Open Banking Meaning
Open banking refers to the practice of allowing third-party service providers to use consumers’ banking data to build new financial applications and services. It often employs open source technologies and application programming interfaces (APIs) to exchange client financial data, resulting in increased financial transparency.
These third-party applications help customers manage their accounts, make transactions, among other services. Because of its regulatory, collaborative, and competitive nature, open banking enables secure interoperability in the banking industry. However, the banking information exchanged could have positive and negative implications.
- Open banking enables other companies to see consumer information with permission. It is an initiative that started in Europe and spread around the world.
- This innovation helps clients gain access to new apps that may help them with services like loans, accounting, investing, etc.
- Several banks such as Barclays, BBVA, and others provide these solutions. It is also possible to find several third-party companies that created apps for it.
- Despite being useful, APIs may pose risks such as breaches or users giving out their information to malicious actors.
How Does Open Banking Work?
Banks and financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. must innovate to help their customers manage finances, make payments, etc. Also, they need to focus on improving their services to increase business revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions. while giving clients access to automated accounting and streamlined lending. Open banking, with its collaborative model where banking data and services are shared between different parties through APIs, is the answer to all this.
While the technology that enabled open banking is not necessarily new, the legislation that supports it is recent. In 2007, the European Parliament devised something called the Payment Services Directive (PSD or PSD1). It was an important step to legalize the practice in the continent.
In 2018, the new PSD2 went into effect. Open banking PSD2 made this type of banking mandatory for all banking institutions operating in Europe. It ushered in a new wave of APIs that aimed to help clients to use their data for new purposes.
Open banking essentially works by creating a channel between a bank’s information about its customers and the third parties that provide services through APIs. While the technical process will vary from bank to bank, the result is the same: the customers are empowered with their financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc..
Now, they no longer need the permission of the bank to access these details. It makes the process much smoother if they need to share data to get services.
Third parties can use this information to provide several services, such as data analysis and transaction processing on behalf of the user. APIs can only do so with the user’s permission, which reduces the risks of sharing sensitive data.
- One of the most famous examples is the British bank Barclays. It was the first bank in the country to offer mobile banking that allowed the users to view their open banking account on other banks without needing to use their first-party software. The company also shares its information, and consumers can use their information from Barclays on third-party APIs.
- Another real-life example may include Open Platform, the platform of the BBVA in the United States. This Banking-as-a-Service platform allows other companies to offer financial services for their clients by using an API.
- On the other hand, there are also third parties providing exciting services using the technology. DueDil, for example, uses the data from the user to check whether they can comply with financial obligations for new investments. It is a handy tool for both due diligence as well as to research companies.
- Then there is software like Ormsby Street, which is an interest manager app. By using information from clients, it provides them with financial insights. It makes use of bank details to help plan investments and request loan payments, and calculate interest.
Like any other innovative technology, open banking online comes with a few promises. For instance:
- It follows the open-data philosophy of allowing information not to be restricted anymore, being shared freely via open-source software.
- Not only the transparency of banking information will be improved and democratized, but access to foreign markets and credit access may also be easier as people will have an easier time sharing their data.
- However, the main changes are in innovation. The creation of apps that use that data and are not owned by banks can be a game-changer. Before open banking, only the bank could offer services for the client, as they controlled the financial information. Now, with a few clicks, any startup offering a creative service can do it as well.
- Companies like DueDil and Ormsby Street are good examples. But new startup prospects are only constrained by their creativity.
- Some possible new solutions include options that will make lending easier, tools that will use artificial intelligence to predict events based on consumer spending, an automated accounting app, for example, and much more.
Risks & Challenges
While open banking is an innovative concept that makes banking simple, it has its share of risk. Most of it, however, stems from the user, not from the banking entities. For example:
- There is a risk of breaches using the open banking API, but the risk is not significantly higher than the risk of a data breach if the software is good. Human error is, after all, the largest reason for security breaches.
- Another reason why consumers may run into problems is that they might give away details about their accounts to scammers or fraudsters in general. Banks will not be victims of scams as they have trained personnel, but it is easier to be fooled by the user.
- Optimally, banks should educate their clients about the best practices to protect their information. However, since most people do not have direct conversations with their banks, it is unlikely to happen with this form of banking.
- Also, these third-party companies may be hacked, too, and unwillingly give customer information to criminals. Banks tend to have a very high-security standard, as their business depends on it. But a small startup company may not be able to pay for the state-of-the-art security protocols, being an easy victim of hackers.
Consumers can avoid most of these problems by carefully researching any company before divulging their information with them. Avoiding unlicensed companies and checking their security protocols is a good idea as well.