What Is Open Banking? (+How It Can Shake Up the Banking World)

March 20, 2019

Open banking refers to the availability of anonymized consumer financial data to provide secure third-party access to banks and financial technology (fintech) developers.

What is open banking?

This is accomplished by using open financial data APIs to grant access to regulated open banking providers. Open banking is designed to promote fintech product development, increase competition between banks, facilitate easier funds transfers, and cut consumer costs.

Open banking was first introduced in 2015 with the launch of the payment services directive 2.0 (PSD2) in Europe. The concept facilitated a shift in the mindset of banks from data stewards to looking at their customers’ data as a useful asset.

Although financial services firms are now more likely to leverage their data sets, the rules set out by PSD2 explicitly place the power to share (or not share) their data with the consumer. There are informed consent stipulations in PSD2 that require banks to tell their customers exactly what data they are giving the bank permission to share.

Open application programming interfaces (APIs) are publicly available APIs that developers use to access backend data. They typically use the insights in that data to structure product development strategy to address the needs revealed by the data. The term “open APIs” with regard to API usage in the financial services industry is a bit of a misnomer, as these APIs do not function like truly open APIs. The rules and regulations set out in PSD2 require that each developer using an “open” API is vetted, which ensures that data is not being misused and that developers are monitored.

Open banking advantages for banks 

At first glance, open banking seems like a blow to banks, or at least an unnecessary neutral policy. The government-mandated opening of secure financial data to promote competition? Sounds like a nightmare for market incumbents.

However, the reality is that prior to open banking, banks were not looking at these datasets as  particularly valuable assets. Now, due to open banking, they’re reframing how they view their data and beginning to take advantage of both their own and other banks’ data. A bank that properly leverages open banking can provide better customer service, offer improved financial products and lower the cost of services. Armed with the insights provided by deep dives into large financial data sets, either their own or others’, they can use those insights to identify consumer needs and create products to meet those needs. Banks that move quickly and leverage the data from open APIs can gain first-to-market advantage by offering new financial products created as a result of the information gathered through those APIs.  

Open banking advantages for businesses and consumers

The end goal of open banking is to improve the banking experience for the consumer. Open datasets allow smaller banks to come to the market with attractive consumer products based on consumers’ needs and habits. Fintech providers can produce separate products using the same open APIs based on those same open data sets to supplement the services provided by banks. The APIs are available for use by both banks and fintech providers, and drive app development.

Data sharing and open banking 

One of the potential issues with open banking is consumer privacy concerns over data sharing. (This is particularly relevant in the wake of large data leaks like that of the Equifax data breach.) The more places your data is held, the more vulnerable it is to being stolen. Consumers are more aware of security risks than ever before and have become more reticent to hand over access to their data.

The fact that all data sharing requests must be explicitly accepted by the consumer should alleviate some of their concerns about open banking. In addition, there is a frequently updated list of regulated open banking third-party providers that must enroll with an open banking regulatory body to ensure that only regulated providers access consumer information. Uneasy consumers can consult the list to confirm whether the banking provider or fintech application they use is on the list.

Transaction data shared through open banking APIs is anonymized, meaning there is no personal information attached to the data. Open banking’s use of APIs in lieu of screen scraping is another notch in the data safety belt.

Screen scraping involves the use of the customer’s actual login details to gain access to their accounts. This increases the possibility of fraudulent activity, as that login information can be hacked and used maliciously. Open banking, on the other hand, does not use screen scraping techniques, which should set the consumers’ minds at ease.

A variety of data types can be shared via open banking. The three most common types of financial data shared using open banking are:

Payment requests — Where payment requests are coming from, what vendor they are coming from, and when they are being made.

Balance information — The customer’s balance along with the date.

Transaction data — Vital information that can include merchant name, purchase location and purchase category.

The data gathered can be used by banks and fintech developers to create applications that are useful to consumers based on their personal data, such as their salary, spending habits and more. Consumers will use the applications created as a result of their data — applications limited only by the creativity and ingenuity of the developers working on solutions for those consumers.

An example of the innovation spurred by open banking is HSBC’s Connect Money application, which allows customers to see all of their accounts from different banks within a single application. This application is a harbinger of things to come. Banks will be able to roll out applications in the same vein, and fintechs will be able to engineer applications that take advantage of the data on offer.

Open banking and fintech application development 

One rationale behind the open banking directive was to spur the development of fintech applications. Armed with the data that exists within billions of transactions, payment requests, and other points of financial consumer information, fintechs can create applications that are primed to meet the needs of consumers.

They can process the amassed data to identify and determine relevant consumer trends. While the potential upside is fantastic, it’s going to take awhile for fintechs to roll out applications that leverage the opportunities presented by open banking. The delay is due in part to consumer reticence, lack of interest in and awareness of open banking, and the time it takes for fintechs to digest relevant insights from the available data and use it to create applications.

Open banking as the future

Open banking is still in its nascent stages in Europe, its birthplace. It has been slow to get off the ground, possibly due to the hesitance of traditional banks and the lack of consumer enthusiasm for the initiative. The former reason makes sense, as traditional banks that fail to take advantage of open banking data may get passed up by smaller, more agile banks who do. The latter reason doesn’t make as much sense, because consumers only stand to benefit from the changes enacted by PSD2.

However, financial regulations have always been a bit dense and difficult to grasp. In particular, open banking as a whole scares consumers: according to market intelligence resource Raconteur, 77 percent of the UK population admitted to having concerns about sharing financial data with third parties. Regulators close to the issue state that open banking was always going to be a slow process, and that’s been proven true as innovative solutions haven’t been launched overnight.

Three things need to happen for open banking to become an unequivocal success:

  1. Consumers must buy in — Open banking is still contingent on customers opting into  data sharing.

  2. Traditional banks must embrace it — Traditional banks must fully embrace open banking and partner with fintechs to deliver new products and more efficient services.

  3. Fintech providers must recognize the potential — Solution providers need to understand the capabilities of open banking and actively pursue product development based on data gleaned from open APIs.

Consumers must demonstrate a willingness to either switch providers based on new products and services or embrace new fintech applications created as a result of open banking. The jury is still out, but open banking presents a ton of potential and can revolutionize the banking industry if properly leveraged by the right parties.

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