Open Finance and the Primacy of Trust
Open Finance and the Primacy of Trust
The road towrds the forthcoming financial revolution won't be paved with data, but with trust.
The promise of open finance - built upon innovations in technology, the regulatory environment, and business models - is changing the way we think about payments, investments, and lending. Yet often missing in the rush to transform finance from a critical process to a product in its own right is the need to sufficiently provision sources of consumer trust.
When retail and service organizations evaluate the business case for open finance in light of their digital strategies, they are missing a critical point: data will never be worth more than the confidence their stakeholders have in their data practices. We focus on three points: trust has always been at the epicenter of banking and finance; the advent of open finance underlines how important fostering trust is today; and trust by design isn't a question of adding value but of designing the foundations of successful practices.
Trust is the Foundation of Finance
The foundations of banking and finance have historically been set around value, credentials, and trust. Value can be defined as the economic, and utilitarian benefits a customer receives in exchange for the price it pays. Credentials involve the recognized qualifications, competencies, and authority of a financial intermediary to act on behalf of its various stakeholders.Trust is the belief and expectation that a specific outcome will occur: it's the glue that holds a consumer's mental model together, permitting markets and economies to function. Without a consensus over operational definitions of value, credentials, and trust, neither finance nor banking would be possible.
Consumer trust in banking and finance has declined considerably over the years for a variety of reasons. As banking and finance have become both increasingly global and dematerialized, the nature of consumer trust has changed considerably. Vanessa Hall pointed out several years ago that "blind trust" based on faith in organizational leadership and products was a thing of the past. Absolute trust had been replaced by "situational trust", where consumers gave credence to the experts because of their focused insight and experience. In today's information economy, where consumers are confronted with a multiplicity of data sources and versions of the truth, situational trust has in turn given way to "referred trust" based on the perception of shared beliefs.
The digital evolution of business and operating models is a second source of consumer concerns that have led to consumer ambivalence if not mistrust. In practice, the digital economy thrives largely on an asymmetry of information in which suppliers of products and services possess greater knowledge of the working of the economy than consumers. Business models based on "People are the product" philosophies are increasingly contested by those who resent being profiled and productized. Data hoarding practices based on "Big is better" are proving as pointless as they are potentially dangerous. Finally, the zero-sum experiences in which an organization's perceived need for data outweighs any concern for individual privacy have justifiably drawn public scorn.
Finally, the recent evolution of financial practices have fueled an endemic lack of trust in banking and financial institutions. Though consumer trust has dropped steadily in all sectors over the last three decades, the financial sector is declining faster than almost all others according to recent survey data from Pew, Edelman, and Harris. Among the potential causes of consumer mistrust is included the perception that banks serve as instruments of manipulation and spurious self-enrichment by privileged elites. Highly publicized examples of financial misconduct, from money laundering to toxic financial derivatives, paint the picture that "modern" finance doesn't play by the rules. Last, but not least, the relatively poor current performance of traditional saving and investment instruments reinforces a widespread belief that the banks can no longer be trusted to build consumer savings.
Open Banking and Embedded Finance
Open Banking is a blue sky vision that promotes the consumer's financial well-being through the provision of financial products and services.
Open Banking regroups technology-driven solutions that employ application programming interfaces (APIs) to share financial data not only between a bank and its customers but between any number of third-party providers (TPPs), retailers, and financial institutions. The vision relies upon public legislation like PSD and PSD2 which "supports innovation and competition in retail payments and enhances the security of payment transactions and the protection of consumer data". Much like traditional financial services, the success of open banking depends upon fostering trust between financial institutions, technology providers, and consumers.
Open Banking is regulated and licensed by public authorities like the UK's Financial Conduct Authority which ensures that all firms offering account or payment initiation services are fully accountable. These accredited data recipients need to comply with a number of privacy and security obligations as either data recipients or data holders. Their data architectures must manage the complexities of consent involving multiple authorised parties: including authorisation, authentication, expiry, and account withdrawal. Finally, their applications need to cater to their customers' requirements for managing their data requests and usage.
If Open Banking's technical specifications present a challenge to both traditional banks and Fintechs, convincing consumers to trust these applications represents another. Simon and Kucher Partners' recent study concluded that "an overwhelming majority or 75 percent of bank customers said they are unlikely or very unlikely to allow their banks to share their account information, transaction history, funds overview and other data with third parties." An ING European survey revealed that only 30% of retail banking customers were comfortable with their bank accounts being shared with third-party providers , even if they had explicitly given them permission to do so. If consumer trust in banking and financial institutions is at all times low, their views of the future Techfins fares even worse: a 2017 study found that only three in ten consumers are willing to grant institutions such as Apple and Google access to their accounts for the purpose of integrating and consolidating their finances.
Consumer mistrust isn't just about data security and privacy, but about how the data is being used to shape their financial future. A first area of concern involves human agency, whether consumers are at liberty to take their own financial decisions or whether machine algorithms dictate their choices. A second concern is over the "objectivity" of automated decision-making, for implicit bias may distort financial data, algorithms, and business logic. Another area of concern if over accountability, to what extent the different actors in the financial process will be held accountable for the decisions they take using the data. Finally, consumers can have misgivings over who should define and evaluate "financial well-being", especially in times of economic crisis. In sum, trust is neither a technological nor legal issue - it is a social and moral perception that either encourages or undermines consumer confidence in consumption and investment.
Smart Contracts, Oracles, and the Future of Finance
No matter which road open finance takes over the next few years, its future will certainly integrate the use of Smart Contracts. A smart contract is a digital code or script that automatically monitors, executes and enforces a stipulated agreement. It is "smart" in that the conditions of investment, payment, or loan can be verified and executed using a distribution ledger (blockchain) on the Internet that automatically executes the terms of exchange. When applied to Open Banking, this translates into the digital management of relationships and obligations of all parties involved using code as the law, the process, and the mechanism of enforcement. The clear upside of smart contracts for both financial organizations is a measurable reduction in operating costs.
The advantages for the consumer are multifold. Smart contracts reduce the costs of payment, formalize the contractual obligations, and verify performance. If implemented correctly, smart contracts provide better transaction security than that obtained by traditional bank and financial processes, thereby reducing coordination costs of auditing and enforcing multi-party agreements. Smart contracts also provide more transparent and accountable solutions for addressing the challenges of the principal-agent dilemma in which banks and financial institutions are tempted to promote their own interests over those of their customers.
As important as smart contracts will be in the future of finance, consumer trust once again constitutes a precondition to profitability. The perception of the integrity and the security of smart contracts will be critical to the widespread adoption within the industry. On one level there is a need to secure the oracles by taking the necessary steps to ensure that the data from off-chain sources can be trusted. On a second level, there is a need to develop trusted coding and formal verification with respect to behavioral specifications. Finally, there is a need to breed confidence in automating open banking procedures and dispute settlement: on-chain and off-chain mechanisms that can resolve complaints or unforeseen situations arising over the life of the financial instruments. The interaction of open-banking technologies, smart contracts and the Internet of Things will pave the way for completely new financial products, services, and asset classes in the very near future.
Banking and retail organizations will choose between becoming core players in developing these new products internally, or to partner with the Fintechs or the Techfins to code the future of open finance. This horizon of possibilities extends far beyond organizations monetizing customer contact points to ecosystems creating mediums of exchange, fiscal, and monetary policies. Trust will condition the use of micropayments today and of tokenisation tomorrow as stores of value - reducing the transactional costs associated with financial products. Trust will condition the future ecosystem's fiscal policies as defined in the protocols in play that regulate the transaction fees. Finally, trust will legitimize the role of organizations and ecosystems to shape monetary policy in defining the proof-of-work that regulates how financial products are produced and distributed.
Trust by Design
Trust isn't an attribute of the quantity of how much data you hold as much as a result of consumer perceptions of how that data is being used.
Open finance will revolutionize how organizations and consumers think about investments, payment, and lending. Innovations in technology, the regulatory environment, and business models will help transform finance from a critical process to a product in its own right. Concerns over consumer trust extend far beyond data privacy or the security of financial transactions. Financial data hosts and service providers will need to actively address the questions of human agency implicit bias, accountability, and financial well-being.
Trust by Design regroups a number of initiatives designed to build trusted relationships between your organization and your customers. A first step is offering the consumers more control over what happens to their data. A second step is putting the right data and algorithms at their disposal - the more informed consumers about how your products work, the better chances they have of understanding the value of what your organization brings to the table. A third step is helping them leverage open finance to address the challenges of financial well-being and the potential solutions at hand. Customer value isn't found either on the Web or on the Blockchain - but in providing products and ue cases that can improve their lifestyle
Our approach to Trust by Design is based on the Business Value Roadmap® that encourages the different stakeholders to explore the four processes their customers deploy to transform data into action: perception, prediction, evaluation, and insights. Within each scenario, visioning exercises are used to bring to light the role of data, algorithms, information governance, and innovation. These guided discussions address a number of questions: Which data items need to be captured, aggregated and shared? Which algorithms are best suited to address the challenge at hand? How do data-driven decisions reflect the organization's core values? How will open banking spur or hinder organizational innovation? The outcomes of the Roadmap allow the organization's stakeholders to clearly understand and monitor the importance of human agency, implicit bias, managerial accountability, and financial well-being in open finance.
I will be discussing and developing these propositions at City & Financial Global's Data and the Future of the Financial Services Summit on May 12th. Please don't hesitate to share your thoughts and suggestions leading up to this event. I look forward to seeing you there.
Dr. Lee SCHLENKER- lee@baieurope.com The Business Analytics Institute
