In just a few years, open banking laws have gone global. Scores of countries around the world have followed the European Union’s lead by creating their own version of open banking regulation. While some are at different stages of development, the global financial system is increasingly “open”.
What is open banking?
Open banking is legislation that allows non-traditional financial organizations (not high-street banks) to build new financial products for customers by accessing their bank account data, with the account holder’s permission. It represents a historic, watershed moment for banking, as it is the first time that financial market regulatory bodies have removed barriers to competition in such a meaningful way. For instance, the UK’s so-called “Big Four” banks of Barclays, HSBC, Lloyds, and NatWest historically and almost exclusively shared the country’s entire banking market. This kind of market dominance by a select group of banks has been a historically similar occurrence in most countries around the world. However, open banking legislation may be what definitively breaks up such market monopoly by ushering in an era of many new market entrants and much greater competition.
More technically, open banking refers to the process of banks sharing customer financial data with authorized third party providers (TPPs) in payments and other financial services, subject to prior customer approval. Shared information may include data regarding a customer’s account, transactions, and payment history, among other financial data points. Banks communicate this information through application programming interfaces (APIs), which enable TPP software to connect to bank systems that house customer data.
What is the purpose of open banking?
Though open banking is now worldwide, it began in Europe. The European Union introduced Payments Services Directive II (PSD2) in 2016, while the United Kingdom’s Competition and Markets Authority (CMA) corresponded with the Open Banking Standard in 2017. Both the EU and UK created their respective open banking regulatory frameworks to achieve what are essentially the same goals.
The overarching driving purpose behind PSD2 and the Open Banking Standard was and continues to be a marked increase in financial service innovation and competition. The ultimate end-goal is to enhance the customer experience by “opening up” financial service provision to more organizations, beyond the historically small pool of traditional financial institution market incumbents.
Pros of open banking
Economies that have rolled out open banking are already seeing numerous benefits.
1. A superior customer experience
Greater competition for virtually all financial services means that customers have greater choice. As a result, service providers – whether traditional banks or third parties – can ill-afford to neglect innovation or their customers. Traditional institutions have had to migrate away from the former, prevalent, profit-centric approach to become customer-centric in order to remain competitive. As a result, banking services have become faster, more convenient, and, for many financial verticals such as foreign exchange (FX), cheaper.
2. New possibilities for financial needs
Traditionally, if a customer’s bank rejected their loan application, that customer would have had few other options to obtain the money that they required. This is no longer necessarily the case. A customer can now use a TPP loan aggregator service, for example. This sort of service can generate a plethora of feasible loan providers for the customer, with each of them competing for the customer’s attention with terms such as interest rate, length of loan term to maturity, and so forth. Open banking grants customers significantly greater agency over their financial lives.
3. Customer control, centricity, and convenience
With open banking, TPPs must first receive permission from the customer to access the customer’s data. Moreover, customers are usually also able to remove this access at any point. As a result, they have strong legal protection over their data. Through open banking, customers can also centralize their financial accounts and services. For instance, a financial organization, be it a traditional retail bank, challenger bank, or fintech company, could offer a service where it enables customers to view all their bank and financial accounts in one place.
4. Open banking goes beyond financial services
Another positive consequence of open banking technology is that governments can apply it to non-financial industries too. This use of open banking technology is more appropriate for industries that suffer from a lack of competition, and in which a select group of large corporations control the vast majority or all of the market. This is already happening in countries such as Australia. The Australian government introduced its Consumer Data Right law in 2017. This reform initially applied to the country’s banking industry but Australia’s energy and telecommunications sectors are following suit. Essentially the same process would occur as with the financial industry. By forcing large energy and telecom companies to share customer data with TPPs, the belief is that it will increase competition and innovation by encouraging new market entrants.
Cons of open banking
While the benefits of open banking are transformational for financial services, there are still a number of perceived drawbacks to address.
1. An absence of reciprocity
Numerous banks have highlighted that open banking regulation obliges them to share customer data with TPPs, including big tech firms such as Apple and Amazon, but that these companies don’t have to share their own customer data in return with banks. Banks argue that this can generate competitive disadvantage, as they – the banks – are subject to more regulatory requirements to compete, compared to big tech organizations.
2. The challenge of winning customer trust
Customers
still trust traditional banks with their deposits more than any other kind of financial service provider. However, fintechs, neobanks, and challenger banks are closing the trust gap by introducing service components such as deposit guarantees. Nevertheless, customer reticence to trust third parties with their money has acted as a considerable obstacle to open banking progress thus far.
3. Data security risk
Many customers are still very wary about sharing their data. Frequent press reports of data leaks, hacks, and deposit theft encourage customers to remain with traditional banks, and even mistrust their primary bank. There is a widespread mistrust of how both banks and TPPs may handle customer data. From the Cambridge Analytica-Facebook data scandal to multi-billion-dollar hacks on cryptocurrency exchanges, and from the PRISM data scandal to repeated instances of regulatory authorities levying fines on banks for misuse of customer data, customers have reason to be wary.
While these three areas have all been problematic for open banking, regulatory bodies largely view them as “growing pains”, which are an inevitable part of rolling out and developing such generationally significant legislation. For instance, many regulators have reviewed the absence of TPP data reciprocity, to be amended accordingly, and they are widely addressing the kind of data misuse that engenders customer mistrust.
How does open banking work?
APIs enable two or more financial service entities – such as a traditional retail bank and a fintech service provider – to connect in order to share customer financial data.
Banks must provide their API integration information to authorized TPPs. A TPP can then connect with a bank. In order to access a customer’s data, the TPP must first gain permission from the customer in question. Once the customer provides access, the TPP can then use their information to provide financial services. For instance, a loan provider could take advantage of open banking to digitally analyze a customer’s banking transaction history to determine creditworthiness.
Open banking also enables financial organizations to expand into new financial verticals, by building and offering customers a range of financial modules.
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Toqio works with financial organizations around the world to build and launch banking and embedded finance solutions quickly. With Toqio, traditional financial institutions, challenger banks, and fintechs can develop any sort of financial application they require, in any financial vertical. Thanks to open banking, they can launch to market immediately and focus on customer acquisition and growth.
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