Open Banking: Regulatory Challenges for a New Form of Financial Intermediation in a Data-Driven World

Abstract

Data has taken immense importance in the last years. Consider the amount of data that is being collected worldwide every day, industries are reshaping their activities into a data-driven business. The digital transformation of all industries, portent of the fourth industrial revolution, is creating a new kind of economy based on the datafication of almost any aspect of human social, political and economic activity as a result of the information generated by the numerous daily routines of digitally connected individuals and technology. The financial services industry is part of this trend. Embracing the digital revolution and creating the right foundations allow incumbent financial institutions to disrupt their own business model. Hence, financial institutions are creating new businesses within their existing structures that adapt and collaborate to meet the challenges of digital transformation and make better use, faster, of their enduring source of competitive advantage – their own customer insight. Open banking and banking as a service (BaaS) are emerging as new forms of intermediation in the financial system that portraits positive and negative externalities for the financial system. Both concepts – open banking and BaaS – refer to the use of open Application Programming Interfaces that enable third parties to build applications and services around a financial institution that exposes its data and/or its infrastructure. The use of these schemes represents a new form of intersection between data and finance, which is changing the way traditional products, services and customer experience traditionally work in the financial sector. This paper explains the open banking and BaaS foundations and what they exactly entail. It also explores the benefits and risks that this interaction between financial institutions and third parties portrait for the financial services industry and analyses from a comparative perspective the different approaches financial, data privacy and competition regulators have implemented to boost open banking phenom. This paper argues that the compulsory approach to open banking is not in all cases the best approach for capitalizing the benefits of open banking and managing its risks. Indeed, some regulators have proposed a compulsory approach to open banking regulations to increase competition in retail banking or in the payment systems. In opposition, this paper argues that open banking and BaaS models in the financial industry might lead to more concentration and these risks have been understated by financial regulators and competition authorities. Finally, we provide some policy recommendations regarding open banking regulations, such as: the same regulatory approach should not apply to all jurisdictions, regulators should encourage reciprocity, especially when choosing the compulsory approach, coordination among different regulatory authorities is needed on a national and international levels, risk-based regulation is a correct type of approach, and monetization of data should not be restricted for incumbents.