The Promise and Perils of Open Finance

Joshua Macey is an Assistant Professor of Law at the University of Chicago Law School. Dan Awrey is a Professor of Law at Cornell Law School. This post is based on their recent paper, forthcoming in the Yale Journal on Regulation.

Open Finance seeks to harness the potential of new platform technology to enhance customer data access, sharing, portability, and interoperability—thereby leveling the informational playing field and fostering greater competition between incumbent financial institutions and a new breed of fintech disruptors. In the eyes of its proponents, this competition will yield a radical restructuring of the financial services industry: offering more and better choices for consumers looking to make fast payments, borrow money, invest their savings, manage household budgets, and compare financial products and services.

The promise of Open Finance is very real. Yet the shift toward Open Finance will force financial institutions and policymakers to confront a host of thorny technical challenges. Paramount amongst these challenges is ensuring that consumers give informed consent to the collection, transfer, and use of their personal information. Once this consent has been obtained, it is also imperative that consumers are adequately protected against the risk of data breaches, identity theft, and cyber-fraud. By the same token, for all the potential benefits of using new technology to promote greater competition, there exists the corresponding threat that expanding access to large volumes of potentially sensitive personal and transactional information will open the door to algorithmic discrimination and the exploitation of consumer behavioral biases. Without question, successfully addressing these—already well understood—challenges will be key to building trust in this new financial ecosystem.

Yet both proponents and critics of Open Finance have thus far ignored a far more fundamental peril rooted in the economics underpinning the development of this new financial market infrastructure. The United States is home to over 10,000 banks and other insured deposit-taking institutions. It is also home to thousands of brokerage firms, insurance companies, and other incumbent financial institutions, along with a large, diverse, and rapidly expanding ecosystem of fintech disruptors. This high level of industry fragmentation is the source of massive coordination problems that make it difficult for financial institutions to develop the standardized application programming interfaces (APIs) necessary to unleash the promise of Open Finance. In the absence of both a common industry standard or government intervention, responsibility for developing these APIs has instead fallen to a small cadre of technology firms known as data aggregators.

Data aggregators are the connective tissue of Open Finance—the technological pipes through which the vast majority of customer information flows. The success of Open Finance—at least in the United States—therefore depends on the economics of data aggregation. These economics are characterized by three mutually reinforcing dynamics. First, as producers of information goods, data aggregators benefit from pronounced economies of scale and scope in connection with the collection and analysis of customer information. Second, data aggregation is a platform business that connects incumbent financial institutions, fintech disruptors, and their customers. Like Amazon, Google, and Facebook, data aggregation thus bears the hallmarks of a “two-sided market” in which strong network effects on each side of the market serve to attract users on the other side. Lastly, the market for software developers exhibits similar network effects, with the most talented developers wanting to write to the APIs of the most successful data aggregators.

These dynamics yield a clear and troubling prediction. In theory, we should expect these economies of scale, scope, and network effects to erect significant barriers to entry, undercut competition, and propel the embryonic data aggregation market toward monopoly. And in practice, that is exactly what we observe in the marketplace. Today, a small handful of data aggregators serves the entire U.S. financial services industry. Moreover, one of these data aggregators—Plaid—has rapidly built a dominant market position: providing API connectivity to more than 9,000 banks and other deposit-taking institutions, and over 4,000 fintech disruptors, in the U.S. alone. This observation leads to a counterintuitive conclusion: while in the short term, the new age of Open Finance may very well promote greater competition, spur innovation, and enhance consumer choice, in the longer term, the economics of data aggregation are likely to yield a highly concentrated industry structure, with one or more data aggregators wielding enormous market power.

The challenge for policymakers becomes how to fulfill the promise of Open Finance while simultaneously minimizing the perils associated with market concentration, the abuse of monopoly power, and the creation of a new breed of too-big-to-fail institutions. Meeting this challenge demands that policymakers strike a delicate balance. On the one hand, policymakers should capitalize on any efficiency benefits available at the edge of today’s technological frontier. On the other hand, policymakers must ensure that the markets in which this technology finds its applications remain fundamentally contestable, so that the forces of competition continue to drive innovation and push the boundaries of this frontier tomorrow and beyond.

To meet this challenge, our paper lays out a blueprint for a new regulatory framework governing the data aggregation market. This blueprint is based on four pillars. The first pillar is a licensing regime for data aggregators that enables policymakers to collect information about this rapidly evolving market, ensure that licensed data aggregators obtain informed consent from customers, and protect customers against the risks of data breaches, identity theft, and cyber-fraud. The second pillar—building on Section 1033 of the Dodd-Frank Act—is a more active role for the federal government in promoting the development of standardized APIs and other infrastructure designed to support customer data access, sharing, portability, and interoperability. The third is the imposition of a universal access requirement designed to ensure that data aggregators cannot unreasonably deny incumbent financial institutions, fintech disruptors, or their customers access to their platforms. And lastly, this blueprint calls for the structural separation of data aggregation from finance: preventing data aggregators from directly or indirectly offering financial products and services.

In advancing this new regulatory framework, we acknowledge that the age of Open Finance is not one that will be universally welcomed. Some observers will view it as further accelerating the harvesting and commoditization of our personal information. Others will question whether it is really possible for consumers to give fully informed consent, or to protect them from the risks of data breaches, algorithmic discrimination, or exploitation. While this paper brackets these questions, we do not seek to minimize their importance. Instead, our message is aimed at those who see Open Finance as the key to promoting greater competition within the financial system. Our message is simple: be careful what you wish for. While Open Finance holds out significant promise, the economics of data aggregation, as highlighted by the concentrated structure of the data aggregation market, pose even more significant perils.

The complete paper is available for download here.

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