Open Banking: A Framework for Fintech Innovation
What’s Open Banking?
Despite being one of the most well-banked nations in the world, Canada’s banking and financial services industry lags behind several countries such as Hong Kong and Australia in its interoperability, data openness and transparency. One of the promising potential solutions to these issues builds off a regulatory framework and movement known as Open Banking. Open banking has been a progressive global banking and financial regulation movement that allows traditionally closed-loop customer financial data to be transferred to and from other banks and third-party financial service firms.
In present circumstances, if you have an account and any information with one financial institution, your data would stay in a closed loop of that single financial institution. If you need to use the services of another institution for another service (ie. mortgages, insurance or credit), you almost always have to start from the bottom up. This creates deep inefficiencies and pain points for consumers and novel financial institutions, creating room for more fraudulent and suspicious financial activity. Open Banking would enable banks and financial institutions to share necessary financial and qualitative data with other third-party apps like phone applications or other website traffic.
Establishing a strong framework for Open Banking can enable much more fluid and natural financial innovation and can make firms not only more efficient but also innovative. It can enable entrepreneurs and firms to experiment with creative mechanisms to alleviate many deep issues in the realm of financial services and technology in a regulated manner. Not only can Open Banking help promote and drive innovation in banking and financial services, but in establishing a strong regulatory and legal framework, it has the potential to build a more dynamic and open data-drive ecosystem and economy. The progression of Open Banking and Consumer-driven banking may provide the necessary impetus for financial institutions to be more transparent and prudent in data privacy, risk profiles and macro risk management.
Canada’s Regulatory Open Banking Framework
Starting in March 2022, the Canadian federal government formally began a series of discussions with consumer groups, and financial institutions about what framework regarding Consumer-Data Banking frameworks may look like. In the formation of Open Banking, there are three types of relevant financial data - customer data, transaction data and value-added customer data. In June 2024, the 2024 Canadian federal budget hinted at the early innings of an Open Banking framework and delegated the formation of the framework over to the Financial Consumer Agency of Canada.
The full implementation of Canadian Open Banking is anticipated to take almost a decade, if not longer, and is most probably going to be a more nuanced series of small and large bills as opposed to one singular bill. However, there lies a great depth of economic, philosophical and even technical problems which need to be resolved before concrete actionable bills are in place. For Canada, the framework has to be interoperable with the coming framework from the U.S. Consumer Financial Protection Bureau. Consumers also need full awareness regarding the benefits and scope of Consumer-Driven Banking.
The Economic Problems of Open Banking
Scope, Scalability and Servicing is an arduous task.
Before talks on specific implementation of an Open Banking framework come, getting the political capital to pass a framework is a feat in itself. Additionally, getting awareness from the public remains a key battle. Every stakeholder in this case has a different set of needs, simply put: Banks want easy interoperability, Startups and Non-Bank entities want ease of integration and scalability and Consumers want lower costs, easier user experience and more security.
In Canada, policymakers have made clear that any set of Open Banking frameworks would be overseen by a government entity such as the FCAC. This emulates the approach taken in the United States. It deviates from the market-based approach in countries such as Hong Kong - which took a developer-oriented approach to Open API functions of Product information, Customer Acquisition, Account Information and Transactions.
In a study done on Customer Data Access and Fintech Entry, through the global aggregation of Open Banking laws and it’s effects - Open Banking policies increases venture capital funding of fintech by 50% and creates more competition and company entrants into the market. However, it also has a downside for customers and a reduction of ex-ante information production.
The Contentions and Implications of Open Banking
The biggest struggle with Open Banking is ensuring consumer data rights aren’t violated and that security standards are maintained for Third Party Providers (TPPs). Additionally, there lies a concern around cyber security practices, total security investments and how they may need to be altered to ensure effective cyber security and prevent ineffective security. Current Closed-Loop Data Workflows give banks a comparative advantage in pricing, marketing and customizing financial products. The consumers who lose the most are those that have the highest willingness to pay, as Open Banking regimes reduces a financial services firm ability to price discriminate.
The biggest application won’t necessarily be in Banking - rather, the application will lie in data. Many present-day, Canadian Open Banking talks take inspiration from Europe’s GDPR bill and will apply to broader data. Through open banking, the possibilities in Canadian data science, analytics and measurement could skyrocket and propel cities like Toronto to be fintech capitals and innovation hubs.
Recently, the vast majority of innovation in the realm of banking, payments or fintech has sprung out of emerging economies. However, many developing nations which can’t absorb inefficiencies like bank runs, insurance defaults or payment errors - innovation is imperative. This requires them to have leniency and openness with banking and payment regulations. In many developing nations, lean innovation has allowed for the adoption of novel innovations such as Microfinance and psychometric and qualitative assessments for financial scores such as credit scores. In most of the developed world, we’ve become accustomed to complacency and inefficiency in our payments and financial systems. However, in a world that has adopted Open Banking, we can see developed nations become a hotspring of innovation in areas such as fintech.
Consumer Benefit of Open Banking
The number of Canadian adults classified as credit invisible is comparable to many middle and low-income nations. This comes as a surprise considering the vast strength and stability of the Canadian banking and financial services industry, but Open Banking improve financial inclusion and help reduce credit invisibility. Having Open API policies adopted by banks and financial institutions, have proven to not only spur fintech investment, but reduce the demand for more non-conventional digital assets such as cryptocurrencies.
The vast majority of people who are credit invisible are those who have had a negative credit report such as defaulted accounts or simply had no inquiries or supposed need for credit. The current scale of people who are credit invisible and have a poor and/or little connection to the banking and financial services industry presents an open opportunity. This is an opportunity Open Banking could help solve, third-party credit bureaus, agencies, banks and firms could source data from different backgrounds and make sure creditors get a holistic view to provide credit to a variety of underserved communities.
Open Banking can ensure that non-financial data and consumer data can be used to inform how financial firms deploy and utilize credit effectively. It can help create a more detailed and psychometric consumer credit profile taking in holistic factors to build a more accurate and considerate risk profile for millions of Canadians.