Open banking: A door to innovation and growth

Banks are unusual businesses. They hold a lot of sensitive financial information about clients that they do not sell on. Firms such as big retailers, on the other hand, which collect a lot of customer data through schemes like loyalty cards, routinely market the data. It’s very valuable. Banks, though, keep customer data strictly private – between the customer and their bank – or at least they did until now.

What is open banking?

Now regulators around the world, including those in the Middle East and Africa (MENA) region are accelerating the introduction of so-called ‘open banking’. Open banking requires banks to set up application programming interfaces (APIs) that allow customers to share their personal account data with third-party service providers if they choose to do so. As things stand, banks are not remunerated for setting up and running the APIs, though so-called premium APIs may be introduced over time.

The idea behind open banking is that third-party financial firms – both banks and fintechs – will be able to mine the shared data to offer customers cheap, personalised and innovative services. Examples include account-to-account payments that have no need for card intermediaries.

Regulators expect open banking to lead, over time, to a new ecosystem of exciting and cost-effective financial products – especially when open banking is extended to include data from other financial services firms, such as insurers, in so-called ‘open finance’.

Not all open banking regulations in the MENA region are at the same stage. Qatar, for example, plans to implement its open banking framework by 2026 while the local pioneer, Bahrain, launched its open banking regulations in October 2020 and is already moving toward open finance.

Bahrain is also a leader in building a fintech ecosystem. It has set up a digital sandbox – a ‘safe space’ – in which providers can try out new ideas to ensure that they’re both good for consumers and compliant with regulations before they go live. Saudi Arabia is another frontrunner with the Open Banking Lab, which is part of the Financial Sector Development Program (FSDP) under Saudi Vision 2030.

A boost to banks

At first glance, allowing third-party service providers to enter the retail financial services market looks potentially damaging for banks – especially banks in regional areas with limited corporate business. And if it’s not good for banks, could open banking be a threat to growth and financial stability? After all, it is banks that carry out maturity transformation – the essential service that turns short-term deposits into long-term investments.

But the contradiction is only apparent. The aim of the regulators is to have open banking increase the overall economic pie, which would clearly benefit banks. And banks won’t just be giving other firms access to data – they will also get access to data they would otherwise not have had, which they can use to improve their own performance.

For example, banks could use data from other financial firms to improve credit risk assessments – both for lending to consumers and to SMEs.

Financial education and inclusion

There is a further important strand to open banking that should help regional financial institutions: financial education. Open banking is, fundamentally, about breaking up data silos to let innovation blossom. Innovators can use the data to develop new services and new approaches to finance that enhance the essential services that only banks provide.

Indeed, the Saudi Central Bank says that the “most prominent” objective of open banking is “educating individuals and inspiring them to develop their knowledge and skills in the fintech field”.

Those new services will also be available to everyone – including those SMEs and consumers who may not currently feel that they need, or can afford, banking services. Again, that has the potential to boost regional banks.

There are several reasons why open banking is a game-changer for banks as well as fintechs. First, digital channels are cheaper for banks to support than physical branches. Second, a bigger range of fintech apps can help banks offer new services that support the financially excluded, such as educational and budgeting apps.

Third, once people become part of the formal financial system, they can start to save, and to borrow from banks to invest, in a way that creates a positive economic cycle.

And there is plenty of inclusion work for banks to do. For example, the MENA region overall has a relatively high proportion of unbanked adults – just shy of 50 per cent, according to the World Bank. There is also a relatively low use of digital payments at around 40 per cent. Clearly, those statistics vary greatly from country to country.

The UAE Banks Federation, for example, recently announced that it has seen a doubling in the use of digital channels. The essential point, though, is that open banking – and innovative fintech – can help banks support and include everyone.

Innovation underway

Regulators in the region have already given the green light to new fintechs that promise to expand the formal financial system and increase financial capability. One example is Tamam, a Shariah-compliant digital microfinance firm in Saudi Arabia, which is a subsidiary of the telecom company Zain, and which came out of the central bank’s regulatory sandbox.

Another is Hakbah, a Saudi-based fintech savings club – which has just raised its first round of institutional capital – and aims to digitise the rotating savings and credit association market in Saudi Arabia and in the wider region. Hakbah, too, is a sandbox alumnus.

As consumers and SMEs see the benefits of such apps, the amount of financial data available online will only grow – further boosting the benefits of open banking. Yes, regional banks will be sharing data that, previously, only they could use. But open banking can increase financial inclusion, financial knowledge and financial innovation – all of which will mean more demand for bank services – and increased economic growth.