Open banking is bringing both extensive promise and security concerns to community bankers as more customers desire the frictionless, near-instant service enabled by the technology.
Consultants say open banking is increasingly becoming table stakes for the industry, even as many bankers remain wary of the technology due to the lack of regulations governing fintechs.
Open banking enables banks and third-party service providers to share financial data through application programming interfaces (APIs), a set of established rules that allow different applications to communicate with one another. Banks have traditionally kept customer financial data in their own closed systems, but in open banking, customers can access and act on their banking data, such as forming a single view of their accounts and even making direct payments from those accounts.
Banks based in the Midwest are already using open banking technology to grow. One example is Spirit Lake, Iowa-based Bank Midwest, which launched digital bank OnePlace.bank in November to grow core deposits in its health care equipment financing business line. The $1.2 billion bank also sought to offer more deposit and Treasury services while growing its digital customer base around its existing base of 6,000 health care financing customers.
“We primarily offered loans and the premise was, could we offer other additional banking services that we do a good job with in our current market base,” noted Chief Information Operating Officer Bryan Wilken.
In 2022, Bank Midwest established a task force to finalize a pro forma and potential return on investment. The group included the current business line leader; Wilken; its chief information officer; leaders of retail banking and marketing, and the CFO. The task force met on a monthly basis leading up to its successful presentation before the board of directors. The idea for the digital bank also received broad customer support in surveys.
Wilken said their pitch before the board was successful because it wasn’t solely based on pricing and included the pledge that the digital bank would ensure continued success with the bank’s current customer base while opening up potential growth opportunities.
Bank Midwest found vendors with previous success in helping other banks mitigate online account opening risks. Alloy offered its best practices to eliminate bad actors, while digital automation platform Newgen helped establish a digital loan operation platform and OAO processes. The bank also worked with core provider Finastra.
“I was always pushing our teams to say we need to act like a fintech and look at different ways to mitigate risk, and so we found some vendors early on that were doing some things differently than what a lot of banks traditionally do in opening up accounts online and validating customers,” Wilken noted.
As of mid-January, Bank Midwest had completed the initial scope of the project — utilizing open banking and open application programming interfaces — and was in the early stages of starting to cross-sell other products and services. The bank only recently started marketing OnePlace.bank and expects to have a better grasp on the program’s success later this year. As of mid-January, approximately 17 companies were utilizing open APIs through Bank Midwest.
“When you get into this space you are going to learn a lot, and by sitting on the sidelines and not participating it’s hard to actually understand what open banking and open APIs can actually do for a community bank,” Wilken added. “So this project has really given us some good experience, and now that we have it up and running, we are looking forward to enhancing it and growing it in 2024 and years to come.”
Wilken said community banks launching their own digital banks must understand the importance of change management. “You have to continue to tell the story to your teams about what we are trying to achieve and continue to take feedback from teams,” Wilken added. “… I think change management is a big part of digital transformation and some of these strategies that community banks are taking on.”
Beyond geography
Community banks’ use of open banking technology comes as the value of such transactions continues to grow. According to Statista, the value of open banking transactions reached $57 billion worldwide last year, and is projected to increase rapidly in the coming years. The number of API calls, which enable secure data sharing, is expected to reach 580 billion in 2027. According to Mastercard’s 2022 New Payments Index of more than 35,000 respondents in 40 countries, more people are using open banking than they realize. Only half reportedly know about open banking, but two-thirds are using it to do their banking, pay their bills and make “Buy Now, Pay Later” payments.
Another community bank utilizing open banking technology is St. Louis-based Midwest BankCentre, which launched digital Rising Bank as a subsidiary in early 2019 to keep pace with customer expectations and broaden its market beyond its traditional focus of St. Louis.
Initially launched to offer deposit products, Rising Bank quickly gained market share, securing $130 million in deposits in 2019 alone. CFO Marsha Benney attributed the pace of growth to the bank’s high-touch, customer-centric support team. “We’ve had continued outstanding growth with Rising Bank,” Benney noted. “It continues to be an important part of our growth strategy, and certainly gives us the ability to lean in outside of our St. Louis market.”
Rising Bank launched an SBA lending division in late 2021 and has since closed nearly $45 million in loans nationwide. It also offers mortgages to customers in 27 states.
The idea for Rising Bank was hatched in late 2017 with lofty integration goals. “We really launched this internal incubator with a diverse, cross-functional team,” Benney said. “We made sure that we had an executive sponsor in every project meeting, so it was really led top-down and bottom-up.”
Implementation — identifying vendors, negotiating contracts and finalizing plans — took up much of 2018. Midwest BankCentre selected software-as-a-service company MANTL for online account opening, which takes three to five minutes. The bank also held weekly project meetings with team members from each vendor. “We really wanted to have a frictionless, high-tech, high-touch customer service,” Benney said. “By partnering together with all of those players, we were able to accomplish that.”
Laying the groundwork
Open banking technology will be mandatory for financial institutions within five years, said Jeff Ostheimer, director of fintech advisory services at Memphis, Tenn.-based bank advisor Strategic Resource Management LLC.
Community bankers should consider joining open banking ecosystems which allow for onboarding, engagement and account servicing for both retail and business users. More digital banking providers are creating open API ecosystems with integrated fintech solutions which facilitate different levels of open banking. Once banks are onboarded to such an ecosystem, a much larger company can then vet the fintech partner on behalf of the bank.
Banks must have the infrastructure to vet fintechs similarly to other partners and ensure contracts allow for terminating existing partnerships if necessary. To Ostheimer, that option is currently lacking in banking. While there are thousands of fintechs in the United States, only 120 financial institutions have a program to vet potential fintech partners.
Cornerstone Advisors Senior Director Chris Miller said bankers must ensure that third-party vendors are held accountable for providing the best possible customer service. He suggested that banks ensure that service-level-agreements include terms such as having a pre-defined timeline in the event of a service outage.
Miller estimated that only 15-20 percent of banks are starting to enter full open banking — allowing customers to access data where and when they want it. Another 30 percent are starting to explore the possibility. Still, some bankers are wary of using open banking technology. Fewer than 30 percent are proactively adopting open banking as a chance to grab deposits from larger banks that don’t offer the same level of customer service, while 50 percent are only evaluating the possibility, noted Baker Tilly Partner Kevin Schalk. Of those not utilizing open banking technology, approximately two-thirds are strengthening security measures against cyberattacks and preparing asset-liability committees and capital plans for asset and liability changes.
Schalk said banks must evaluate their vendor management policies and undertake more rigorous due diligence to account for the increased risk of third-party cyberattacks and data breaches. Banks must also potentially adjust their policy limits for alternative financing such as brokered certificates of deposits or Federal Home Loan Bank borrowings to account for deposit gaps from any customer outflows.
“Directors need to consider whether the bank wants to hold additional capital to account for potential variability in balances,” he noted. “Does the strategy clearly outline the vision for how it will engage in open banking and what risks it is and isn’t willing to take with regard to product offerings, interest rate changes as a result of new and increased competition from other banks and fintechs competing for their customers?”
To protect against the risk from data breaches, Schalk said banks must update their information security programs and policies while promptly responding to cyber risks. “This includes not only controls within their own systems but within third-party technology service providers where most of the recent attacks have taken place,” he added.
To Schalk, some bankers are too focused on the perceived risk of other community bankers using open banking technology to take customers from each other. Instead, he said smaller banks should realize that they can use open banking technology to attract deposits from multinational banks.
Risk vs. reward
Though open banking technology will allow customers to find additional loan or deposit products without traditional bank boundaries, Schalk also expects it will raise the ante for banks with poor customer service, raising the risk of them losing customers to banks with more advanced technology and products. He said banks that do only the bare minimum in open banking will lose customers.
“The remaining community banks are resistant to change and likely will make minimal changes until they are forced to do so either by regulatory mandate or competition,” Schalk added. “There are also small community banks in rural areas of the Upper Midwest where I reside that still have no technology interface with customers, so those clearly will not apply.”
Many community banks understandably became hesitant about open technology following last spring’s bank failures and recent regulatory actions against early adopters, said John Mizzi, co-founder and CEO of New York City-based lending-as-a-service provider Vero Technologies.
“No, I don’t think there are enough banks taking advantage of open banking,” Mizzi noted. “With that being said, we also understand why they are not moving towards adopting open banking solutions faster.”
Regulatory attention to open banking has left banks with more guidance to manage programs, Mizzi said. He is aware of a handful of open banking solutions that don’t require customers to disclose personally identifiable information, which is especially important for budgeting tools that exist outside of a bank’s security walls.
Open banking solutions which operate on the fence between a bank and fintech must have a security compliance framework, Mizzi noted. Banks must have an IT security and compliance function to evaluate whether their vendors are undertaking sufficient due diligence around information security and are in compliance with how they manage that function.
“Banks now have more guidance in terms of what’s required to successfully manage these programs from a regulatory perspective, so I think there will be more clarity and confidence to implement programs now that examples have been made of those who, maybe, operated outside of bounds,” Mizzi added.
Mizzi’s positive view of the future of open banking technology is mirrored by a recent report from Juniper Research. According to the company, the value of global open banking payment transactions will surpass $330 billion by 2027, far higher than $57 billion last year. According to Juniper Research, consumer fears regarding the sharing of their data via open banking must be alleviated for open banking to achieve its true potential.
Mizzi expects innovation in open banking to explode over the next several years. “All we have to do is look over to Europe and how they use open banking applications as a benchmark,” he said. “Frankly, the United States’ banking environment is a few steps behind.”