Fintech Open Banking

BankThink Open banking’s three biggest pitfalls (Jacob Kosoff, Aaron Bridgers, Henry Lee, American Banker)

Moving to an open banking system comes with both costs and benefits that each bank will need to weigh before diving in.

The benefits are clear: an ability to focus on core financial services, a better line of sight into the overall financial picture of a client, new revenue opportunities and better risk-based pricing. However, there are also costs: An open bank carries strategic, operational, model, conduct, financial crime and reputational risks.

These risks will be magnified due to the amount of change needed to open the bank’s processes to third-party partners. Yet, the strategic risk by doing nothing could prove to be the greatest risk as customer and strategic partner expectations continue to evolve in an increasingly connected world.

That being said, there are three main risks that banks will need to assess before opening their network.

The first is model risk. An open banking business model is heavily dependent on models in the form of decision engines and artificial intelligence. These models are fundamentally different than traditional models in that they perform calculations in real time, interact with streaming data, reside within a cloud environment, are accessed through external application programming interfaces (APIs) and are regularly used by outside parties.

Additionally, these models may be internally developed or externally developed. Model risk groups will need to ensure that bank partners use these models appropriately by closely monitoring performance and that external applications are implemented correctly.

This requires model risk groups to become more sophisticated, enhanced through technology and nimble to enable the bank’s open-banking strategy.

The second risk to be mindful of is strategic risk. The decision of whether or not to become an open bank has vast strategic implications. If a bank moves toward turning its products and services into a platform for third-party partners to develop on top of it, it’s critical to find the right partners and the right networks.

Banks will have to create a strategy for increasing both their development and their customer networks. The number of third parties that develop on top of bank APIs will impact the quantity and quality of innovations, which draws in customers.

Additionally, the number of bank customers will also impact the number of third-party developers that a bank attracts. In other words, banks need customers to attract developers; and developers to attract new customers.

This classic chicken-or-the-egg problem will necessitate plugging into existing ecosystems and networks, such as online merchant platforms to interest both customers and developers.

The first-mover banks will also have to balance bringing in new relationships through open banking and maintaining existing relationships that are built on the tenets of traditional banking. Conversely, banks that do not move toward open banking run the risk of becoming obsolete.

Third, all banks are managing the reputational risk posed by data breaches and similar negative news events related to strategic partners. However, open banks will have to mitigate and monitor additional dimensions of reputational risk.

Open banks will have to actively monitor online developer communities to ensure that their platform remains competitive. They will also need a continuous feedback loop with the development community to ensure that their platform provides the features needed by developers as well as a software development kit that keeps up with the evolution of technology.

A bank’s reputation with application development communities will impact the quantity and quality of partners. This reputation will also impact a bank’s ability to attract the internal talent needed to support the platform.

Open banking has significant benefits, but the transition will create new risks that could shock the culture and processes of an organization. Banks must strengthen their model risk infrastructure, decide strategically to be a first mover or not, and better monitor the developer community to manage these risks.

A little known secret in lending circles is that unlike in any other consumer loan category, nearly every single consumer mortgage loan requires a credit score that was built on data from prior to the turn of the century.

Banks must be thoughtful during this transition.

Editor’s note: This BankThink is the third in a four-part series on open banking, the potential risks and how to regulate it. The first examined the process to becoming an open bank and the second looked at common pitfalls with third-party vendors.

The opinions expressed in this article are those of the authors, intended for informational purposes only, and should not be attributed to Regions Financial Corporation or any of its subsidiaries or affiliates, including Regions Bank. Any representation to the contrary is expressly disclaimed.

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