Columbia Business School - the Eugene Lang Entrepreneurship Center Contributor
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In part one of my two-part comparison between the American and British fintech ecosystems, I explored a growing trend of open banking and what it could mean for the modern consumer. Now that we understand the implications of open banking for companies, banks and individuals, what specific opportunities for disruption can be identified in these two fintech markets?
Unless you are a policy aficionado or obsessed with fintech (like me), you probably don’t care much about regulation. However, regulation is crucial for shaping what we can and can not build in fintech. Regulation is the cornerstone of fintech innovation, and seeing what policymakers have in mind for the future will be critical to understanding what the next wave of fintechs will look like.
In the U.S., there is a clear path towards not only open banking but more comprehensively open finance. Construction of this path began in July of 2021 with President Biden’s Executive Order on Promoting Competition in the American Economy, which focused on upholding antitrust laws, increasing competition and continuing to expand upon Dodd-Frank s1033. The CFPB, which exercises the bulk of ownership for consumer financial data, has taken several key steps required for a regulatory framework, including conducting an advanced notice of proposed rule-making. Next, the institution will be holding a SBREFA panel for small businesses to provide their input on the impact of these regulations.
Regulation is the cornerstone of fintech innovation, and seeing what policymakers have in mind for the future will be critical to understanding what the next wave of fintechs will look like.
John Pitts, policy savant and head of global policy for Plaid—one of the largest data aggregators in the US—believes that the CFPB will provide regulatory guidance in 2023 on the minimum data that must be shared by banks. With this, the CFPB will designate who is a financial institution, establish oversight of third-party aggregators and define the control of consumer data.
Unlike the United States, the next frontier in the UK and Europe is a move from open banking to open finance. There is nothing novel about the kind of data at the forefront of this overseas shift, which is supplied by mortgage providers, insurance companies and pension funds. The challenge lies in building the channels to facilitate these transactions, convincing consumers, regulators, governments, data providers and third-party providers to get on board, all while ensuring data security and bank compliance.
Now that we understand where the regulation is headed in both regions, let’s talk money and the investment opportunities that open banking brings.
Make it Rain in the US!
In the U.S., three investment opportunities exist in real-time payments, building and accessing credit, and digital identity.
When speaking with Nik Milanović, GP at The Fintech Fund and previously the Head of BD & Strategy at Google Pay, he provided a framework for the future of open banking in the U.S.:
“Open banking - and, importantly, the portability of user financial data - is an inevitability in the U.S. and ultimately means (1) more interoperability and (2) customer-permissioned open data access, both of which will facilitate innovation in the space and make banking better.”
How will each of these opportunities play out? Let’s dive in...
1) Real-Time Payments
Innovations and solutions in American payment systems generally result from skirting around the existing regulatory blocks. Recognizing this, there are massive opportunities in remittances, P2P payment and B2B payment spaces that have yet to be fully realized in the States.
The most common payment rails are ACH FedNow, card networks and same-day electronic funds transfer systems (Fedwire and CHIPS)—but they aren't cutting it anymore. They are expensive solutions with long waiting periods that are severely fragmented across the industry. Some companies, however, have come up with solutions. They include are Orum, a payments orchestration company that routes money on whatever rail is best for your business, and Affirm Debit+, which acts as a hybrid debit-credit card allowing customers to use the card for all of their purchases to pay in full or through monthly installments. Both of these represent strong opportunities for filling the gaps in American payment infrastructure.
“Open banking - and importantly, the portability of user financial data - is an inevitability in the US.Open banking in the US ultimately means (1) more interoperability and (2) customer-permissioned open data access, both of which will facilitate innovation in the space and make banking better.”
2) Building and Accessing Credit
FICO recently estimated that 53 million people in the U.S. don’t have enough data in their credit files to generate a credit score. This void has a massive impact on a person’s ability to rent an apartment, buy a house, and it can even hinder them from securing a job. There is a huge opportunity for a more inclusive credit system based on other data points.
Companies like Petal are exploring the usage of nontraditional data points like bank history to understand cash flow data. “Our success in expanding financial inclusion at Petal demonstrates that cash flow underwriting can bring the tens of millions of credit invisible or thin-file consumers into the financial system,” said Jason Gross, CEO of Petal and Prism Data. “The majority of Petal cardholders had either thin or no credit history when they were first approved, and more than 40% of our members have been previously denied credit by a major bank. Petal cardholders with no prior credit history have gone on to achieve an average credit score of 676 — a ‘prime’ score potentially qualifying them for auto loans, mortgages, and other financial opportunities previously out of their reach.”
The success of Petal and the predictive power of cash flow underwriting has expanded to Prism Data, an infrastructure solution that partners with loan providers like credit card issuers and auto lenders to integrate cash flow underwriting into their lending platform and increase access to credit.
3) Digital Identity Play
The current standard financial identity in the U.S. is federated, where third parties issue digital identity credentials using other companies to verify your identity. Think of using your email or Facebook login to identify yourself. Banks are operating as identity providers that authenticate and authorize the use of data.
On the government side, you are seeing a slow move toward implementing digital identity with Canada using Verified.Me and the US using ID.me. Two major issues that arise here are 1) privacy and security risks and 2) dependence on third-party companies to verify your data. Brian Costello, vice president at Yodlee, believes that the opportunity lies in a self-sovereign identity (SSI) where a person owns their data, controls the data being shared and eliminates third parties in the process.
We are witnessing a shift towards SSI as residents in Arizona and Georgia become the first in the U.S. to store their driver’s license on their phones with a state agency on the front end and Apple’s Wallet app as the authorized agent on the back end.
Brian Costello, Vice President at Yodlee, believes that the opportunity lies in a self-sovereign identity (SSI) where a person owns their data, controls the data being shared, and eliminates third parties in the process.
Banks and data aggregators want to get in front of the identity play. Plaid’s acquisition of Cognito, which provides ID verification and compliance solutions, is seen as a strategic move to get ahead of future open banking regulatory changes and market demands. Companies like Portabl are solving this issue by creating a universal digital identity that gives consumers control of who has access and what data they share with a vertical focus on financial institutions.
When I spoke with the founder of Portabl, Nate Soffio, he shared that, “The future of financial identity and… the future of fairer financial access hinge on the ability for people to be their own data controllers or custodians. For this to succeed, it means we need to transform the processes by which we "prove" and "re-prove" ourselves to financial apps and services we use while ensuring the data is interoperable and privacy-preserving.”
He went on to add, “Private sector innovation may be where we get the breakthrough, but it will fall on policymakers and public resources to facilitate broad-based adoption and change. We are optimistic that the advances in open banking regulations and technical standards will provide the backdrop that millions want and need.”
Let the Pounds Rain on the UK!
Across the pond, three bets I see for investment are digital transformation for banks, personal finance and wellness, and unlocking variable recurring payments.
1) Digital Transformation for Banks
As PSD2 is being widely implemented and CMA9 falls in line, digital transformation for banks becomes a massive opportunity to compete with fintechs.
Since 2018, Barclays has been one of the banks in Europe and the UK leaning into the changes and prioritizing digital transformation. It has paid off as the institution is seen as a leader in the fintech community. They have built RISE, a platform that connects fintech founders and corporate clients, supported Rainmaking, an initiative targeted at global fintech founders and invested in the Female Innovators Lab that funds women founders in the fintech space.
Instead of pushing away from the regulatory and market changes, Barclay has leaned in, and it has become a central part of the fintech ecosystem as a result.
As PSD2 is being widely implemented and CMA9 falls in line, digital transformation for banks becomes a massive opportunity to compete with fintechs.
2) Personal Finance and Wellness
As an avid consumer of fintech trends, I was surprised to learn that there were opportunities for personal finance and wellness in the UK—this is one of the most thoroughly explored corners of fintech in the U.S. When I asked why this hasn't happened yet, the answer was simple: Sure, we have lots of transparency in the UK, but what do you do after you have the nice graphs that reinforce that you’re broke? You need action.
Marie Walker, cofounder of Open Future World, believes that, “Today's budgeting or personal financial management tool can evolve into something much more powerful that helps people with their financial wellness, day-to-day financial management, filing their taxes, saving for retirement.” The next step is providing a comprehensive picture of a consumer’s financial health and automating the action that follows.
One company already building in this space is CHIP, a savings and investment app that uses open banking to enable customers to take the action of depositing funds to investment funds. With CHIP, every time the payment is done, it's done on a card. The solution is expensive and users are required to authorize every transaction, but some are presenting solutions to those problems with VRPs.
3) Unlocking Variable Recurring Payments (VRPs)
Payments in the UK are more advanced and cheaper than in most places around the world. Currently, cards and BEKS are the rails where most of the payments and recurring transactions take place. They are cumbersome and lack features that users are looking for in digital payments. VRPs, which involve consumers authorizing banks and third parties to make automated transactions on their behalf, promise better checkout flow, decreased costs for bill payments, and stronger B2B payment solutions. In December 2021, NatWest became the first UK bank to conduct a live VRP transaction, and in the next six months major UK banks will be providing VRPs at scale. This is a huge opportunity because it streamlines the process to a single-click experience for trusted beneficiaries.
According to Michel Jenkins, who works in strategy at Fidel API and is Editor in Chief of This Week in Fintech UK & Europe, “This early testing of VRP is exciting, but it's just the tip of the iceberg as we start to see the massive implementation of VRP transactions. This changes the game for payments innovation you will see out of the UK ecosystem and enables additional use cases.”
This creates a faster, more secure, and in control experience for customers. For merchants, you will see real-time settlements and a decrease in cost, fraud, and customer churn. This will provide a way for banks to monetize open banking and create a mutually beneficial relationship with fintechs. This is payment enablement on steroids and it makes a future of control, consent and most importantly choice very viable.
“This early testing of VRP is exciting but it's just the tip of the iceberg as we start to see the massive implementation of VRP transaction. This changes the game for payments innovation you will see out of the UK ecosystem and enables additional use cases”.
Future of Open Banking
There is an undeniable need for an open banking regulatory framework that mandates data sharing between banks and fintechs. However, the real opportunity lies ahead in open finance providing a more holistic view of a consumer’s health by integrating banking, payments, mortgages, investments, pension funds and more.
To achieve this, banks need to be incentivized to increase access to third-party providers, data aggregators and fintechs, spurring innovation. Mandating data-sharing reciprocity between banks and fintechs can make this possible. Lastly, as we look to our future it is important to create an interoperable digital identity for consumers that we can use as we continue to move forward from open banking to open finance and eventually to open data.
Each of these progressions represents an enormous challenge for fintechs and banks alike. But we are already making progress toward an economy primarily operating on seamless, efficient open banking. Focusing on these emerging opportunities will propel us into the future of open banking and open finance.