Open banking continues to spread worldwide and is heading for the United States, in what some have been calling its “smartphone moment.” The infrastructure is falling into place to support open banking, and the Consumer Financial Protection Bureau has begun safeguarding the consumer protections necessary for this to happen.
In a recent PaymentsJournal podcast, Amit Shastri, Senior Director of Product Management at Worldpay from FIS, and James Wester, Co-Head of Payments at Javelin Strategy & Research, discussed the various payment rails that will facilitate open banking and what the benefits could be for banks, merchants, and consumers.
The Taxonomy of Open Banking
It’s important to understand the terminologies used in open banking, a new topic for many people. There are key differences between account-to-account (A2A) payments and open banking. A2A payments rely on legacy banking systems and often involve manual user steps, resulting in a suboptimal user experience. Open banking is not limited to the bank’s technology but can be seamlessly integrated into other apps with a stronger focus on conversion rates and experiences. A2A payments tend to lack interoperability across regions, whereas open-banking payments have the potential to be integrated into cross-border payments. In short: Although all open-banking payments are A2A payments, the reverse is not true.
In the United States, open banking is centered on the API-based connectivity that enables the sharing of bank account and balance information. U.S. consumers have become familiar with linking their bank accounts as part of the checkout process, then leveraging that connection to make payments again and again.
The term “real-time payments,” or RTP, refers to the underlying infrastructure that enables instant or near-instant transfer of payments between two parties. RTP operates 24 hours a day, weekends, and bank holidays. Open banking is effectively the overlay of services on these RTP rails, and it has the potential to revolutionize payments for consumers, retailers, small businesses, corporations, and governments.
Where Open Banking Stands
According to Shastri, open banking accounted for nearly $525 billion of e-commerce transaction value in 2022 and is expected to see a 13% compound annual growth rate through 2026. Some of the key successes of open banking around the world are seen in Brazil, which has a payment scheme driven by the Central Bank of Brazil, and in India with UPI, which was launched in 2016 by the National Payments Corporation of India and the Reserve Bank of India. In India, there were 10 billion open-banking transactions in September 2023 alone.
If the market and the regulators support it, the potential of open banking worldwide is phenomenal. “The market-led approach that we have in the U.S. works very well for most consumers,” Wester said. “But what we are seeing is recognition that the open-banking model does work better, and that is where we need to be going, regardless of how it’s being led.”
Today’s consumers want improved, innovative shopping experiences, and they want instant gratification. Consumers want greater access to their financial data, and they’re willing to share that if it results in improved services and less costly financial products. Meanwhile, merchants are under extreme pressure to reduce their operational costs. Because open-banking transactions happen outside of traditional card rails like those used by Visa and Mastercard, there are no interchange and scheme fees. Open banking has the potential to save merchants millions of dollars annually.
“At Worldpay, we do not discriminate between payment methods,” Shastri said. “We offer a plethora of payment methods to our customers because, ultimately, we want to drive financial inclusion. When consumers are successful, businesses are successful, and that’s what we are striving for every day.”
Open banking is proliferating around the world, but it’s just getting off the ground in the United States. Shastri explained that there are four U.S. rails upon which to build an open-banking ecosystem:
- ACH has been the fundamental backbone of money movement since the 1970s. These payment methods are not real time, however; they are processed in batches. The cost of these payments is low and therefore a very effective choice for large-scale, repetitive transactions, but they typically take from one to three business days to settle.
- The RTP Network was set up in 2017 and is governed by The Clearing House. According to The Clearing House, about 60% to 70% of U.S. consumers can send RTP payments, but more than 80% receive an RTP payment.
- Wires are fundamentally used for high-value, cross-border, and urgent domestic transfers. They typically facilitate funds between banks and financial institutions and incur higher fees compared with RTP and ACH.
- FedNow is the newest real-time U.S. payment rail, live as of July 2023, with more than a hundred participating financial institutions and payment service providers.
“For a payment method to be successful, it needs to reach the broadest possible consumer base,” Shastri said. “Shoppers don’t really care about RTP or ACH or FedNow. It’s for us as a payment service provider to solve that complexity for consumers and merchants, so that they have the broadest possible reach of the payment method in the country.”
Perhaps the biggest challenge in this space is bank fragmentation. The United States has more than 12,000 banks, whereas countries like Canada are in the double digits. The legacy banking system that supports smaller financial institutions is not equipped to support real-time and clean data-sharing capabilities.
Because no standards have been set, each bank can enable the sharing of data or enable payments in a slightly different way. “We could have tens of thousands of potential ways to connect to the bank account,” Shastri said. “The cost of integrating, managing, and maintaining these API integrations will be significant for the players in this space.”
Data Privacy Issues
With open banking, consumers are the ultimate owners of their financial data and can choose to share it with whomever they choose. But this leads to legal and ethical implications around sharing data with multiple third-party providers. “As an industry, we need to solve for some of these legal initial implications and assuage any concerns from a legal and ethical standpoint,” Shastri said.
The legal basis of open banking flows from Section 1033 of the Dodd-Frank Act, which requires banks to make this data available to the consumer in a usable format. Earlier this year, the CFPB issued a notice of proposed rulemaking to allow consumers to have control over their financial lives and gain new protections against companies’ misuse of data. Consumers’ own data would be made available to them at no charge through digital interfaces that are safe, secure, and reliable. They would also have the legal right to share their data with whomever they choose and revoke their access to data as well.
“This is the core basis for open-banking adoption in the U.S.,” Shastri said. “CFPB is doing a phenomenal job of regulating the space, making sure the ecosystem players behave and play by the rules while protecting consumers from malicious practices and data security.”
‘The Smartphone Moment’
Shastri expects to see action around the fragmentation of APIs, with common standards for the interfaces being adopted at least at a country level. That will be closely also aligned through the ISO 20022 messaging standard to improve the insights through data and conversion rates.
“To me, this is like the smartphone moment of financial services,” Shastri said. “This is the start of the journey of building innovative products using data. Open banking will become more and more feature-rich. There is already work going on around variable recurring payments, which will enable person-to-business use cases across a number of industries.
“Open banking is not just about sharing your banking data but sharing all your financial data, including mortgage, savings, and pension. We could even add other nonfinancial data, like your utility consumption or your Internet of Things data sources. Not just in the United States, but around the world, we will enable our merchants with tools that they need to create value for their consumers. We will create a better, financially inclusive ecosystem where everybody wins.”
