A Strategy for Financial Data APIs in an Open Banking World
As the UK moves closer to its Open Banking Framework (OBF), many have criticized US banks for remaining protective of their customer’s financial data. US Banks’ resistance to a free flow of financial information has spawned a handful of API providers who use a mix of screen scraping and partnerships to create the backend that allow our favorite FinTech apps to operate. Given the innovation and debundling in this space, it seems inevitable that the access to and movement of financial information will become open and standardized in the US.
On the surface, an open banking framework in the US like the one proposed for the UK appears beneficial to today’s API providers. If such a framework was widely adopted, API providers would see overhead cost reductions and product improvement, as they would no longer need to support the multitude of proprietary banking system that exist today. Additionally, because US financial institutions would no longer need to support multiple APIs, an open framework would de-risk the possibility for API providers that their product does not become the industry standard. However, this de-risking is a double-edged sword and creates strategic problems for today’s providers.
Complete harmonization of non-standardized banking systems and formats dramatically lowers the barriers of entry for the financial data API space. Such an open system commoditizes access to financial data and devalues the existing services API providers offer. Providers face an interesting strategic challenge--how do they avoid commoditization while simultaneously pursuing their missions of making banking data open and ubiquitous?
In a commoditized world, API providers can not charge a premium to simply be an intermediary platform for connecting banking data to FinTech services--that will be free. These companies must productize the information they transport rather than productize the flow of information itself. But how can they do that without compromising privacy? API providers must build their own proprietary services based on aggregated banking data that respects the privacy of the individual. Some obvious and immediate use cases for this information are services like fraud prevention and credit risk analysis. For instance, individual banks can call an API for a credit risk assessment on a potential borrower that leverages the data and insights of all banks, not just their own. That's actually extremely valuable. Better yet for API providers, these services create data network effects that generate positive feedback loops.
When a FinTech company uses an API to connect to its users’ banking data, that API provider gains access to data from which it can build services. If valuable, those services attract new FinTech companies who in turn provide access to even more data, which enables even smarter services. It is not difficult to imagine an industry dominated by one or two major API providers who give away a majority of their services for free to capture the flow of information on which they build valued products. Vast amounts of data make these services so good, it becomes nearly impossible for a data-poor challenge to build a comparable product. Building defensibility this way is strategy implemented by many of today’s most successful internet companies (Amazon, Facebook, Google, etc).
As with any industry in a state of flux, there is the question of whether the innovators can get scale before the incumbents get innovation. The intense regulation of the financial services industry certainly tips the scale in favor of the incumbents, but which new company has the best chance to win what will quickly become a multibillion dollar industry? In my opinion, Plaid is a clear front runner. Not only does Plaid have the best API, it also has several data driven services built in. Plaid’s Info, Risk, and Income features do more than just connect data, they leverage it to create insights that benefit its API users. They add rich transaction details, flag fraud, and verify income instantaneously and cheaply. These service provide differentiated value above what will soon become a commoditized connection product. I do think it is a mistake for Plaid to charge for basic API usage, but when you look at the rest of the field, it’s hard to say any other firm is pointed in a better direction.