In financial services, open banking (OB) allows for financial data to be shared between banks and third-party service providers through the use of application programming interfaces (APIs). By giving the customers the ability to share their financial data, OB promises to upend the organization of the financial sector while increasing competition and financial innovation.
A granular look at the benefits and drawbacks of OB
In this paper Babina et al. construct a hand-collected dataset of OB government policies around the world and find that OB is now present in 80 countries. The authors find significant heterogeneity in these policies’ timing, purpose, and implementation as well as a large increase in fintech activity following a strong OB implementation. To analyze the benefits and drawbacks of OB, they develop a general-purpose quantitative model of data production and usage, borrowing from standard IO models of consumer choice with heterogeneous consumers, and calibrate it to two financial products: mortgages and financial planning advice. Their model highlights two important issues:
- Distributional effects: Depending on how data is used, some consumers—in particular customers who are perceived as costlier or have a higher willingness to pay—are hurt by wider data availability, even if they can choose to opt out. This potential cost is most relevant in OB use cases that use data to screen or price discriminate against potential customers. In contrast, these distributional effects are not present in OB use cases where the data is used to provide higher quality or more targeted products, where customer welfare increases broadly.
- Impact on the banking business model: Opening data pares back banks’ economies of scope in such a way that the entire banking ecosystem could reorganize around more specialized and interconnected firms. The large reaction of fintech investment to OB shows the potential for disruption and just how valuable innovators perceive these data to be. In addition, OB reduces the value banks’ capture from their data which reduces their ex-ante incentive to produce that data.
Customer Data Access and Fintech Entry: Early Evidence from Open Banking
Authors: Tania Babina, Greg Buchak, Will Gornall
From: Columbia University, Stanford University, University of British Columbia
Regulation and OB
In this paper, Eccles et al. argue that OB will create two different types of depositors and hence two different forms of banking: for the depositors who embrace OB there will be banks and shadow banks which will take full advantage of attracting deposits from those customers. The banks and shadow banks that follow that route, will face strong competition. For the depositors who do not embrace OB there will be some banks which will adopt a strategy of focusing solely on these customers limiting thus their opportunities to grow. Hence OB will create two diverse banking models: competitive banks and monopolistic banks. This creates a challenge for policymakers whose policies should take into consideration the impact on the overall system risk from banks moving from one banking type to another. The authors argue:
[A]n increase in capital requirements bites less on the profits of competitive than monopolistic banks. Some banks thus move to the (riskier) competitive sector which we show can increase overall risk in the system. A deposit rate ceiling dampens the impact of Bertrand competition, making competitive banks more profitable, so the (riskier) competitive sector grows. Hence, rather than making the system more stable, a marginal lowering of a deposit rate ceiling can increase risk. We also show that, in many scenarios, the regulator must choose between banks funding private sector projects or all banks being safe, the regulator cannot have both. This has implications for the optimal risk weights of sovereign debt. In our model, none of these effects are driven by the presence of unregulated assets/sectors nor on impacts on charter value, as is the case in papers that find outcomes that are the opposite of what was intended.
In terms of regulation they suggest:
- When OB levels are comparatively low, then the best strategy (in the sense of giving highest welfare) is to choose the lowest capital requirement that incentivizes monopolistic banks to invest in low-risk projects while competitive banks can invest in high-risk projects.
- When OB levels are large, then regulators will need to address the cost of the risky choices made by competitive banks and higher capital requirements become optimal.
Open banking, shadow banking and regulation
Authors: Peter Eccles, Paul Grout, Paolo Siciliani, Anna (Ania)Zalewska
From: Bank of England, University of Leicester School of Business
