reference.”
While that is no cause for alarm, it means we may need to pump the brakes on open banking, according to Managing Director, BGA Digital and founder of UBank, Gerd Schenkel.
“The government, in the budget, essentially made a commitment to open banking but didn’t really say what that will be,” Schenkel told Which-50.
“That review will finally tell us what steps will be taken and when. And only then can you really say this is going to be significant or not.”
Schenkel agrees that incumbents have tended to resist any form of account portability, but global trends and changing perceptions on data ownership and banks means we have “reached a point where something will have to be done.”
“The royal commission has demonstrated publicly that the community expectations on the industry are such that they want change.”
And while that change may hinge on the results of the government review, whatever it calls for probably won’t happen quickly, according to Schenkel.
“There will be political will to implement these measures but then there’ll be a reasonable ask for time to implement the technical requirements. With these kind of things, if the time is too far into the future it will have no effect today,” Schenkel said.
The “reasonable ask” could be several years, according to Schenkel, as incumbents face the prospect of upgrading legacy architecture to unlock customer data. For some of Australia’s large banks that task is still a struggle internally and will require major investment.
“Many of the incumbents are not even, internally, able to have a full view of the customer,” Schenkel said.
Indeed, incumbent banks have recommended open banking be phased in over several years to allow for the upgrading of systems. Time to prepare and cost considerations are reasonable request from the banks, but incumbents should have seen it coming.
“The big banks will have a fair view of what to expect given that this has been a topic for a long time and the smart ones have probably already made a number of investments in the technology platforms,” Schenkel said.
“Because even without legislative action there are benefits for incumbents. Especially internal, where a more open system also means a lower cost system.”
Schenkel described a similar benefit for the banks in terms of cyber security upgrades. Banks already share consumer data with third parties and “the requirement to people that the system is safe exists today.” An open banking requirement would further upgrade these systems, he said.
“In reality we already have hundreds of parties involved today. I can’t think of any incumbent bank that does not provide access to their database or their backend to a number of consultant firms, technology firms, sometimes offshore companies. So it’s already pretty unclear to the consumer who sees your data and who gets access to it,” Schenkel said.
“In fact, arguably the replatforming required for open banking forces the industry to upgrade to more modern platforms that are probably more effective than what they have today.”
The banks’ concerns over open banking are genuine and despite public perception they are not “evil”, Schenkel said.
“They’re just confronted with a huge amount of capital need all across the systems and they probably have other things they would rather spend their money on besides regulatory compliance.”
While details are scarce, it’s likely the Australian regime will be modelled on or at least compared to the UK’s recent open banking move, Schenkel said. But there are some key differences.
“Meaningful” UK government action is enabled by a stronger mandate following the collapse of UK banks during the GFC, according to Schenkel.
“The government actively had to rescue some of the banks and in fact they owned one of them. That allows the government a much stronger licence. That’s the flip side of what we have here [in Australia].”
A relatively limited mandate for the Australian government means there’s potential for a watered-down open banking system that achieves very little real change, Schenkel said. Open banking success will depend on ensuring any regime includes products and services “at the heart of people’s financial affairs”.
Despite their differences, when details do emerge it’s likely the UK system will still become the benchmark for any Australian open banking regime, due to a lack of comparable open banking markets, Schenkel said.
“The question is really are regulators going to have a less stringent or more stringent set of requirements than the UK and also what time will they allow the incumbents to implement.”
A Global Trend
Australia’s move towards open banking is not particularly radical, according to Gartner research VP and distinguished analyst, Kristin Moyer.
She told Which-50 that regulators already require open banking in 25 per cent of G20 countries and it’s expected to hit 50 per cent by 2020.
There have also been significant moves to open banking in Japan, India and Singapore, she said.
Regulators around the world are taking these steps to drive innovation and competition in the banking industry, according to Moyer. For banks that resist regulation or meet minimum compliance it quickly becomes “a race to the bottom”.
“Banks need to do more than just comply with open banking in order to remain relevant and not end up as a back-end utility.”
“Aggressive banks who want to become more like technology companies have been working on open banking for years already,” Moyer said.
Not all bad news for the banks
While the consumer benefits appear relatively clear, it raises the question of what’s in it for the banks? Open banking potentially means banks lose several competitive advantages: customer data, market share, and low churn.
But there is a silver lining for the incumbents, provided they are proactive.
According to UNSW’s Dr Nicholls, the increased competition of open banking means “the cost of customer retention will go up, but the cost of customer acquisition will go down”.
“Any bank that thinks it has the most competitive offerings will have the chance to increase its customer base,” he said.
There’s also potential for banks to modify the risk profiles of their customer base, according to Dr Nicholls. By aligning its risk and return profile banks can increase shareholder value, he said.
“In effect, open banking offers the potential for a bank to be able to stratify a range of customers as if they were asset classes and then manage exposure to each of these asset classes. The effect will also be that some of the other institutions will have the opportunity to acquire customers that do not fit well in all of the big four risk profiles.”
According to Gartner’s Moyer, “Open banking creates opportunities for new products and business models, which aligns well to CEO objectives to increase revenue.”
It presents CIOs with three possible responses, she said.
- Ignore them. Continue to provide your existing products and services and use your current delivery mechanisms, and win through scale.
- Join them. Share business services such as algorithms (for example, credit scoring), data (for example, aggregated payment data) and transactions (for example, peer-to-peer [P2P] payments) with other digital platforms. Win through specialisation.
- Beat them. Make the bank the digital platform that enables an entire customer journey (for example, buying a car), using services from business ecosystem partners to deliver. Win by turning the digital platform into a product.