Open Banking and the Limits of Traditional Regulation: What Bankers Need to Rethink

By Ania Zalewska, Professor of Finance University of Leicester

Open banking and modern AI-based tools that are developing are often perceived as a positive competition story, bringing more entrants, better pricing, and improved customer outcomes. For banks, however, the more consequential shift may be structural. The way deposits move, the way customers behave and, ultimately, the way banks position themselves are all changing. This will have direct implications for how effective existing regulatory frameworks, particularly Basel-style tools, can be in managing risk, as discussed in the recent research paper available on SSRN. 

A Structural Split in Banking Models

Open banking  increases the ease with which customers can compare rates and move funds. In practice, this creates two distinct customer segments.

"The way deposits move, the way customers behave and, ultimately, the way banks position themselves are all changing.

On one hand, there will be more mobile depositors who are rate-sensitive and respond quickly to rate differences, allowing some banks to compete aggressively and grow rapidly but with squeezed margins and the higher level of risk associated with this. On the other hand, there will always be the less active depositors that will tend to remain with incumbent banks, allowing these banks to retain reduced deposit volumes but in exchange for higher profitability per customer. Such banks will have large sticky deposit bases and be relatively safe. But why does this structural change matter?

Having two distinct business models means that we will have to worry about how they are linked. If one business model becomes more profitable, banks will shift toward it until returns equalise across the system. That dynamic is where regulation becomes more complicated.

Why Basel-Type Tools Struggle in This Environment

Traditional prudential regulation based on capital requirements, liquidity rules, and conduct constraints has largely been designed with a representative bank in mind. The assumption is that if each bank is made safer by an increase in capital requirements, then the system becomes safer. Open banking challenges that logic.

An increase in capital requirements, for example, will have a different impact on banks competing for mobile deposits than banks that rely on a stable deposit base (since the latter are already offering low deposits because of the weak competition for their sticky deposits). But if one business model becomes more profitable, banks will shift toward it until returns equalise across the system.

Hence, it is no longer enough to look at the impact of regulation on representative banks, it is important to consider any consequent changes in relative size of the two sectors. If that segment that increases in size happens to be the one with higher risk, then the overall risk in the system can rise even if there is no change in the risk profile of individual banks within each segment. 

In other words, standard supervisory metrics may not flag a problem. Each bank may appear compliant and just as stable as before the change, yet the system as a whole becomes more fragile because of how activity is distributed. This is not something the Basel framework was designed to capture.

Each bank may appear compliant and just as stable as before the change, yet the system as a whole becomes more fragile because of how activity is distributed.

Other Policy Tools may have Unintended Consequences

Also, other familiar regulatory tools may behave in counterintuitive ways in this environment. For instance, historically, deposit rate caps have been used to limit excessive competition for deposits and reduce incentives for risk-taking. But in a market shaped by open banking, such caps primarily constrain the most competitive banks, i.e., those targeting mobile depositors. Limiting how aggressively these banks can price deposits makes their business model more attractive relative to others, encouraging more banks to enter this market segment. Thus, the net effect of imposing deposit rate caps can be an increase in system-wide risk, rather than its reduction. 

Faster Deposit Flows, Tighter Margins

The above problems are exacerbated because open banking affects the speed at which deposits can move. Digital interfaces and third-party platforms allow funds to shift rapidly in response to small changes in rates or perceived risk. Recent market episodes, such as SVB, have already shown how quickly confidence can erode when withdrawals can be executed in real time.

Rethinking Risk Oversight

For practitioners, the key takeaway is that, with open banking and modern AI-based tools that are developing, risk is becoming more systemic in structure rather than purely institutional in origin. Monitoring capital ratios, liquidity buffers, and leverage remains necessary, but no longer sufficient.

Greater attention needs to be paid to:

1. How funding profiles are shifting across the sector

2. Which business models are expanding or contracting

3. How sensitive deposits are to pricing and information

4. Where competitive pressures are compressing margins

From a policy standpoint, there is a clear challenge. Frameworks rooted in Basel logic are effective at addressing risks within banks, but less equipped to handle risks arising from shifts between bank models. The system is becoming more dynamic. The regulatory approach will need to evolve just as quickly.

About the author

Ania Zalewska is a Professor of Finance and Director of the Centre for Finance, Governance and Sustainable Growth (FGSG) at the University of Leicester School of Business, UK. She is also a visiting researcher at the Bank of England and Lead of the Green Finance Thematical Advisory Group at the Land Use for Net Zero, Nature and People Hub. A cross-disciplinary researcher, she has advised numerous UK government bodies including the Competition Commission, HMRC, FSA and the National Infrastructure Commission, as well as leading international companies and consulting firms. She holds a PhD in Financial Economics from the London Business School and a PhD in Mathematics from the Polish Academy of Sciences.