Challenges in building public infrastructure with private sector incentives
Open banking ushers in the promise of a new banking age. Premised on the notion that customers have control over their data, open banking enables data sharing based on customer consent, and unlocks new use cases around a wider range of financial product and services ranging from savings, payments, lending, insurance.
Traditionally, banks are not that open. The banking relationship has been seen as a closed and confidential relationship between bank and customer. Banks are protective of their control over customer data as a way to maintain a competitive moat to their business.
What incentives do banks have to open up? It’s no surprise that open banking first took off in markets with mandatory regulatory regimes. Starting with the UK in 2017, and the European Union in 2018, regulations such as the PSD2 payments framework are key banking reforms towards establishing single European payments market and ensuring market competitiveness. Banks are mandated by regulators to share customer data and adopt open standards. However, not all markets follow a top-down approach to open banking regulations. As with most of the world, SE Asia does not have a mandatory open banking regime. Industry adoption of open banking in SE Asia is primarily driven by commercial drivers. Banks like DBS are embracing open banking innovations as a way to improve their value proposition to their customers.
As I explore the fintech space in SE Asia this summer, the question I have on the back of my mind is — how do you build a public infrastructure with private sector incentives?
Let’s start with why is open banking a public infrastructure. Open banking, like other forms of infrastructure (e.g. highways, bridges), is a public good with positive externalities but when left to market forces there tends to be an under-provision of the good.
Allow me to indulge in some game theory to illustrate the cooperation dynamics at play. If we think of the prisoner’s dilemma, or a public goods game — the dominant strategy is for players to behave non-cooperatively assuming narrow selfish preference. However, the socially optimum outcome would be for all players to cooperate instead.
- Banks would prefer to not to have data sharing of customer data to retain all benefits of data ownership to themselves (data sharing would be under-provided).
- Banks are afraid if they shared their data, and the other party chooses not too (the free rider), they would instead be taken advantage off, and lose their competitive edge.
- However, if all players in the ecosystem choose to share their data, everyone benefits from have access to a larger and richer dataset that can lead to new use cases and new market opportunities.
- This argument can extend to data sharing regimes, harmonization of technical API standards, interoperable solutions; these are just different sides to the same coordination coin.
For everybody to win — you need (1) mutual reciprocity aka open-ness (no free riders!), (2) commitment to common standards to facilitate coordination and cooperation.
However, here’s the reality. Incentives do not yet align! In real life, banks (in fact, not just banks but any player with a rich data ecosystem) tend to pursue bilateral partnerships and have a tendency to build closed walled garden ecosystems.
What then, should the role of institutions be? Institutions can help to change the payoff of players. These could include reciprocity in customer data sharing framework as advocated by the Institute of International Finance, or voluntary industry groups working towards harmonization of open banking standards like ASEAN Banker Association. There already are promising signs that regulators are on board. In the Philippines, the Bangko Sentral ng Pilipinas (BSP) recently approved new guidelines for the Open Finance Framework on June 10, 2021. The Open Finance Framework also contains provisions on registration/compliance requirements for third party service providers engaging in the AISP and PISP model, plus content on IT infrastructure standards, data security standards, consumer protection measures and other relevant matters
Institution, be it formal or informal, can go a long way to change the incentives of market participants to build open banking infrastructure in a way that is mutually beneficial for all.