Why do most U.S. banks shut the door on 'open banking'?

December 20, 2017 6:02 PM

On Jan. 13, banks in the European Union will become the leaders of the so-called open banking movement, allowing access to customer account data for any third-party service provider their customers approve via a dedicated communication interface.

The move is the fruit of the second Payment Services Directive (PSD2), which the European Commission says will “facilitate innovation, competition and efficiency,” give consumers more and better choice in the EU retail payment market, and introduce higher security standards for online payments. (The security standards, which call for stronger authentication, take effect later.)

In the U.S., however, open banking is largely ad hoc and more of a workaround. Many data aggregators and fintechs screen-scrape customers’ account data without their bank’s approval or involvement. A few large banks, such as Wells Fargo and JPMorgan Chase, have made bilateral agreements with data aggregators and accounting software providers. And a small number of banks — Capital One, BBVA Compass, Silicon Valley Bank, Citi and CBW Bank in Weir, Kan. — have embraced open banking and offer APIs to almost anyone.

The rest have mostly opted out. Here’s why:

Self-preservation
“There are fewer and fewer moats banks have to protect their legacy business,” said Lex Sokolin, global director of fintech strategy at Autonomous Research. “Those moats are regulatory access and capture, internal data on clients and client references, and customer acquisition — banks have spent millions on customer acquisition and it will take the SoFis [Social Finance] many more millions to scale up to that.”

All three of these advantages are being eroded by fintechs, the Office of the Comptroller of the Currency’s proposed fintech charter, and declining customer acquisition costs as customers adopt nonbank apps and voice assistants, he said.

To counteract these forces, some banks seek to mimic the business models of Google and Amazon, which use artificial intelligence to create personalized services based on customer data.

“The bank thinks if they have the data and it’s proprietary to them, then the solutions they can build on them are proprietary to the bank,” Sokolin said. That way, they can retain customers.

“The logic is right, but it’s not the right tactic for the chessboard that’s in play,” Sokolin said. “The chessboard is, the AI and big tech companies have already won the virtual assistant war, because they can infer your financial position without ever seeing your transactions.” They can analyze purchases and searches, for instance.

To be featured inside virtual assistants, banks have to be willing to integrate with the software of Amazon, Google and the like.

But they have little commercial incentive to “lower the barriers and the walls so that fintech startup No. 2,500 can build a mobile app,” Sokolin said. “That’s why in Europe this is mandated.”

On Jan. 13, banks in the European Union will become the leaders of the so-called open banking movement, allowing access to customer account data for any third-party service provider their customers approve via a dedicated communication interface.

The move is the fruit of the second Payment Services Directive (PSD2), which the European Commission says will “facilitate innovation, competition and efficiency,” give consumers more and better choice in the EU retail payment market, and introduce higher security standards for online payments. (The security standards, which call for stronger authentication, take effect later.)

In the U.S., however, open banking is largely ad hoc and more of a workaround. Many data aggregators and fintechs screen-scrape customers’ account data without their bank’s approval or involvement. A few large banks, such as Wells Fargo and JPMorgan Chase, have made bilateral agreements with data aggregators and accounting software providers. And a small number of banks — Capital One, BBVA Compass, Silicon Valley Bank, Citi and CBW Bank in Weir, Kan. — have embraced open banking and offer APIs to almost anyone.

The rest have mostly opted out. Here’s why:

Self-preservation
“There are fewer and fewer moats banks have to protect their legacy business,” said Lex Sokolin, global director of fintech strategy at Autonomous Research. “Those moats are regulatory access and capture, internal data on clients and client references, and customer acquisition — banks have spent millions on customer acquisition and it will take the SoFis [Social Finance] many more millions to scale up to that.”

All three of these advantages are being eroded by fintechs, the Office of the Comptroller of the Currency’s proposed fintech charter, and declining customer acquisition costs as customers adopt nonbank apps and voice assistants, he said.

To counteract these forces, some banks seek to mimic the business models of Google and Amazon, which use artificial intelligence to create personalized services based on customer data.

“The bank thinks if they have the data and it’s proprietary to them, then the solutions they can build on them are proprietary to the bank,” Sokolin said. That way, they can retain customers.

“The logic is right, but it’s not the right tactic for the chessboard that’s in play,” Sokolin said. “The chessboard is, the AI and big tech companies have already won the virtual assistant war, because they can infer your financial position without ever seeing your transactions.” They can analyze purchases and searches, for instance.

To be featured inside virtual assistants, banks have to be willing to integrate with the software of Amazon, Google and the like.

But they have little commercial incentive to “lower the barriers and the walls so that fintech startup No. 2,500 can build a mobile app,” Sokolin said. “That’s why in Europe this is mandated.”

Core software compatibility

Another hurdle to open banking for U.S. banks, especially midsize and smaller ones, is that they rely on a small number of core systems providers that aren’t embracing open banking. And some have aging cores.

“A lot of the banks don’t have control over the core banking platform, so they can’t go down this path,” said Alan McIntyre, head of Accenture’s global banking practice.

Some core banking providers, such as FIS, Finastra and Temenos, talk about APIs and open banking. But often what they’re offering is either one-off integrations with outside providers or a way to plug fintech software into their platform (rather than share bank data with others).

“Open banking is two-way street,” McIntyre said. “Most of the regulatory focus of PSD2 is about exporting out information and services,” something core banking providers are weak on.

Lack of demand

“It's hard for an incumbent to come up with a random API when there are no customers at the door,” pointed out Tom Austin, co-founder of Bungalow Insurance, who spoke at S&P’s Fintech Intel conference in mid-December. “There's a risk that you could create APIs that no one wants or uses. So you have to wait until a customer comes knocking and asks you for it.”

Bungalow Insurance developed an API that lets other companies, like auto lenders and online rent payment companies, offer its renters' insurance engine on their websites. It’s one of very few insurance companies to offer an API.

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Lack of budget

“I think that most small banks aren't interested and or are unaware, and those that are aware and interested, are under resourced,” said Dan Kimerling, co-founder and general partner of Deciens Capital, a micro venture capital firm in San Francisco that makes angel and seed investments in fintechs.

To develop an API internally can take teams of developers, all making six-figure salaries, six months or more. Without a business model to support this, it can be hard to carve out the budget.

The consent order between the Federal Reserve and Capital One required the bank to submit progress reports on its efforts to improve its risk management functions.

Michael Nagle/Bloomberg

Lack of business case

“An old strategy when external APIs were first becoming the new thing was, let 1,000 flowers bloom — put these APIs out there and it will create all these new businesses,” said Dave Goldberg, senior director of platform products at Capital One Financial. “That has not worked out in most cases in the market. Pure openness hasn't worked without a plan for long-term business alignment.”

Capital One makes several APIs available. One lets people prequalify for credit card offers and is used by credit card aggregator sites, which then drive customers to Capital One. Another API is for rewards programs, and a third is for opening bank accounts.

Capital One is exploring an API for identity management that would let it enhance its ability to verify customers’ identity to others.

Lack of standards

In the U.K., banks are building APIs on a unified specification. But in the U.S., where there are thousands more banks, this is not feasible.

“I think a top-down spec is much harder to enforce versus the bilateral approach we're seeing here,” said Lowell Putnam, co-founder and CEO of the data aggregator Quovo, who also spoke at the S&P conference. “In 2017 America, the likelihood of a required API spec coming from D.C. is zero. Forcing an open banking API spec onto the next 10,000 banks is a 50-year technology project.”

Lack of urgency

Though the Consumer Financial Protection Bureau has recommended that banks share their account data freely with third parties, nothing is pushing U.S. banks toward open banking yet.

“No banks, U.S. or UK, are motivated to lower the barriers to new entrants or to reduce friction in switching to a competing bank,” said Jon Zanoff, managing director, Techstars. He’s responsible for the Barclays Accelerator in New York.

“There are two primary reasons to spur competition via regulation,” Zanoff said. “The first is simply to lower costs to consumers and improve quality of life. The second is to reduce systemic risk of the High Street monopolies by nurturing new entrants. U.S. regulators haven’t shied away from spurring competition to lower costs for consumers.”

However, the competition already exists. There are more banks in New York City than in all of the U.K.

PayPal signage is displayed in front of eBay Inc. headquarters in San Jose, California, U.S., on Tuesday, Sept. 30, 2014. EBay Inc. is spinning off its PayPal division, heeding demands by activist shareholder Carl Icahn and giving the business independence it can use to contend with rising competition from Apple Inc. and Google Inc. Photographer: David Paul Morris/Bloomberg

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Coming around to it

“Well-resourced banks worry about how regulators will look at the idea,” Kimerling at Deciens Capital said. “Some would rather perpetuate the illusion that they control the customer and the customer data. But in the end, they'll need to [become more open] because consumers and regulators will demand it, on some time frame.”

Despite all these hurdles, some U.S. banks are becoming more open.

Accenture's McIntyre says the days of the bilateral deals are numbered and the large banks will start adopting a more standard interface for sharing account data. Competition will force a move to more openness, he said, pointing to PayPal’s example.

“PayPal made it easy to put a ‘Pay with PayPal’ button on websites and mobile apps, and suddenly PayPal became ubiquitous,” McIntyre said. Visa and Mastercard quickly responded with their own express checkout tools.

There’s also more going on under the surface than the public can see, McIntyre said. Large U.S. banks are starting to invest in the technology to provide open banking, though they’re not publicly talking about it yet. “Ultimately, they will have to have that capability,” he said.

Editor at Large Penny Crosman welcomes feedback at penny.crosman@sourcemedia.com.