Will open banking cause big companies to fail?

Open banking is redefining the way financial services customers can regain control over their personal banking data. The fight for control over data ownership has become so universal that it spans almost all industries. Whether it’s social media data or bank account information, consumers are no longer okay with one company having sole access or control over their personal information.

Industries that aren’t greeting the rise of open banking with open arms include those challenged by restructuring their old ways and adopting new technologies. For some industries, open banking may simply be a pain in the neck, while for others it’s the end of an era. With any such far-reaching changes, there are bound to be a lot of industries disrupted by open banking, so who stands to feel the greatest impact?

Who's being disrupted?

It’s been a quarter of a century since Clayton M. Christensen and colleagues introduced their theory of disruptive innovation. Today, it’s too often an overused mantra for any sort of business that shakes up the market through technology. Not all new technology can necessarily be labelled as disruptive.

When discussing open banking as a disruptive innovation, Harvard Business Review has put it perfectly: “a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses.”

Open banking isn’t changing how everyone controls their financial data overnight, but we can see major, long-term changes happening in several industries. Christensen theorised that when big incumbents realise the value of disruptive innovation, it’s too late for them to react and keep up with the disruptor.

Big retail banks

Open banking allows alternative financial service providers to create competing solutions for banking clients, facilitating and increasing competition in the banking space. The total control retail banks once had over client information is officially becoming a thing of the past.

By giving clients access to their banking data in real-time to make transactions, invest and save most conveniently, open banking provides opportunities for third-party apps to provide services previously only offered through a retail bank. To stay competitive, banks would need to transform legacy systems and embrace the growing popularity of digital channels.

Plus, there’s the cost of creating the APIs. In Europe, all retail banks must comply with PSD2 and create open APIs that allow certified third-party providers to securely access their client’s banking data with the client’s permission. The median amount banks spend on open banking-related projects to become compliant is between €50 million and €100 million.

But according to the European Commission, it’s worth it to create a “payments environment which nurtures competition, innovation and security to the benefits of all stakeholders and consumers in particular.” 

Traditional credit bureaus

The credit bureau model thrives on financial information locked up in silos. The reign of credit bureaus, which dates back to the 19th century, began as a way to increase trust and transparency in the financial system. Today, their influence reaches beyond just finance. Now, credit bureaus are also involved in establishing trust between parties - sometimes at the expense of privacy.

Open banking allows for the free movement of financial data, which by extension, reduces the information silo model. The expansion of open banking will inevitably reduce traditional credit bureaus’ grip on both banks and lenders. Additionally, Covid-19 has highlighted some of the deficiencies credit bureaus suffer from, signalling the end of an empire.

Who are the disruptors?

Open banking may not be a game changer for every industry, but there are some stand-out opportunities in several verticals. Any industry that provides access to more personalized products and services, frictionless payments, and more convenient sharing economy services is well on its way to becoming a disruptor to open banking opportunities.

1. “Buy Now, Pay Later” e-commerce

The “Buy now, pay later” (BNPL) business model is based on boosting purchase conversion rates by reducing the number of steps clients need to take to get the product they want. Open banking helps BNPL companies keep conversion rates high by providing access to income and credit risk information for potential clients in less time and without needing to contact traditional credit bureaus. BNPL has already proven to be a grand challenger to traditional credit cards and consumer loans. 

2. Digital mortgage lending

Open banking reduces the steps and documents needed to apply for a mortgage. It can be a substitute for the bank statement banks require submitting a loan application and automate loan applications. For credit specialists, this saves time on data validation and allows them to focus on asking the right questions during the mortgage application process. This creates a better customer experience, which is critical in making one of the most important consumer decisions. Open banking has a lender’s best friend.

3. Consumer lending

Consumer lending is increasingly going digital, and open banking allows consumer lenders and credit card companies to increase conversion rates and approval rates for creditworthy customers. Open banking not only increases the speed of loan application screening and approval, but also reduces admin costs for servicing each loan application. 

4. Loan brokers

Similar to consumer lending, loan brokers also need to be able to understand customer needs and match them with appropriate loan providers. Besides reducing servicing time and costs for individual applications, open banking enables brokers to learn more about each loan seeker and automate matching between lenders and applicants.

5. Online gaming

Smooth user experiences are critical for online gaming and betting sites. Open banking enables them to verify the source of funds quickly and seamlessly. It also helps identify high-risk customers and become more compliant with responsible gambling rules. 

6. Rent 

Rent payment delays put unnecessary financial stress on landlords and housing companies. Open banking provides global access to information about a tenant's current financial well-being and ability to make rent payments, including when tenants are foreign nationals. It also allows tenants to prove creditworthiness to landlords by sharing their income information with landlords directly and securely.

7. Debt collection

Debt collection comes down to understanding the true financial health of a customer and helping them settle their debts. Open banking adds a layer of cash flow information previously not available to debt collection agencies, enabling them to collect and refinance debt more.

8. Insurance

Customers are increasingly choosing to pay for insurance in monthly instalments. Open banking can be used to evaluate customer creditworthiness before providing the insurance product and to reduce credit risk associated with financing larger insurance products.

9. Payments

Open banking enables a frictionless customer experience when authorizing payments in mobile wallets, gaming sites, investment platforms and other transactional applications. It enables various platforms to allow their customers to authorize payments to and from their personal bank accounts without the need to send their bank statements.

What’s coming next?

While we’ve taken a look at the industries where open banking disruptors are currently changing the course of “business as usual” – the effects of financial services innovation won’t stop there. Helped along by progressive legislation, new fintech startups are constantly increasing the use cases for open banking. 

Just like with online shopping, once consumers get used to the convenience of going digital, it’ll be hard to convince them to come back to using legacy technologies. Verticals like personal finance are patiently waiting for the next “Amazon” to come in and completely change the industry, so watch this space.