Can Open Banking deliver merchants a transformational payment solution? (Part I)

by Michael Tomlins on January 27, 2022
What is Open Banking? A quick re-cap...
Historically, banks have held the world’s financial data on legacy technology that was fragmented and clunky making it difficult to progress beyond a “one-size-fits-all” approach to money management.
European regulators were concerned that the old technology stacks of banks were impacting innovation and harming competition in the sector, resulting in a poor customer experience and high costs for both businesses and customers. Through the Payment Services Directive 2 (PSD2), regulation was introduced that required the banks to provide access to this valuable data to third-party service providers (TPPs). It was hoped that PSD2 would enable FinTechs to use the data to build innovative new financial products and services, remove inefficiencies in the sector and create a more competitive financial services sector. Beyond being a simple payment product, open banking regulators mean to usher in a new era of open data and open finance.
Early indications suggest that Open Banking APIs have fuelled innovation with API call volume increasing from 425.4M API calls in June 2020 to 772.6M in December 2021 according to Open Banking’s figures.
Opposing Regulatory Approaches for Open Banking: Market-led vs. Regulator-led
An ongoing debate by regulators globally is whether to follow Europe and adopt a regulatory-led framework (Regulator-led) or allow the market to compete and innovate with little intervention (Market-led).
Regulatory frameworks like the EU’s PSD2 essentially require banks to publish API to enable the flow and careful use of financial data. Because it has users' explicit approval, open banking allows personal information to be exchanged between companies in a standardized and secure manner. TPPs can now access information rapidly and cost-effectively, allowing for the development of innovative solutions.
While the EU’s open banking approach is primarily regulator-led, Singapore has adopted a more market-led approach and moved away from a mandated approach by providing loose but progressive guidelines. The Monetary Authority of Singapore (MAS) pursued an organic approach, encouraging collaborative efforts between banks and FinTechs. In 2018, MAS launched a financial API marketplace to promote cross-border collaboration to promote innovation and financial inclusion.
Although we could debate the merits of each approach, I’d like to argue that rather than being two split approaches, these are two ends of a spectrum of adoption. In the middle of these two approaches lie many countries - Bahrain, for example - that are quite flexible in their implementation with regulators, in some cases, developing localized guidelines but not enforcing them as regulatory requirements.
Will open banking provide a powerful new payment method for merchants?
With brick-and-mortar stores closed for months as a result of the COIVD pandemic, customers had to adapt their buying habits online, meaning eCommerce has achieved a decade's worth of growth in just a few years. As more options for online purchasing emerge, merchants must deliver a personalized experience to compete for customer engagement, with the checkout experience now being a major priority.
Traditional payment mechanisms, which were created for the pre-internet economy, present several challenges in the digital world. Card-not-present fraud is on the rise, as are the expenses of transaction fees and chargebacks, combined with low levels of payment conversion and delayed refund methods.
Because open banking enables retailers to securely connect to a consumer's bank account using open APIs, merchants can simply initiate a real-time payment or retrieve data on the customer’s behalf and optimize their purchase experience. As the sector continues to develop, a slick payment experience could offer merchants several important benefits:
  • Reduced operational costs – Cards processing fees are seen by many as a ‘tax’ on merchants becoming a material cost for business, even leading to Amazon threatening to stop accepting Visa cards on their UK site. OB payment initiation can be processed for just a fraction of the cost. Additionally, less time spent reconciling payments (no more mistyped references, payment details are automatically populated)
  • Higher conversion rates – This is especially true for Plaid's native mobile Open Banking experience in the UK, where conversion rates for Plaid's customers are as high as 75-85%. Higher transactions are also expected to come with open banking in the UK reaching 2.6M transactions in September 2021
  • No chargebacks – because open banking providers instruct bank transfers on behalf of the customer, there is no built-in chargeback mechanism
  • Lower fraud – every payment is authenticated by the user’s bank and goes through the banks’ fraud detection engines. Reducing the risk of fraud is an important segment of open banking hence the implementation of Strong Customer Authentication (SCA) under PSD2
  • Immediate settlement - Monies are transferred directly into the merchant’s bank account, meaning settlement is conducted immediately, supporting better cash flow for the merchant
Whilst the benefits for the merchant are clear, for widespread customer adoption of OB payments to occur, key stakeholders will need to combine to create a competitive proposition. The payment schemes have invested billions of dollars educating customers on the ease and security of using payment cards, issuing banks have incentivized customers with attractive offers such as cash-back, loyalty schemes, and other value-added services. Moreover, regulators have built-in robust consumer protection measures all aimed to provide customers with the confidence to use payment cards. The question remains, who will fund the education of customers for open banking payments?
In Part II, we shall explore how governments and regulators in the Middle East have approached the opportunity that OB presents, the innovative solutions developed by leading local FinTechs, and what this means for merchants in the region.

Topics: Alternative Payment Methods, Payments, Open Banking