The hype, the panic, the uncertainty – we all remember the coverage from September 2007 as hundreds of customers ran and queued to remove their savings from branches of Northern Rock all over the UK.
At that time, savers’ deposits were protected up to a maximum of £31,700 by the Financial Services Compensation Scheme (FSCS). Claims took up to three months to process and many consumers were not willing to take the chance, hence the first run on a bank in more than a century took place.
Almost 12 years on, the digital environment in which banks operate has changed significantly. The use of digital solutions for banking is booming and the FSCS now protects savings up to £85,000.
Would this higher level of protection prevent a run on a bank today? It’s unlikely; when customers’ these days perceive that their savings may be in jeopardy, they are likely to take preventative action and vote with their feet – or with their fingers on a keypad!
Today, competition and innovation is widespread and this is where open banking comes in.
Open banking ensures that the UK’s nine biggest banks release data in a secure form, so that it can be shared between trusted third parties, and there is a legislative framework to ensure this happens.
It is delivered by the Open Banking Implementation Entity and is underpinned by two important pieces of legislation – PSD2, the second Payment Services Directive, implemented by the Payment Services Regulations 2017, and the Competition and Markets Authority’s Retail Banking Market Investigation Order.
An influx of fintech firms has benefited from this regulatory change. For example, money-manager apps provided by regulated third-party providers (TPPs) allow customers to have an overview of all of their accounts across multiple banks in one place.
At the touch of a button, customers can analyse their finances and at the touch of another they can switch their balances.
Not only this, but some TPPs’ functionality includes making banking or provider – such as a utility firm – recommendations based on spending, balances and budgeting. Studies have shown this is particularly popular with the under 40s.
Providing easier solutions for switching accounts is not new. In 2013, the current account switching service was launched but, despite its mission to “foster a simple and stress free way to get the best from my financial providers…”, it has only delivered five million switches to date.
It is hoped that the innovations brought about by open banking will see a marked improvement in the rate of consumers switching current accounts.
Unlike insurance products – where customers receive an annual reminder of their deal – there are no incentives or even reminders for consumers to switch banks.
Switching is perceived to be burdensome, however, if an app sends you a reminder or recommendation and completes the transfer for you – even automatically – that hurdle is removed.
If open banking is as successful as hoped, the speed and simplicity of the transfer of balances is a real threat for many financial institutions. Aside from the potential data issues, some big banks’ liquidity models are based on the presumption of a steady flow of balances and the Prudential Regulation Authority (PRA), the successor to the Financial Services Authority, is aware of the threat posed by open banking.
In fact, in the independent review of the prudential supervision of The Co-operative Bank published last month, it was recommended that the Bank of England and the PRA actively consider how open banking may affect the PRA’s resolution tools used when banks are in distress.
The risk that comes with a bank run also applies to TPPs. This eventuality could include reputational risk and complex legal situations for breach of the Payment Services Regulations.
You can just imagine the backlash if a TPP were to recommend that a customer switch provider to get a better deal, only for the proposed bank to then fail or not execute a transfer on time.
Aside from any legal fallout – compensation, complaints, regulatory intervention, sanctions and censure – how would the TPP bounce back from such a blow to its credibility?
The innovation race in relation to open banking is exciting – if you’re entering that race, make sure you don’t trip up.
Caroline Stevenson is Legal Director at transatlantic law firm Womble Bond Dickinson