Open Banking

Updated on April 9, 2024
Reviewed byDheeraj Vaidya, CFA, FRM

What is Open Banking?

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, increasing financial transparency. Since the data is shared widely on a open banking platform, it poses significant risks of data leaks.

open-banking

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Open Banking (wallstreetmojo.com)

These third-party applications help customers manage their accounts and 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 such as data leaks, identity theft, and cybercrimes.

Key Takeaways

  • 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 access 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.
  • Despite being useful, APIs may pose risks such as breaches or users giving out their information to malicious actors.

Open Banking Explained

Open banking refers to the allowance to third-party applications to access data of consumer banking and other financial functions. As a result, the user experience and the landscape on an open banking platform become significantly better for users across the industry.

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. read more 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.read more while giving clients access to automated accounting and streamlined lending. With its collaborative model where banking data and services are shared between different parties through APIs, it 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 the Payment Services Directive (PSD or PSD1). It was an important step to legalize the practice on the continent.

In 2018, the new PSD2 went into effect. It ushered in a new wave of APIs that aimed to help clients use their data for new purposes. Open banking PSD2 made this type of banking mandatory for all banking institutions operating in Europe.

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.read more.

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.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Examples

Let us understand open banking standards and other related concepts with the help of a few examples from the business world. These examples will help us understand the concept in detail and allow us have a practical adeptness around the intricacies of the concept.

  1. 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.
  2. 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.
  3. On the other hand, third parties also provide 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 and research companies.
  4. Then there is software like Ormsby Street, an interest manager app. It uses bank details to help plan investments, request loan payments, and calculate interest. By using information from clients, it provides them with financial insights.

Opportunities

The ever-developing industries of technology and banking have always thrived with opportunities for raising the open banking standard. Let us understand the opportunities in this field of work through the discussion below.

  1. It follows the open-data philosophy of allowing information to be restricted and shared freely via open-source software.
  2. 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.
  3. However, the main changes are in innovation. Creating 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.
  4. Companies like DueDil and Ormsby Street are good examples. But new startup prospects are only constrained by their creativity.
  5. 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

Despite the fact that an open banking platform makes banking more efficient and widens the scope of development in terms of user experience and technological infrastructure in websites and mobile applications, it is also important to address the risks and challenges.

There are significant risks of opting a route of development of this sort. Let us understand the risks through the explanation below.

  1. There is a risk of breaches using the open banking API, but the risk is not significantly higher than a data breach if the software is good. Human error is, after all, the largest reason for security breaches.
  2. 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 fool the user.
  3. 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, this form of banking is unlikely to happen.
  4. Banks tend to have a high-security standard, as their business depends on it. But a small startup companyStartup CompanyA startup can be expressed as a business in its initial phases, searching for a practical and scalable model. Often, these companies launch and market a unique idea, product, or service that in some way offers fresh benefits to the society. Reliable models aid in the rapid growth of the business.read more may not be able to pay for the state-of-the-art security protocols, being an easy victim of hackers. Also, these third-party companies may be hacked, too, and unwillingly give customer information to criminals.

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.

Frequently Asked Questions (FAQs)

1. What is the relevance of open banking? 

Open banking is highly relevant as it transforms the financial landscape, offering enhanced customer experiences with personalized services. It promotes financial inclusion by catering to underserved populations and accelerates innovation by enabling fintech companies to access secure customer data. Open banking also provides valuable data-driven insights for informed decision-making and offers seamless financial management through aggregated account information.

2. Is open banking safe? 

Open banking is designed with a strong focus on security and data protection. Financial institutions and third-party providers must adhere to strict regulations and security standards to ensure the safe handling and sharing of customer data. Robust authentication methods and encryption techniques are used to protect sensitive information during data transfers. 

3. What is the difference between banking and open banking?

Traditional banking refers to the conventional banking services offered by financial institutions, where customers can deposit, withdraw, and manage their funds, apply for loans, and access other financial products. On the other hand, open banking allows third-party financial service providers to access customer financial data (with their consent) from multiple banks through APIs (Application Programming Interfaces). 

This has been a guide to What is Open Banking. Here we explain Open Banking’s examples, risks, and opportunities in detail. You may also have a look at the following articles to learn more –