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QUONA THOUGHTS

How APIs are transforming banking

By Sheena Jain

Open-Banking” and “API Banking” are two terms we’re hearing about across the globe. The potential to radically improve customer experiences, to tailor products with precise consumer insights, address new target segments and do away with time-consuming processes has caught the attention of banks, insurers, payment service providers, investment houses, and — of course, fintechs. Of late, Open Banking has become a catchall phrase: does it include a neobank? Is it banking as a service? Or a financial data aggregator? The common denominator is the existence of APIs, or “Application Programming Interfaces,” which are tools and protocols that that enable communication across disparate systems and platforms, and thus have opened the doors to customer data analytics.

Before diving in, let’s clarify what Open Banking really means. It initially surfaced in early 2018, when two milestone directives from the EU and the UK came into effect, forcing the big banks to securely release their customer data to third parties. This expedited the development of APIs and pushed legal but risky screen scraping out of favor. Technically speaking, third-party platforms now had open access to financial data using API pipes, which came at a lower cost, faster speed, and better security. With advances in technology innovation, companies started leveraging the APIs for functions beyond just data sharing, which led to a much broader set of outcomes under the “API Banking” umbrella.

In India, where I work, we’re observing similar developments, which hold great promise for the digital banking space in the next 2–3 years.

How did it begin in India?

Let’s start with the banks. Broadly speaking, they have 3 core exclusive functions:
a) Set up an account
b) Move money in and out of that account
c) Authenticate accounts/payment codes etc.

Several products — such as credit and debit — offered by banks today use a combination of these functions. Over the years banks have been able to capture enormous amounts of customer data– salary inflow, expenses, average account balances, fixed deposits, outstanding loans, repayment patterns, and so on. Legacy databases and lack of technologically advanced systems have hindered banks from analyzing this data. A few fintechs capitalized on this opportunity and started creating linkages with banks. But integrating directly with banks is fraught with challenges. Their tech stack is less agile, and it is a lengthy process once started.

In 2013, some banks including Yes Bank and RBL Bank were quick enough to launch their own set of APIs to help external platforms connect seamlessly and avoid playing around with the core bank operating system. The smarter platforms latched onto this and developed their APIs in the banks’ sandbox to build offerings on top of the regulated infrastructure. This commenced the formation of a broader suite of APIs including credit profiling of customers, loan disbursement, recurring payments, card issuance etc. Despite the convenience of APIs, each fintech must link with each bank independently and for each functionality–an uphill task achieved by many over the last 4–5 years. As this symbiosis grew exponentially over the years, it paved the way for (i) banks to extend their functions via tech platforms and for (ii) several tech startups to integrate financial services into their core offerings.

Companies like Razorpay have used APIs to link bank accounts and payment networks to simplify customer payments, vendor payments, automatic pay-outs, etc. Similarly, on the lending front, ZestMoney, a Quona portfolio company, has been able to disburse credit at check-out and collect equated monthly installments— generally known as “EMIs”—by integrating with 15+ lenders having their own set of myriad requirements. A complex network of in-house APIs has allowed the systems to talk to each other.

Today, almost every fintech company uses such a network to plug into the banking realm. Three specific business models have come to life only because of an API plumbing network.

1) Data Aggregators

As financial institutions opened up, fintechs started to yearn for a larger share of the pie that was customer data — the very foundation of Open Banking. They could fully leverage financial data to deliver truly personalized experiences at scale or reduce friction in the user journey. Be it for cash flow analysis, loan monitoring, budgeting, investment advisory. U.S. companies like Plaid and Finicity engage in exactly this — accessing customers’ bank accounts to provide refined data to other fintechs. Closer to home, this resembles Perfios.

This type of business model, christened as an Account Aggregator (“AA”) in India in 2016, works to provide data aggregation services based on customers’ explicit consent, given the strict data protection policies being implemented around the world. The underlying framework was put together by the Sahamati Foundation. Using AAs, financial services companies will reach out to customers to seek their consent before using their personal data to optimise their product offerings. Customers will be able to manage all their financial data using any AA app to give consent to each company individually. (No prizes for guessing that this will be riding on an API network!)

Companies that have received the AA license are currently working on APIs which will enable pulling of raw encrypted data from banks/GST Portal, etc. in real-time once consent is received. We can expect AAs to go live by the end of the year. We can see data fudiciaries/Financial Information Providers (“FIPs”) being common across all AAs, but the Financial Information Users (“FIUs”) they work with will depend on their sales strategy and efficiency. It will be a pure customer volume game.

2) Neobanks

Fintechs showcasing themselves as Neobanks use an underlying bank license and offer services that are built on top of traditional products, along with benefits such as fast account opening, customized reports, easy setup of payments, budgeting tools, etc. Since India’s regulations do not permit 100% digital banks, API banking is the only way to implement this. Neobanks can help sell current and savings accounts for banks, and for customers they provide a convenient and fully digital experience. An interesting point to note: very few Neobanks have been able to create a two-way flow of data, i.e., get read and write access to banks’ OS, the latter one being a difficult nut to crack. Often Neobanks just send back the service command for the banks to act upon, thus underscoring their dependence on incumbent banks.

Neobanks globally have been most successful in Europe, those in the U.S. have not been able to attract a sizeable customer base. Neon and Nubank in Brazil have seen phenomenal growth. In Asia, countries like Singapore and Hong Kong have rolled out their virtual banking licenses and the rest are soon to follow.

In India, a Neobank today is loosely defined given the lack of regulations. It mostly acts as a digital representative of a traditional bank and attracts customers through inaugural incentives which may not be sustainable or scalable. But yes, Neobanks are designed to facilitate faster growth on the back of API partnerships. Unfortunately, dependence on any one bank can be detrimental if that bank partner goes down. Moreover, each bank has limited transaction processing power. Hence the need to diversify and link with multiple banks, leading to new problems around reconciliation and standardized commercial agreements. Some of the other questions that continue to surface are: Who owns the customer relationship? How should the Neobank route new customer requests across multiple banks? What is the spread it can earn? Will it eventually become a commodity if the possibility of a digital banking license is ruled out in India? It’s still early in the game but what will be important is how Neobanks differentiate themselves. Since a few traditional banks like SBI and Kotak Bank have launched their own digital initiatives to target the same customer segment, the battle is getting tougher.

3) Banking as a Service

With APIs opening the door to so many use cases, it was a cue for API Stack players to enter, building a comprehensive set of APIs that can be used by multiple banks and fintechs establishing multiway partnerships. They operate more like a plug and play middleware, which can be used by a fintech company to connect with banks or other fintechs without the hassle of a one-to-one integration. Think of it as a marketplace of APIs facilitating “banking as a service” (BaaS) where integration with banks, card networks, and the corresponding regulatory compliance is handled by the BaaS company.

A productized approach to an API-based platform can empower third-party developers to implement any of the 3 core banking functions digitally with a faster time to market. Any fintech can connect with multiple lenders to initiate loan disbursement, or with several payment apps at once to facilitate loan collections. A Neobank can use a BaaS platform to plugin with third party lenders, insurers, payment providers etc. to provide an all-in-one solution to its customers. Given the uncertainty of a digital banking license, a Neobank can choose the BaaS formula to strengthen bank partnerships. Also, traditional banks can extend products offered by fintechs to their existing customers. It’s a win-win for all stakeholders. Use cases are exponential, though manifestation is yet to happen.

Interestingly, some of the Neobanks in India aim to launch their own BaaS marketplace a couple of years down the line, which is not surprising given that their API infrastructure should be in place by then. Through this, they can either offer their own product suite or partner with fintechs to offer shared products and services to new companies. Starling Bank in the UK is a good example. Such a model will come with its own challenges, but the possibilities are endless.

Some of the young BaaS players are in the process of obtaining an AA license while some have decided not to walk this path and instead use another AA’s APIs once publicly available. The former combination is a powerful one: a single API marketplace can help fintech companies access raw banking data, refine it, and perform banking functions without forcing the customer to leave the fintech’s platform.

Going forward, whether we see independent BaaS models or combinations of AA and BaaS, Neobank and BaaS, or maybe a 3-in-1 model, the need for a BaaS play is inevitable. Globally, companies like Cross River Bank and Galileo have tasted early success. As Gilles Gade, CEO of Cross River Bank said, “We are positioning ourselves as a new bank play, somewhere between what a bank should be and what fintech aspires to be.”

What lies ahead?

The Indian market is well poised for the growth of the BaaS model. The payments sector has already made significant headway with the UPI stack, a remarkable example of an API marketplace. We are seeing early innovation in vertical plays such as lending-as-a-service, card issuance and insurance-as-a-service.

What will be truly transformational is when any digital company will be able to offer financial products using just these modular API blocks. This will make it increasingly easier for any company to become a fintech, not that there is a dearth of them! Here is how can it look for a company like Swiggy:

Clearly, the onus lies on the BaaS middleware technology to seamlessly connect the relevant entities and maintain full compliance with the regulatory protocol, which is no easy feat. Building a modular tech architecture and the right institutional partnerships early on in the game will be key success enablers for BaaS to succeed, as APIs will have to commensurately scale up with newer use cases and products. It should be able to help absorb the complexity so that companies can focus on their core business and succeed at what they do best.

We at Quona are definitely excited about this space and see immense potential in all our focus markets. If you are a young start-up that’s part of this API revolution and you’d like to connect, please reach out!

Sheena Jain is a Senior Investment Associate for Quona Capital, focused on Asia investments. She works closely with Quona portfolio companies NeoGrowth and ZestMoney, among others.

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Quona Capital

Quona Capital

Quona Capital is a venture firm specializing in financial technology for inclusion in emerging markets. Learn more at quona.com.