SALAHUDDIN

Essay: Financial Technology

In the last decade, the world of finance has been shaken up by the digital revolution which has quickly emerged as the biggest challenge to traditional banking models. As the digital revolution accelerates, it is leaving traditional payment methods meandering for innovative technologies to keep pace with the latest developments in digital finance. The whole enterprise of banking and finance has been shaken up by digital technologies, particularly Fintechs, which are cutting out the financial intermediaries to directly serve the customers through innovative offerings. As the economist points out, conventional banks now account for only 72% of the total market value of the global banking and payments industry, down from 96% a decade ago. Today, most people do not have to deal directly with their banks as transactions are settled digitally and in real-time. People’s interactions with their banks have been largely limited to mundane transactions. Once the money is deposited into a bank account, people usually have limited options within the banking ecosystem to move their money or use it for investment purposes. Open banking is a new and transformative way of banking that can significantly alter how people interact with the financial markets.

Data has value

The idea of open banking is based on the premise that the data held by the banks does not belong to the banks but the customers. While this is not a revolutionary idea, it could potentially lead to a seismic change in the financial industry if backed up by government policies and regulations. If the customers can decide who can access their data and how it can be used, then it has huge implications for the financial industry because it would lead to a rebalancing of power between the consumers and the financial institutions.

Traditionally, banking has remained a closed ecosystem with a monopoly on user data. Banks hold the users’ transaction data without leveraging it to create and improve new products and services that might be better suited to the needs of their customers. The real potential and the value of customer data remain unutilized since it is kept in silos and the banks do not share it between themselves or with other financial service providers (FSPs). The banking industry already collects an enormous amount of information on customers which is essentially wasted away in routine transactions.

A closed banking ecosystem means that potential FSPs who could be better suited to innovate and experiment with tailored products and services do not get access to the customer’s data to understand the market needs. In open banking, all potential financial providers, such as Fintechs, will be able to access user data which can then be used to develop bespoke financial products and services. Through explicit user consent, FSPs will be able to access the customer data, analyze it, and use the insights to design new savings, credit, insurance, and financial management products. This will help unlock innovation in the market by removing the monopoly on user data and making the data interoperable.

Consumer protection, a prerequisite

While open banking is not yet a reality in many developing economies like Pakistan, it holds the potential to increase financial inclusion by encouraging innovation and product diversity in the financial services market. Regulations have already been introduced in some advanced economies to help consumers protect their personal data, a prerequisite for open banking. In Europe for example, the European General Data Protection Regulation (GDPR) is giving consumers control over their personal information which can be shared with third parties. Organizations such as banks will have to obtain explicit consent, through an opt-in model, from the consumers to share their data, such as information on transactions. A related second regulation, the Payment Services Directive (PSD2), is specifically developed to give consumers control over their financial data. With consent from the consumers, banks and other FSPs will have to open their data and payment initiation capabilities to third parties. Using third-party applications, consumers will be able to access all their financial information on a single dashboard, similar to account aggregation services like Mint.

Open banking, an instrument for financial inclusion

Open banking can be used as an instrument to demonstrate that previously unprofitable segments of the population hold value. It can also show that there may be cost-effective and sustainable business propositions to explore which could help the unbanked and the underbanked in getting access to financial products and services. Open banking can potentially lead to an increase in credit, unbundling of financial products, information symmetries, better deals on savings accounts, and smart repayment plans. In an open banking regime, customers will be able to choose to provide access to their data in return for better financial products and services which are tailored to their specific needs. Using advanced analytical tools and machine learning algorithms, FSPs can uncover hidden patterns and find value in previously unprofitable segments. Furthermore, as pointed out in a report by CGAP (Open Banking: How to Design for Financial Inclusion), open banking will facilitate the market entry for new entities, leading to a more competitive financial services market. As the report further points out, this could result in “lower prices and increased product diversity” which would allow low-income segments to afford financial services.

Currently, the low incomes segments and the SMEs are underserved by the financial sector because the banking industry has limited capacity to innovate and does not offer diverse enough financial products. The banking industry has limited incentives and high costs to consider increasing the size of the customer pie by accommodating low-income segments and small businesses. All in all, the current financial services market is not a well-functioning market that does not works for all segments of the population. Open banking can change all of that since it does not have to rely on the brick-and-mortar model of traditional banking which is associated with high-cost structures and cumbersome paperwork. With open banking, many application processes can be automated. Consumers will no longer get bogged down in endless paperwork that serves as a discouragement to applying for credit or finding and investing in the most suitable financial products.

Many developed economies like the UK are already experimenting with open banking. It is yet to see how open banking plays out in the developed economies and if it succeeds in unlocking the potential that customer data holds. Nevertheless, open banking will play a decisive role in the future of finance and will become closely embedded in the financial services sector. Regulators and policymakers in Pakistan should start thinking about open banking and how it can help move the needle on financial inclusion. A sturdy and reliable consumer protection framework would be a prerequisite. With the introduction of Raast, Pakistan has already enabled interoperability in the market and the platform is there to be utilized by Fintechs and FSPs. It is now time to put this platform to good use by integrating it with the wider payments ecosystem. Raast can play an enabling part in realizing the promises of open banking by facilitating interconnectivity which will allow financial institutions to share information. The focus must be on developing a data-sharing regime that satisfies the legal and institutional requirements, so we move one step closer to realizing the goal of financial inclusion in Pakistan.