Embarking on a digital payments journey with an open banking horizon

In a growing digital payment world, it’s all-hands-on-deck for the banks to provide a frictionless and secure online payment experience for their customers.

With cash usage decreasing and bank offices receiving fewer walk-ins off the street, it is key that wherever and whenever customers want to access their bank account and make payments online, the bank is right there on the digital channel for them to make this happen.

So how are the established brick-and-mortar banks navigating to this new digital horizon? Are they losing the wind in their sails on open sea? Or are they welcoming the momentum of digital transformation as the tailwind to keep up with the pace? What are use cases of digital payment being embraced by customers around the world and where are banks already involved?

Let’s dive in and find out.

The open banking horizon

Until recently, a consumer’s financial data was centrally held within their bank. But this has started to change with the implementation of various open banking initiatives that have evolved through the past decade and launched within recent years across the globe.

But what is open banking? Open banking is a loosely defined term that means different things to different people. In the US and Asia, open banking typically refers to a broad set of software interfaces, offering services to other software, so-called API-based connectivity, and which allows greater sharing of account and balance information. APIs in payments can be used to reduce friction in the checkout process, reach new customers without the need for new banking relationships and reduce the risk of fraud. The most common application of open banking is account clustering via API where third-party providers give their customers access to accounts held with multiple banks with one simple log-in.

In Europe, the revolution of open banking truly started when the Second Payment Services Directive (PSD2) came into force in 2018, including payment initiation (PISP) and account information (AISP) services. Banks needed to open to others, sharing account data as well as allowing payment initiation with the consent of the end-user. This immediately created an endless pool of opportunities for all the players active in the financial sector, whether regulated entities – financial institutions – or non-regulated ones like fintechs and third-party providers (TPPs).

According to recent research conducted by Accenture, 76% of banks worldwide expect customer adoption and open banking API usage to increase by 50% or more in the next three to five years – from lending and payments to personal finance management ^[1].

Navigating on the mobile payment channel

Since the obligation for banks in Europe to publish PSD2 APIs, the market is rapidly evolving towards so-called embedded finance. Here, e-commerce merchants, car sellers, software companies, travel agencies, and many others are directly integrating finance solutions – or banking-as-a-service – within their applications and/or processes. This enables them to provide their clients with a single seamless experience throughout their entire journey – from searching to purchasing add-ons and paying.

It’s worth mentioning that when we speak about digital payments across the world, these are mainly via the mobile channel with the rate of adoption directly linked to access to smartphones and telecom networks. The user base for mobile payment globally has tripled since 2015 from 0.4 billion to 1.2 billion users in 2020 ^[2]. The furious growth in digital payments in developing countries, especially in Asia, demonstrates the impact of the Covid-19 pandemic in advancing online retail sales, as well as the role that governments and regulators play in facilitating the spread of new payments systems.

This is further illustrated by the appearance on the stage of super app models in the East by tech giants such as Alibaba and Tencent that have presented consumers with new ways of consuming banking services, most clearly in the payments area. Challenger banks such as MYbank and WeBank (backed by Alibaba and Tencent respectively) have grown substantially in the past few years.

The use cases connected to super app models as created by Alibaba and Tencent are found with their apps AliPay and WeChat. These apps link users’ mobile phones to existing bank accounts and already achieved a spectacular increase in Chinese e-commerce in the 2000s. Originally used for online purchases and messaging, the apps now have expanded to become all-in-one platforms that offer ride-hailing, food delivery, entertainment services and a full range of financial products, including credit and insurance. Singapore’s Grab, Indonesia’s Gojek, South Korea’s KakaoPay and India’s Flipkart and PayTM are aiming to build their own super apps.

In China, the birthplace of the super app, the flipside of this development is that after allowing simple payments providers to grow into major distributors of financial products, regulators now want to make them subject to the same supervision that is applied to banks.

By contrast, Southeast Asia lacks the cautious approach of Chinese regulators, with governments largely supportive of native super apps, at least at present. Most of the region’s economies have large informal sectors, which means that significant sections of the population have limited access to banking and other savings products. Governments in emerging Asia will maintain a positive attitude toward regulating super apps, looking to leverage such platforms to achieve financial-inclusion targets.

Card-backed digital payment system dominating the waters

When talking about a digital payment transformation and the role of mobile payments, the most familiar—and least revolutionary—change is occurring in developed countries, where the existing card-payment infrastructure has been extended to mobile phones and contactless cards. For example, the widely adopted systems of Apple Pay, Google Pay and Samsung Pay use traditional branded cards embedded in mobile apps to make transfers at improved point-of-sale (POS) terminals. They use the existing infrastructure to move money from payer to recipient while allowing card networks and issuers to continue to collect fees. Contactless payment, adoption of which was slow-moving prior to the pandemic, has taken off amid fears that the virus is being spread by handling cash.

Card-driven contactless payments will further continue to dominate in the Americas and Western Europe, where consumer wearables (smartwatches, for example) will also emerge as a key medium for payments. In contrast to chip and pin-based cards, virtual cards reduce transaction time and provide a seamless experience for both merchants and customers. Mobile apps such as Apple Pay and Samsung Pay will continue to lift the engagement levels of their users, incentivizing them to use their platforms for a host of other digital transactions, including utility bill payments, personalized savings and credit products and online shopping. Meanwhile, players in Europe, such as Sweden’s Swish, will continue to evolve to provide services enabled by real-time payment infrastructure and other innovations that the regulators are pursuing in the region, such as QR codes.

The journey of banks to digital transformation

From Asia to Europe, US to Africa, and Australia to the Middle East, consumers are increasingly adopting digital – most are now demanding it. While the movement toward our ability to bank anywhere is inevitable, the path towards transformation varies from one region to the next.

In the US, though regulatory changes are likely far off, it is inevitable that a more open model will emerge as big tech players like Google, Apple, Amazon, and Facebook play with payments and similar activities.

In Europe, financial institutions are confronted by both an increased number of European regulations and a growing multitude of digital-led opportunities as mentioned earlier. To navigate and succeed in such an environment, they are required to deeply transform to stay relevant. This transformation is crucial for retaining existing customers and attracting new ones, by satisfying their rapidly changing needs and providing unique, innovative, flexible, and easy-to-use services.

While the PSD2 regulation is boosting development for the banks, at the same time security needs to be safeguarded when putting open banking into practice. Elements to consider are biometrics for authentication, the prevention of social engineering fraud, the authentication of people’s identities with electronic signatures and on mobile apps, the complex nature of the authentication process in general and the ability of a payment initiation service provider (PISP) – i.e. third-party provider – to refuse a payer’s request to initiate a payment transaction.

On the technical implementation side, open banking needs to be practiced by the banks by opening their APIs to the third-party providers and collaborate to achieve a uniform API standard, i.e., offer the same level of availability and performance, including support, via the APIs to the third-party providers as with the interfaces made available to the bank user for directly accessing its payment account online.

A working group ^[3], tasked to consider APIs in the light of PSD2 to remove some of the obstacles that payments firms face with open banking, has addressed issues to the European Banking Authority (EBA) for clarification around the implementation of APIs partly because they are not standardized throughout the EU, something that both the European Banking Authority and the European Commission have shown an interest in changing in an upcoming review of PSD2. According to the EBA's website, the working group includes people from some of the EU's largest banks, such as Deutsche Bank and BNP Paribas, alongside API initiatives such as the Berlin Group and France's STET and third-party providers (TPPs) such as TrueLayer and Tink. TPPs are companies that use open banking data; the Financial Conduct Authority regulates them in the UK.

Already a few years earlier in 2016, the Competition and Markets Authority (CMA) in the UK published a report on the UK’s retail banking market ^[4] . The report found that older, larger banks don’t have to compete hard enough to gain customers’ business, while newer banks find it difficult to access the market and grow. One of the CMA’s recommendations to tackle this problem was indeed open banking.

Since 2018, the Open Banking Implementation Entity (OBIE), created to drive competition, innovation, and transparency in UK retail banking, has taken a prominent place in creating software standards and industry guidelines. Since its roll-out activities for the benefit of the technical infrastructure of the open banking ecosystem, over 20 million API calls for data are currently being made every month. Great beneficiaries have been banks like HSBC, Santander, and Nationwide, along with fintechs like Monzo, Starling, and Revolut ^[5].

Still existing banks are struggling with the right way to evolve. Some choose to stand up a whole new separate digital bank to appeal to new population groups (as in the case of Standard Chartered in Hong Kong), while others choose to rebuild and rebrand.

The challenge of the latter is obvious that the digital experience is dependent on the ability to update/upgrade the legacy core system. Regardless of which path to take, the fact remains that going digital extends beyond moving transactions from analogue to internet to mobile as part of some surface level technology refresh. Becoming digital is a complete transformation that requires a change to the bank’s DNA.

Turning the tide for financial services

This is the new normal of transformative business model evolution within financial services. As opposed to the “move fast and break things” culture of Silicon Valley, innovation – to be effective and sustainable – must be thoughtful and disciplined.

This new mindset needs to be embedded in the culture of the organization. Bringing new products and services to the marketplace will require willingness to trial by error, tolerance to accept failure, and openness to learn. “How open are we?” becomes not only a question of technical capabilities but also a question of culture and one of survival.

Mobile banking quickly became a table stake instead of a nice-to-have, and the financial experiences expected from our applications have moved from reporting the past to predicting the future. To compete, banks must re-imagine banking itself within the context of our daily lives, our routines, our needs, our desires, and their impact on our future.

That said, the willingness does exist to invest into open banking. According to Statista, USD 705 billion have been invested in fintech companies worldwide since 2016, which has funded many new and ambitious companies. Over the last three years, Statista claims there have been 74,312 fintech startups, all looking to become players in open banking and create new opportunities.

But what are these opportunities? Accenture released a report this summer analyzing the predicted changes that open banking could bring to the industry. Their analysis, built on data covering 20 of the largest economies, responsible for over 75% of global GDP worldwide, predicts that as much as USD 416 billion in revenue will be at stake as the era of open data arrives ^[6] .

Setting sail for the final stretch

While open banking for Europe, as defined by PSD2, is not perfect, it has provided innovative services across half a billion citizens and 6,000 financial institutions [1]. It has opened minds as to what may be possible not just for banking, but for finance and data. It has led to open banking around the world and the journey continues. There is an increasing expectation about the rollout of open finance, with further direction expected from the European Commission in 2022.

Around the world, the absence of common regulatory standards among geographically contiguous countries, potentially leading to the creation of regional monopolies, is a concern. Regulators must work towards the standardization of technology such as quick-response (QR) codes, while also building universally accessible payments infrastructures. These allow for the participation of private firms, providing an additional boost to the digital economy.

Meanwhile, traditional companies, such as brick-and-mortar banks, run the risk of being overrun by their digital counterparts and payment-platform providers, despite their own significant investments in technology. Many have been unable to create the culture of innovation that is the trademark of the digital player, although some have put up for sale digital businesses or turned to acquisitions to remain relevant in an increasingly digitalized world.

Nevertheless, the benefits of digital payment systems overall across the world significantly outweigh the risks associated with them. For governments, they provide an avenue to raise financial inclusion and further the cause of economic development. For regulators, there is an important role to drive value of a good API infrastructure for the ecosystem that stimulates the banks. The working group under PSD2 as well as the OBEI in the UK are examples of offering this helping hand. Furthermore individuals, especially those in developing countries, can more effectively participate in economic activity and private organizations will benefit from the new opportunities created as a result.

While card payments are perhaps less revolutionary, based merely on an existing infrastructure, they are just a mobile phone away from benefiting from the digital user experience. The fast-growing rate of users globally using mobile phones for payments and moving away from cash and plastic has illustrated this.

We can conclude that open banking is likely to arrive at different times in different markets. Trying to predict which segments of the industry will see the biggest change is difficult. However, the winners will be those developing plans that have a clear commercial benefit and drive efficiency. 

Whether as a bank, third-party provider, government, or regulator: working together and embarking on the same journey with customers as end-users is the key to meeting the market demand for a smooth and secure digital payment experience for all at our common destination.

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[1] Open Banking Report 2021| ThePaypers 

[2] Going digital: payments in the post-Covid world | Eiu.com

[3]  VIXIO Payments Compliance – August 2nd 2021 - EBA Publishes First Responses To API Working Group Since 2019 in reference to EBA publishes clarifications to the sixth set of issues raised by its industry working group on Application Programming Interfaces under the Payment Services Directive (PSD2) | European Banking Authority (europa.eu)

[4] Retail banking market investigation | GOV.UK (www.gov.uk)

[5] Open Banking: The future of banking and digital transformation | Paymentscardsandmobile.com

[6] Is Open Banking Finally About to Change the Direction of Financial Services? | Financial IT