Canada’s Department of Finance released a consultation paper earlier in 2019 to examine the merits of introducing an open banking framework in Canada. An open banking framework would give Canadians more control over their financial data, enabling them to easily and securely share their data with third parties. The consultation paper is expected to be just the first step in a lengthy process. It does not propose a specific framework for consultation, and instead asks for stakeholder views on the benefits of open banking, how best to manage the associated risks, the appropriate scope, and what role the government should play.
Open banking may go a long way to promote competition in financial goods and services in the short-run, but it may not go far enough in the long-run. Should open banking come to Canada, the nature of competition in the financial sector could radically change.
Amidst the discussion of how big a boon open banking will be for fintechs, experts are urging banks to reinvent themselves to maintain their competitive edge. One suggestion has been to learn from the Amazons and Googles of the world, the dominant platforms in the digital economy, which could undermine the very objectives that open banking is trying to achieve:
- Intensifying competition at the margins could cause banks to eventually reinvent themselves as platforms (defined further down) in the digital economy, which would change the economics of the markets within which banks operate.
- Platform markets have significant returns to size, which could make banking — should banks adopt the platform-based business model — even more concentrated than it is today.
- The tools economists and regulators have at their disposal to deal with issues in the digital economy give us no easy answers. Authorities around the world are contemplating various forms of intervention, some very aggressive.
- Open banking is a start, but the government may be unintentionally giving the tech giants a leg up by not developing its policy approach in the broader context of data portability and the digital economy.
Competition in financial services
Canada’s banking sector is dominated by a handful of very large players. The share of bank assets held by the five largest banks has increased from 46.6% in 1996 to 83.4% in 2016 (down from a peak high of 95.7% in 2009 in the aftermath of the global financial crisis). In addition to the largest banks expanding across many product lines — deposits, mortgage lending, wealth management, securities dealing, auto loans — several mergers and acquisitions, as well as the post-crisis exit of a few foreign financial institutions, have contributed to this rise in concentration in Canada.
The Competition Bureau has also documented several barriers to entry that exist for new fintech companies in Canada. Various regulatory challenges exist, particularly for digital business models, and new products and services. Structural factors, such as economies of scale and scope, switching costs, and market maturity, also play a role. Economies of scope, for example, have allowed banks to respond to competitive threats in the past: when faced with new competition from mutual funds, banks responded by adding their own mutual fund business line. Product bundling can also make entry less attractive for new firms and complicate the process of switching banks for consumers.
Despite the importance of competition in the financial sector, many would argue it has long been neglected for other public policy objectives. During the financial crisis, for example, most regulators around the world emphasised financial stability and prudential regulation with little consideration for competition policy. But things are beginning to change, and Canadian policy-makers are taking note. The Department of Finance is undergoing a review of the federal financial sector regulatory and legislative framework, proposing several potential policy measures that support competition and innovation. One of them is open banking.
Intensifying competition at the margins could change everything
Unlike banks, many fintechs have chosen to focus on a particular product or service, rather than offer a full range of financial services and products. Taking a very narrow set of financial services and using technology to reduce costs or otherwise improve the end-user experience has proved a viable business model for many fintechs.
These competitive dynamics were described by the Financial Times as,
Death by a thousand cuts. Banks and financial institutions are huge whales — sprawling businesses built over decades that make them seemingly impenetrable to the technological disruption faced by other industries. But ‘fintech’ start-ups are nimble piranhas, each focusing on a small part of a bank’s business model to attack.
Open banking could bolster this attack. Most fintech companies rely heavily on access to their users’ banking data, but experience difficulties accessing it consistently. Open banking could change this, giving fintechs the right of way to access the data through secure channels.
But experts on business strategy have offered banks a way to respond. Major consulting firms, as well as some academics, have suggested the platform business model. Professors at the Warwick Business School write that, “in a world where a large variety of services will be provided as part of a platform, banks will need to reconsider their competitive advantage compared to the numerous players that are specialised on various technologies and data-related services.”
What exactly are platforms? They connect market actors, allowing them to transact. Uber doesn’t own any cabs, for example, but it connects people who want to provide taxi services to people who need a lift. YouTube doesn’t produce the vast majority of its content, but it serves as an intermediary between consumers who want entertainment and advertisers who are vying for captive audiences and data. Likewise, Amazon is ultimately a marketplace that brings together buyers and sellers of various goods. Platforms that help us navigate the almost limitless information available today have become some of the most valuable companies in the world.
Platform banks in the digital economy
In a diverse ecosystem of fintechs, banks can create value by connecting providers of financial services to their customers who are looking for new products. They could become platforms like Amazon, but for financial services. While open banking could one day bring Canadians outside their banks and to the marketplace for financial goods and services, customers will still need to distinguish the signal from the noise, and banks could keep customers from leaving by bringing a curated marketplace to them.
What’s good for banks, however, may not be good for Canada. Platforms in the digital economy often give regulators and antitrust practitioners reason to worry. When narrowly defined, the markets within which platforms do business tend to be concentrated, the spectre of excessive market power always looming, and behind it the associated inefficiency and consumer-welfare loss. The concerns aren’t just economic, either. Some are worried about the political power of the big tech platforms.
This concentration is something of an inevitability for two reasons: one has to do with the cost structure of firms in the digital economy and the other with the multi-sidedness of platform markets.
The cost structure of firms in the digital economy favours size. Firms in the digital economy often face high fixed costs and low, or even zero, marginal costs. This screams natural monopoly, due to the significant cost-related benefits of being large.
Multi-sidedness also favours size because of the associated network externalities. Jean Tirole, a pioneer in the economics literature on multi-sided markets, has described these forces by invoking a see-saw:
If one side of the market benefits a lot from interactions with the other side, then the platform can charge more to the former and, in a “seesaw” pattern, will want to charge less to the latter side to make it more attractive to join. The platform thus needs to know which side of the market is most interested in the service (has the lowest elasticity of demand, and is therefore likely to pay more without ceasing to consume), and which side brings more value to the other.
A platform’s success depends on it being able to court the different sides of the market, in other words, but coming aboard the platform at the outset for any side of the market is only valuable if participation is already high on the others. Take Uber, for example: to incentivize participation on the rider’s side of the market, Uber needs drivers on the other side of it. But to court drivers, Uber needs riders. Solving the chicken-and-egg problem, capitalizing on the network externalities inherent in these markets, is a crucial piece of every platform’s puzzle. This gives platforms revenue-related benefits to being large, which is why entry for new players is difficult, and why the successful platforms today are so big.
The banking industry already favours size. There are regulatory hurdles firms need to jump over to become banks, but there are also economies of scale, such as spreading fixed overhead costs over many activities, offering complementary combinations of products, and diversification of liquidity and credit risk, to name a few. Banks in Canada have also become larger over the past few decades through mergers and acquisitions.
If banks were to become platforms, however, multi-sidedness and network externalities could intensify these returns to size. Why couldn’t open banking, then, make the financial sector more concentrated than it is today?
Examining the available tools
Platforms have been with us for some time, but they have become more relevant of late with the emergence and ostensible market power of “big tech” platforms, such as Google, Amazon, Uber, and Apple. Still, some argue the analytical tools we have at our disposal to promote efficiency, competition and innovation, and consumer welfare in these multi-sided markets aren’t very useful in the real world. Indeed, some say economists barely have the tools necessary to understand the things policy-makers and antitrust practitioners are even meant to be promoting.
Platforms in the digital economy routinely charge prices below and above cost and they often do it out of necessity, and so the cruder signals of anticompetitive behavior of old aren’t as telling in the economy of today. In fact, high pricing on one side of the market isn’t necessarily indicative of market power, and low pricing on the other isn’t necessarily indicative of predatory behavior. Pricing a particular good or service above or below the cost of providing it to one side of the market — and having the other side subsidize it — is routine and can often be competitive.
Like pricing, concentration is also not a clear signal of a problem. For one, concentration is difficult to measure. Indicators of concentration are sensitive to how the relevant market in which one is measuring concentration is defined. For example, while Amazon accounts for roughly half of the e-commerce market in the U.S., it accounts for only 5 percent of overall retail. What’s more, it’s not obvious at what point concentration is even a problem. What may matter most is not how concentrated a given market is, but whether or not that market is contestable, or how easily new competitors can enter the market. Even in cases of monopoly or oligopoly, the credible threat of competition can keep incumbents on their toes, forcing them to innovate and keep their prices low.
Despite the shortage of obviously useful analytical tools, there has been no shortage of proposals to deal with big tech platforms. Some, like U.S. Senator Elizabeth Warren, have gone so far as to propose breaking up the big tech companies and regulating them like utilities. Others have been more measured, proposing that antitrust practitioners scrutinize mergers more closely, as just looking at prices and market share is too simplistic. But antitrust is hard enough to get right in more traditional markets,, let alone in markets governed by more complicated platform economics.
A more recent idea is data portability, which focuses on one of the more valuable commodities in the digital economy. Platforms receive information for their services: Facebook, for example, can sell targeted ads based on the information its users share on the platform. Collecting and analyzing troves of data can also help platforms better tailor their services and gauge demand. With seemingly unlimited choice in the digital economy — what to listen to, what to watch, what to buy next — it can be difficult for a new platform to draw users away from the existing platforms when they have little to no existing data on those users. By giving consumers greater control over their personal information, allowing them to share their personal data with new platforms, it becomes easier for new platforms to enter the market, attract new users, and grow to maturity.
Fair competition without reciprocity?
This idea is not materially different from the one behind open banking: giving Canadians greater control over their personal financial information. Whether or not there is merit in the idea is one thing, but open banking in Canada is being discussed too narrowly, independent of the idea of a broader, economy-wide data-sharing framework.
Open banking could let customers give Amazon access to their banking data, but it wouldn’t let users give banks and fintechs access to their Amazon data. One of the Canadian banks may become the Amazon of financial services, but it’s more likely that Amazon will become the Amazon of financial services. Or one of the other technology giants such as Google. For the big tech platforms, which already offer financial services, banking could become a big part of their service offerings.
If the government wants to promote competition and thinks data portability is part of the policy solution, open banking needs to be discussed in the broader context of data, privacy, and competition in the digital economy. If it isn’t, the government may find itself grappling with far bigger giants than the large banks.
Working on the Policy and Regulatory Affairs team, Alex does research and gives strategic advice on matters relating to Payments Canada's mandate and public policy objectives. Before joining Payments Canada, he worked in tax controversy and transfer pricing, providing economic advice to large, multinational firms. He's also worked in public policy advocacy on matters relating to international trade. In school, Alex studied economics and journalism.
As an economist on the Research team, Shaun conducts research on policy issues related to fintech and high-value payment systems. Prior to joining Payments Canada, he worked at the Competition Bureau, where he researched the impact of fintech on innovation and competition in Canada's financial system. Shaun holds a Master's degree in economics from Carleton University.
 See “Technology-led innovation in the Canadian financial services sector: A market study,” a report by the Competition Bureau published in 2017.
 See “Fintech: Is This Time Different? A Framework for Assessing Risks and Opportunities for Central Banks,” a staff discussion paper by the Bank of Canada published in 2017.
 A great example is the CIBC Homeowner Banking Bundle, which offers a chequing account, savings or investment account, credit card, and mortgage or line of credit. Accessible at https://www.cibc.com/en/personal-banking/bank-accounts/banking-bundles.html#completedetails (last accessed on 5 May 2019)
 See “Competition in Financial Services,” by the Centre for International Finance and Regulation published in 2015.
 See “The API Economy and Digital Transformation in Financial Services: The Case of Open Banking,” a SWIFT Institute Working Paper by Markos Zachardisis and Pinar Ozcan published in 2017.
 See “Amazon’s Antitrust Paradox,” by Lina Khan in the Yale Law Journal.
 See The Economics of Information Technology: An Introduction by Hal Varian, Joseph Farrell, and Carl Shapiro.
 See Economics for the Common Good by Jean Tirole.
 See “The Economics of Two-Sided Markets,” by Marc Rysman in the Journal of Economic Perspectives.
 For example, when a new video game console hits the market, games need to have been developed for it if players are to buy it. Without a collection of available games, players derive no value from buying the console. Likewise, developers won’t have an incentive to produce games if there aren’t any players on the other side of the market already to buy them. One solution to this “chicken-and-egg” problem is to sell consoles at a loss and charge producers of video games a royalty on each game sold. This strategy signals to video game developers that the platform is invested in wide and ongoing use of its console.
 For a more detailed and technical example of the difficulties of measuring concentration, see Carl Shapiro’s discussion in “Antitrust in a time of populism,” in the International Journal of Industrial Organization.
 See Economics for the Common Good by Jean Tirole.
 See “Antitrust in a time of populism,” in the International Journal of Industrial Organization by Carl Shapiro.
 See “Does Antitrust Policy Improve Consumer Welfare? Assessing the Evidence,” in the Journal of Economic Perspectives by Robert Crandall and Clifford Winston.
 For a thorough explanation of the complexities of merger control, see “Antitrust policy towards horizontal mergers,” by Michael Whinston in chapter 36 of the Handbook of Industrial Organization, published by Elsevier in 2007.
Disclaimer: The views expressed in this paper are those of the authors and do not necessarily reflect the views of Payments Canada.