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There is a question mark over whether European open banking regulations really favour innovation, with the Asian approach potentially showing a better way forward. Analysis by Matilde Guilhon of ESCP Business School.

Matilde Guilhon photo

Open banking regulations were designed to promote innovation in banking services by opening the sector to new entrants and providing third parties with access to banks’ customer data and functionalities. However, the European banking sector is struggling in its transition toward open banking models. In Asia, where the open banking concept emerged later, the banking sector is nonetheless experiencing significant transformation thanks to greater intensity and a faster pace of innovation.

In Europe (including the UK and EU member states), it is mandatory for banks to open their data to third-party providers when customers elect it. In Asian countries such as Hong Kong, Singapore and Japan, regulators have adopted a liberal approach, leaving the field relatively free for open banking initiatives to connect different actors, such as financial institutions, big techs, developers, fintechs, and firms belonging to non-financial sectors.

Imposed innovation

The legislation-based model adopted by European countries corresponds to imposed innovation, where pressure from non-market stakeholders is high, while the economic incentives to implement the innovation are relatively low. In contrast, in countries where the liberal approach is dominant, as in Asia, the incentive to engage in open banking is associated with high expectations in terms of competitiveness and profitability.

Open banking regulations in Europe preceded innovation, leading to several challenges for existing actors. On the one hand, since they are ill-adapted to the reality of the market context, open banking regulations lack precision in addressing key issues such as legal liability in collaborative arrangements between banks and third parties. The European regulations apply across the region, failing to take national specificities sufficiently into account.

Although such regulations were designed to provide consistent standards at the European level, their lack of clarity, together with the varying characteristics of national banking systems, resulted in diverse methods of implementation and limited success. For instance, inadequate adaptation to national financial landscapes led France and Germany to delay implementation of the second EU Payment Services Directive (PSD2).

On the other hand, regulators aimed at boosting innovation and competition in the retail banking industry by putting pressure on dominant positions. In other words, the aim of the regulators was not to frame and set standards for an industry where incumbents compete with new entrants, but instead to explicitly encourage these new actors by promoting their innovative offers and setting them against traditional banking services. Regulators thus adopted a hard standpoint with regard to traditional banking. 

Together with technological innovations and the emergence of digital consumption, PSD2 contributed to the shift from a supplier-oriented retail banking system dominated by incumbent retail banks to a market-oriented banking sector, where incumbents’ positions are increasingly contested.

Threats to incumbents

There are four major limitations to the European open banking regulatory approach from an incumbent perspective.

First, the cumbersome and ambiguous guidelines provided by the European Commission and the UK Competition and Markets Authority explain the limited success of open banking regulations in Europe. Almost three years passed between the adoption of PSD2 and its implementation. Traditional banks spent a great deal of time deciphering the burdensome regulations and attempting to comply with them, rather than developing an appropriate innovation strategy.

Second, complying with regulations that precede innovation is difficult and costly, given the yoke of complex legacy IT systems in incumbent firms and the considerable time pressure imposed by European regulators. Historically, banks’ technological infrastructure was designed to operate in isolation. Opening up these siloed infrastructures as technology evolves forces incumbent banks to deconstruct systems that have been built up over decades.

Third, since European banks perceive novel entrants more as a threat than an opportunity, they cannot take full advantage of the open banking environment. Successful positioning could be achieved by integrating fintech-style options with banks’ existing products. Singaporean bank DBS has gone one step further by collaborating with Microsoft on a global hackathon, an initiative for developing next-generation fintech solutions based on the Microsoft Azure platform. The project provided a unique opportunity for talent and product development, and for collaboration between a bank and a big tech company.

Fourth, in addition to the open banking regulations, antitrust regulations are particularly stringent in Europe, discouraging initiatives like those taken by DBS, which has developed strong ties with dominant players in other activity sectors, such as electricity and mobility. Such collaboration in Europe could be difficult to achieve as banks must abide by antitrust regulations, restricting them from engaging in such co-operation.

Customer experience

There is no doubt that regulations can be a catalyst for open banking. However, market factors such as consumer habits, competition and technology are equally important drivers of innovation in the context of open banking. Where compulsory regulations apply, as in Europe, banks passively attempt to comply with imposed innovations without appropriating them or viewing them as an opportunity.

From the customer perspective, what is happening today in the European banking sector is dissatisfying as traditional banks are struggling to develop a customer-centric approach as enticing as that offered by big techs. Regulations that open up industries with higher consumer inertia to competition might inadvertently favour big techs, which are likely to make advancements while staying on the regulatory fringes.

Matilde Guilhon is a PhD candidate at ESCP Business School.

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