Open Banking and Alternative Data in Brazil: Key Legal Issues

An Interview with Bruno Balduccini, Partner @Pinheiro Neto

It would be no exaggeration to say that Bruno Balduccini is one of the top fintech gurus in Brazil. We first met Bruno when we started working in Brazil a few years ago. He has always been extraordinarily generous with his time and willingness to give advice – and when Bruno gives advice, it is worth listening. That is why we were excited to have the opportunity to sit down with Bruno, and discuss one of the more relevant topics in fintech today: Open banking.

As a partner at the renowned firm Pinheiro Neto Advogados, and having been with the firm for 30 years, Bruno specializes in banking, payments, foreign exchange, crypto, blockchain, and M&A. Bruno was a pioneer in drafting key legal solutions, which were used by the Central Bank to facilitate and regulate online payments, lending, and now open banking. Today, Bruno works closely with some of the top fintechs in the country, including Nubank, PagSeguro, Stone, Neon and many others. In addition, Bruno and Pinheiro Neto are strong supporters of many early-stage Brazilian fintech startups and entrepreneurs in PN’s own accelerator program, which includes several fintech unicorns!

Welcome, Bruno. Open banking is really taking off in Brazil. What do you think about this initiative, and how do you think it will change lending practices in Brazil (if at all)?

“I think it is a little bit too early to say that Open Banking is taking off. Banks that are considered systemically relevant from a banking perspective (approximately 15 banks) have to compulsorily join the open banking for sharing client personal and transactional data. The remaining financial and payment institution have the option but not the obligation to join this part of the open banking. The products/services that started in this phase of the open banking are accounts (pre-paid and deposit accounts) as well as postpaid instruments such as credit cards and any king of loan/lending products. It is a relevant change and clients have to adapt themselves under this reality. The potential of disruption however is massive and soon we expect a bank approaching its client offering, for example, a loan and asking to access other loan transaction information in other financial institutions that he/she has a relationship, so that such bank can offer a better/cheaper loan. If this happens, the other financial institutions that suffered “an attack” will counter attack by offering a cheaper/better loan. This will cause interest rates to drop empowering the client to choose the best option. So as you can see the potential is massive, and we expect to start seeing some changes in the next few months.”

Are all of your clients trying to jump onboard, or are some lenders/banks waiting?

“The systemically relevant banks had to jump in the Open Banking in the client data and transactional sharing. So they are starting their battles to acquire clients and offer loan products. The fintech banks which are not systemically relevant are not obliged, and for the time being decided to adopt a wait and see mode.”

Does joining open banking require certification? What does that process look like?

“Open Banking has three main pillars: (i) sharing of client personal and transaction data for a set of banking and payment products (including loans), (ii) adhering to payment initiation services and (iii) offering of credit services through electronic banking correspondents. In the first two pillars at least you need to be a financial and/or payment institution. Also these entities need to meet the minimum security and cryptography standards as well as adopt the standard APIs and integration technology agreed under the Open Banking group. It is a technology driven certification process and does require additional tech work specially for incumbent banks who traditionally have legacy systems that use old programming language and are generally less flexible.”

The initiative is being led by the Central Bank of Brazil. Are people happy with their involvement, and what is their role in the oversight and supervision?

“The general perception is that the Central Bank is doing a great job and is fulfilling their mandate which is foster competition and drive interest rates down. The role of the Central Bank is to guarantee that the incumbent banks do not impose their dominant position in order to create any de facto barriers for the entry of new players. So it is very common seeing the Central Bank imposing standards that are easier to access by the newcomers even if the proposed standards of the incumbent banks are stricter or even better. Central Bank acts as a judge in the process and is very attentive to avoid the creation of any distortion. As a consequence the general perception is that the Central Bank tends to be harsher in relation to the larger incumbent banks.”

In open banking, consumers’ financial information is shared outside of their bank. Are there potential privacy issues, and/or legal dangers to doing this?

“What I usually say to clients is that the Open Banking is in fact “closed”. The logic is that client personal and transactional data can only be freely shared if (i) there is client express consent and (ii) to another regulated entity part of the open banking. In addition, to be a part of the open banking you need to be either a financial or a payment institution, which is subject to a very strict bank secrecy rule. Breach of bank secrecy can even lead to criminal consequences to officers of financial or payment institutions. Finally, third party non-regulated data aggregators cannot have access to the Open Banking. Open Banking rules for example allow a regulated entity such as a financial or payment institution to partner with a non-regulated entity in order to offer solutions to the clients provided (i) there is express consent of the client and (ii) any information obtained by the regulated entity through the open banking cannot be shared with this non-regulated entity. Hence my statement that in fact open banking is in fact closed.”

What else should lenders and banks be careful about from a legal perspective regarding open banking?

“I guess the main concern would be clarity in the offering of competing banking and payment services specially for consumers. Therefore, communication is key here. Another issue is responsibility. If a bank fails in a service or product, would the other regulated entity be also responsible for losses suffered by a client? Note that in consumer relations in Brazil, all entities that are part of chain of a service are jointly liable. In addition, what if is some data shared by one regulated entity to another regulated entity is somehow leaked and client suffers a loss? Central Bank is aware of these issues and has set forth reimbursement rules among regulated entities. In addition each regulated entity must appoint an open banking officer who will be personally liable towards the Central Bank together with the regulated entity for such issues.”

Are lenders allowed to use any kind of alternative data for credit decisioning? Is that changing due to open banking?

“Yes absolutely and Central Bank wants to incentivize technology that uses such alternative data credit decision tool. In fact, nothing in the rules prohibit that. Once common client data is equally shared among the participants of the open banking an alternative technology tool is key to allow a regulated entity to provide a better credit. Note that open banking will drive interest rates down (and margins) so technology that decreases credit risk will be fundamental.”

Our psychometric data provide ‘positive data’ to boost credit ratings and promote financial inclusion. Is this in-line with the open banking objectives?

“Absolutely, Central Bank has tried for years to impose positive data bureaus for banks to use but has been unsuccessful. Brazil has historically adopted a negative data culture. So good payers do not enjoy a better or cheaper interest rate when they obtain a loan. To the contrary, a good payer in Brazil pays a higher interest rate in order to “finance” the bad payers performance. Open banking and new psychometric solutions like yours could in fact change the market substantially. Any technology movements towards this goal is something the Central Bank is looking for.”

To conclude, what do you see as the future of open banking and the use of alternative data in Brazil?

“I see the future as a more competitive baking market with partnerships between banks and technology partners. I also see some banks dropping products and services they are not good at, and in some cases, the end of one stop shop concept for some larger banks. Because open banking will share standardized client personal and transactional data among its regulated participants, alternative data solutions are going to be a game changer, and participants of the open banking (especially in the lending arena) that fail to see this may have their profitably (and eventually their existence) compromised.”

This has been a fascinating conversation – Thank you, Bruno!