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Jacqueline Powell: Hello, and welcome to the Payments Podcast. I'm Jacqueline Powell, and today I'm hosting Marcus Hughes, Head of Strategic Business Development at Bottomline. Our topic for today is focused on how open banking is evolving into open finance, which in turn is forecast to expand into open data.
Now, this is part three of a three-part series. In the first episode, we chatted about the general adoption of open banking, account information services and payment initiation services via APIs, and we touched on the move from open banking to finance and open data.
In part two, we focused on how countries worldwide are approaching open banking and data sharing. In this final episode, we'll now look at the impact and benefits of open banking across businesses of different sizes. Welcome, Marcus, and good to have you with us again.
Marcus Hughes: Thanks for inviting me, Jacqui.
Jacqueline Powell: It has been a very interesting world tour of open banking and open finance. Taking it up a level on future strategy, over the last two years, much of the initial focus for open banking has been on the consumer customer segment, but here's a question, and probably one on the top of many people's minds, is do you think open banking for small and medium-sized businesses could be the next big thing?
Marcus Hughes: Yes, I certainly do, Jacqui, no doubt about it. Today, most open banking products are focused on account aggregation and on personal finance management, and easier and faster access to finance for consumers.
This is thanks to improved decision-making, using API-driven account data for credit providers, but there's a growing realisation that small and medium-sized businesses are a significant market opportunity for open banking and open finance. They offer great potential for a wide range of not only banking services, such as payments and finance, but also adjacent services, such as invoicing, cash-flow forecasting, credit management, expense management, tax return preparation, and even automated KYC and customer on-boarding.
So, the open banking market for SMBs is far less developed than consumer services at present, but competitors are beginning to bring their propositions to market. We are, therefore, seeing the emergence of small and medium business platforms which are underpinned by open banking technologies and which integrate a wide range of payment and related value-add products – all this in a single, easy-to-use platform and divided into micro-services.
The key benefit for small and medium businesses is that these platforms aim to give the small business owners more time to focus on their core business activities. Competition among solution providers is definitely going to be fierce, with contenders from all quarters: incumbent banks, challenger banks, as well as FinTech and Big Tech, of course.
The latter two categories are generally becoming regulated third-party providers under open banking rules, in order to access bank data more efficiently, but these new platforms are definitely not just for tech companies. They also offer banks themselves a unique and scalable solution, working with chosen FinTech partners against the competitive challenge of other hostile FinTechs.
In this territory, banks have several fundamental advantages, including large customer bases, rich data. Probably most important of all, banks are generally trusted by their customers. This means banks are really well placed to expand beyond their traditional role and into adjacent services.
Despite the huge scale of the small and medium-sized business market, this segment has historically been unattractive. That's because it has a low return on equity: only about 7% to 8% for traditional banks.
Serving small and medium-sized businesses is expensive for traditional banks, although it's worth noting that digital banks specialised in this sector enjoy a significantly lower cost to serve than those traditional banks. That's because incumbent banks have higher branch costs and operational costs.
Historically, credit profiles and the data for small and medium-sized businesses have been more difficult to assemble and assess. In any economic downturn, banks typically suffer substantial bad-debt loan losses in the small and medium-sized business sector. There has, therefore, been a strong tendency for small and medium-sized businesses to be underserved by banks, meaning that many small businesses struggle to access finance.
As regards payments, dedicated host-to-host connections and multi-bank SWIFT connectivity are only practical and affordable for larger corporates. As a result, small and medium businesses have historically had little option but to use internet banking platforms, which in some cases still require manual uploads and fragmented processes. But new technologies, especially APIs, are changing the situation and making small and medium-sized businesses an attractive sector, thanks to improve automation and easier access to data, and in real time.
This new opportunity to better serve small and medium businesses is opening up this market to a new wave of solution providers, with compelling customer-centric propositions. Of course, an important driver for this focus on small and medium businesses is that those business owners are becoming used to convenient and tailored services in their personal life. This in turn is shaping their expectations about how they want to interact with financial services in their business lives.
I think SaaS-based accounting platforms are one of the most compelling categories of new entrants in the provision of small and medium-sized businesses – of solutions for that sector – based on open banking techniques.
Extending their field of activity well beyond their core accounting functionality, they already span a wide range of services: for example, customer relationship management, tax return preparation and submission, e-invoicing, cash allocation and cash-flow forecasting. That’s as well as payroll, point-of-sale payments, multi-bank cash reporting, and debtor tracking.
I'm sure we're going to see a growing number of banks partnering with, or even acquiring, SaaS-based accounting platforms as a valuable, new service for their small and medium-sized customer base.
One of the greatest advantages of open banking for small and medium-sized businesses is likely to be easier access to finance. By linking financial information, such as invoicing, and bank account data, such as payments, including analysis of KPIs like days payable outstanding and days sales outstanding, a lender can build a much better picture of a business's financial health.
This will enable finance providers to make better-informed decisions and offers smart, personalised, and automated advice, at the same time as making it easier for businesses to access more credit and at attractive pricing.
So, we can see that automated, multi-bank data aggregation which provides full cash visibility is going to be extremely valuable. That's because many small and medium-sized businesses lack this information today, but I'd suggest that it will also become quite commoditised in a relatively short period of time.
It will, therefore, be necessary for successful solution providers to deliver value-added services, such as cash-flow forecasting and data analytics. This solves at least two of small and medium-sized businesses’ main worries. That's cash flow and liquidity management.
Multi-bank payment initiation via a single interface should also prove relatively useful to small and medium-sized businesses, although many microbusinesses are only likely to be single banks.
However, for me, many small and medium-sized businesses, whether multi-banks or not, will soon be looking for value-added services, such as sweeping and pooling, to avoid overdrafts and maximise their investment returns on surplus cash. In my opinion, this is actually far more useful for small businesses than multi-bank payment initiation, and it should have a wider target market.
Jacqueline Powell: Okay, so great opportunity for SMB market. Talking about the wider market that you refer to, what do you think about large corporates as a target market for open banking?
Marcus Hughes: That there are early signs that major transaction banks are developing new API-based solutions for large corporate customers. To date, a few of the global transaction banks have been pioneering APIs for corporates, and I think we're going to see more of these initiatives. This in turn is driving availability of APIs for corporates, which make it easier to manage multiple bank accounts.
Traditionally, this is a classic use case for large corporates to become a member of SWIFT and connect with multiple banks via the SWIFT network. This well-established model is typically too costly or too complex for small, or even mid-sized, corporates, but there's a growing trend for corporates to offer their services via API, in accordance with open banking principles.
In this way, banks are beginning to dissect and componentise their corporate applications, such as cash, liquidity management, foreign exchange, cash-flow forecasting, and payments. This enables direct access, via API connectors, to the bank's back-office treasury applications from a corporate ERP or treasury management system.
Through these new open banking, API-enabled channels, treasurers can access all of their bank accounts and manage their payments more efficiently. It’s worth noting that, in order to counteract this threat, SWIFT is also starting to provide APIs which enable corporates to make real-time calls on their banks and to obtain instant treasury updates on demand.
Jacqueline Powell: So, certainly sounds like a win for treasury teams in enterprise organisations, without doubt. Coming back to what's happening in the UK, what are the new developments to look out for in the UK’s version of open banking?
Marcus Hughes: As you'd expect, there are several exciting, new things happening in UK open banking. The Competition and Markets Authority recently announced that it is going to require the nine biggest UK banks – that's the CMA9 – to implement Variable Recurring Payments, using APIs. This will enable customers to sweep money between their own accounts.
The important VRP initiative injects another element of competition into the UK’s retail banking market. Furthermore, it does lay the foundation for a series of compelling use cases that will make cash management and subscription payments easier and more efficient.
Variable Recurring Payments will be an additional open banking API that banks are required to build. From July 2022, Variable Recurring Payments will provide a new way to collect payments of variable amounts from the same customer, on a recurring basis, without the need to gain a new permission for every payment.
This is an important change to the current open banking situation, where third-party providers can only initiate single immediate payments, and customers have to authenticate each payment separately.
With Variable Recurring Payments, the customer will be able to agree the payment parameters with their third-party provider and authenticate the payment mandate with their bank in advance. From then on, payments will be initiated without the customer having to take any action.
It's important to note that, even with this additional recurring capability, VRP does still fully respect the central ethos of open banking, which means the customer remains in control. The model, therefore, allows the customer, at any time, to ask a third-party provider to cancel the recurring payment mandate. As an additional control, the customer can also ask their bank to cancel the third-party provider’s access.
The first phase of Variable Recurring Payments to be imposed by the CMA is sweeping. That means the ability to transfer money between two accounts belonging to the same party – a business or a consumer. This new requirement will enable third-party providers to deliver recurring payments for customers of any of the nine biggest UK banks.
There are two compelling use cases for sweeping. First, personal finance apps and providers of high-yield savings accounts will be able to use Variable Recurring Payments to fund these accounts, by moving money from current accounts and low-yielding savings accounts. The movement of funds will be quicker and cheaper, and the customer will have more control.
Another key use case is smart overdrafts. An important component of the CMA’s open banking remedies addresses the pain point of high interest rates that consumers are charged on overdrafts. Smart overdrafts will allow customers to ask third-party providers to automatically cover their overdraft in one account, by transferring funds from another account which has a positive balance, such as a deposit account.
There's a great deal of potential that can be unlocked with just these two use cases. That’s why Variable Recurring Payments are expected to be hugely beneficial for non-CMA banks and FinTechs. This explains why the incumbent CMA9 have tried but failed to resist the implementation of Variable Recurring Payments.
The reason the big banks have resisted this move is because it's the top UK banks, the CMA9, which incur the costs of creating these new APIs. Yet they stand to lose significant credit balances from customers who decide to move funds to higher-yielding accounts or covering overdrafts.
Although the immediate requirements of Variable Recurring Payments only apply to sweeping, the work that the banks are having to do to build these new APIs will create an infrastructure that has even greater potential to be used for much more in due course.
If the banks choose to use this infrastructure to its full potential, there are a number of other use cases that go beyond sweeping from a customer's account A at one bank, to account B at another bank.
For example, the same VRP APIs could provide merchants with an important alternative to direct debits and on-file credit card payments. That's because Variable Recurring Payments offer consumers the same flexibility as these well-established payment instruments, but that's with lower fees, no chargebacks, and immediate settlement, as well as reduced risk of fraud and enhanced controls.
We could, therefore, potentially see Variable Recurring Payments used for several types of recurring payments and for variable amounts. That would include regular household bills, like utility bills, subscription payments for goods and services, card-on-file payments, such as apps for booking and paying for cab rides, and repeat invoices.
Recognising the benefits for consumers and businesses, including merchants, telcos and utility firms, it’s likely that the CMA will unlock this functionality at a future date. But setting aside the usual hype which generally accompanies new initiatives like open banking and blockchain, to be realistic, it's likely that some of the use cases I've just mentioned are going to have faced resistance, or even inertia, of one kind or another.
For example, large-scale users of direct debits, such as well-established telcos and utilities, may prefer to continue using direct debits. After all, this widely used collection instrument has proved highly reliable and robust for many years, even if it's slow and perhaps at times appears a little clumsy. So, the old saying, “If it ain't broke, don't fix it” may well prevail, I fear.
Jacqueline Powell: It's true. It really does sound like open banking offers endless potential, and certainly in time to come. Apart from Variable Recurring Payments, which you were talking about a moment ago, what other trends do you see emerging in the open banking and open finance space, Marcus?
Marcus Hughes: There are two related trends which are emerging, and very fast, I'd say, here in the UK and internationally. They're both new ways of delivering financial services, more than just payments. One is called ‘Banking as a Service’, and the other is ‘Platform as a Service’.
‘Banking as a Service’ is a business model whereby a bank uses APIs to distribute its core financial services, but through new channels. That means partners, many of which don't actually have a banking licence. These partners could be retailers wanting to offer financial services, such as credit facilities, to their large customer bases.
Banks with an efficient product manufacturing capability, strong operational processes and robust backend capabilities, are probably best suited to offering this ‘Banking as a Service’. These criteria would apply not only to API first-challenger banks but also to some of the large incumbent banks – with huge economies of scale, of course.
Another important aspect of this new business model is that banks are recognising that they no longer need to own the end customer or to control the user experience, which under this new model would be managed by the bank’s partner.
‘Platform as a Service’ is different. This is where a bank combines its traditional services with other new services from third-party providers. The bank then offers these new services through its own channels, to its own customer base.
Use cases include solutions like cloud-based accounting software for small businesses, or e-invoicing in order to support improved working capital along supply chains. Banks with a large customer base and a strong digital footprint, as well as new challenger banks that want to capture market share, are well suited to this business model.
In order to deliver these new open banking models, banks are having to consider their strategy. For example, they need to plan how they can arrange their businesses differently, build new capabilities, rethink their partnership models, re-evaluate their operating model, and invest in an enhanced technology architecture.
Very important indeed, banks’ technology stack must now include APIs and micro-services, as well as authentication enablers, developer portals, consent management, data ingestion, and data analytical tools. So much of this is entirely new for traditional banks, so in many cases they'd be well advised to seek help from their FinTech partners.
Jacqueline Powell: Thanks for that insight on things to look out for in the UK on open banking and open finance, Marcus. As we draw to the end of this podcast, do you have any concluding remarks that you'd like to share with us?
Marcus Hughes: There is a whole range of countries that we've not really had time to mention today, or in the previous podcasts on open banking. In these countries, they're all moving forward with open banking at a different speed, each one with slightly different characteristics. These are countries like Canada, Japan, Saudi Arabia, and Taiwan. They've all got their own flavours of open banking or open finance, and spanning a wide range of financial services and beyond, to eventually create an open data ecosystem.
So, I'd suggest that the term ‘open banking’ is becoming so widely used that we should, perhaps, give some serious thought to dropping the term, since what we are developing is actually a new way of delivering financial services. This is achieved by accessing and manipulating data in a real-time and secure manner.
What all these initiatives have in common is a recognition that personal data belongs to the customer and should be readily transferable to other parties that are selected by that customer in order to access innovative, new services, whether they be financial or otherwise, which can solve customer pain points more easily and more efficiently.
Finally, looking ahead, we can certainly expect to see an increased use of APIs, as well as ‘Banking as a Service’ and as well as more partnerships between banks and FinTechs. All of these are aimed at driving improved customer experiences while making our lives easier and more comfortable.
Jacqueline Powell: Thank you so much, Marcus. All the information that you shared with us over the last three episodes has been hugely insightful, so thank you.
Marcus Hughes: My pleasure. Thanks for inviting me.
Jacqueline Powell: Today, this chat concludes the third episode of a three-part series on open banking. The other two episodes are available on our channel in case you missed them. For now, that's all we have time for today. We’ll be back soon, with more insights on the changing payments landscape. Thank you and goodbye.
In the 1/3 episodes, Marcus Hughes, Head of Strategic Business Development at Bottomline, shares his insights on the current adoption the evolution of Open Banking to Open Finance and the process behind the information sharing and payment initiation services.
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