From compliance to open banking to embedded finance – all thanks to APIs

Banking, insurance and finance have always been highly centralised in their hierarchy, business models and information systems. But in the digital age, these industries require modification and innovation.

With the explosion of digital channels and apps, modern generations no longer visit their local bank branch for their financial needs. They want to access banking services not where banks are, but where they are. It is up to the bank to adapt to modern, multi-channel customer journeys.

This new demand, combined with the emergence of innovative software technologies, is creating a fresh form of finance that is embedded through application programming interfaces (APIs)  that allow your bank services and your data to end up on third-party applications.

Banking leaders who don’t get the business potential created by APIs will miss the shift from traditional banking to modern and distributed banking, which represents a shift from $3.6tn to $7.2tn, according to Simon Torrance, finance adviser at the World Economic Forum. Will the next growth of banking be a growth of banks? Not so sure.

In 2010, UK and European policy-makers created regulations obliging banks to open data and services to third parties securely in order to foster innovation that would transform and create better financial products for consumers. This led to greater investments within the fintech ecosystem, as many entrepreneurs and investors grabbed the opportunity to revolutise banking with the support of the current incumbent infrastructure, which could finally be accessed and leveraged by startups.

This initiative, called open banking, was pushed out in the UK with Open Banking UK regulations and in continental Europe with Payment Service Directive 2 (PSD2). Some industry leaders understood the exciting business potential, but many chose to maintain the status quo by focusing on simply being compliant.

They couldn’t see that, while the competition now is about banking product vs product, it would soon be about platform vs platform and then ecosystem vs ecosystem. And how do you become a platform and an ecosystem? By being integrated and embedded in other people’s applications and customer experiences.

Many businesses are watching the wave of the API-driven economy coming, but if they are not prepared to surf – it will ultimately drown them.

Software is eating the banking world

APIs enable applications to connect and exchange data in a programmable and automated way. For instance, if you want to connect multiple bank accounts into just one application, the application behind the scenes must connect to the different banks’ APIs to trigger and aggregate the data. We don’t see it as users, but actually applications that are connected to many APIs make things happen.

And these technical interfaces have huge business benefits. It means you can be embedded into third-party applications and conquer customer experiences that were previously out of reach.

Thanks to these interfaces, banks and insurers can export their services to other customer journeys and find themselves not only on their own mobile application, but in a trove of outside platforms. Applications for things like vehicle purchasing or real estate agencies that assist in making rental or purchase offers, e-commerce websites that allow consumers to pay on credit at the time of purchase and a multitude of other customer experiences exist outside of the banking world, yet benefit immensely from banking services.

Because of this, the economy of banking and embedded finance is estimated at nearly $7.2tn – more than twice the current banking market. This has created a monumental opportunity for both traditional players and fintechs.

The banking API apocalypse 

In a business context, APIs are not technical interfaces, they are digital products ready to be embedded to deliver and export capabilities enabling new banking customer experiences.

According to the report Quarterly banking API state of the market 2020, we have more than 200 banks with an open API platform, representing more than 1,400 available API products, integratable and embeddable into other applications from accredited companies. Mainly pushed by regulations, the repartition of API products is mainly account information (31%), followed by payments (25%), as these two types of API products are the ones required by both Open Banking UK and PSD2 regulations.

Mark Boyd, author of the report, says: “Banks in Europe are moving past regulatory requirements and are creating ‘confirmation of funds’ APIs in addition to their PSD2 payments initiation requirements. This helps banks offer a complete payments processing suite of APIs to fintech.

“Interestingly, following a trend started by Capital One in the US from the early days of exposing open APIs for new business use cases, banks are opening know your customer (KYC)/identity APIs. Credit scoring and loan pre-approval APIs are also increasing in frequency. Banks often open ATM locations and banking products APIs first, as these are low risk. In areas like Australia and the UK, they are also mandatory as part of regulations.

“As APIs begin to get consumed by fintech in budgeting and savings apps, these product APIs could be helpful in creating features like product switching and identifying better wealth creation bank products to consumers.”

In Europe,  the number of accredited companies that are allowed to build embedded banking applications has increased by 7.5% from the first quarter to the second quarter to reach over 2,500. The UK leads the movement with 189 accredited providers – over 40% more than the second country on the list, Germany, with only 115 accredited providers.

It is interesting to note that this does not relate to the size of the country, but mainly focuses on the part of GDP brought by finance in the economy, for example Luxembourg 16th with 77, or the digitisation of society with Estonia (18th) with 72.

Banks were not prepared

For years, policy-makers have worked on building regulations to open banks to create innovation in the industry for all users. Banks were not prepared, because their business model was based on customers held captive by their monopoly. Now they are obliged to open APIs, and this has levelled the playing field. As a result, startups are able to attract new users, thanks to more agile methods and more feedback loops that allow them to deliver a better user experience.

Today we have a much healthier level of competition between incumbents and new players, even if startups are authorised to use the infrastructure of the established ones.

In 1994, Bill Gates said: “We need banking, we don’t need banks.” Twenty-six years later, banks are still here and stronger than ever, but banking is moving beyond their corporate walls, into a plethora of new channels and end-user experiences. Banking is winning widely and strongly, but not necessarily as a result of the traditional financial institutions.

Banks that only stay open to follow “open banking” regulations will lose out to all the companies that will come to consume their APIs and compete with them. To react, survive and continue to grow, banks, insurance and traditional finance companies need to adopt the API mindset and aim to be embedded in all the potential applications and customer experiences that need banking, to continue to reach new customers on their own terms.

Banks will not be able to attract all users on their digital channels – the only way to reach them is to be embedded in other people’s applications. 

The need for financial services will never go away. In fact, we need more banking than ever before. What has changed is that we need more banking embedded in our lives to give us what we want, when and where we need it, and to do this, more banking needs more APIs.

This is the future of banking. Ignoring embedded finance is not an option.

Mehdi Medjaoui is a software entrepreneur and author who co-founded identity API platform OAuth.io. He is also the founder of APIdays conferences and invited professor in main EU MBA and EMBAs (HEC, EMLyon). APIdays London will take place virtually on 27-28 October and will explore how APIs enable incumbents to capitalise on embedded finance.

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