In recent years, there has been a growing demand for transparency and control over personal and business finances. As the financial services industry is evolving, new technologies are emerging that will allow greater control over finances.
What is Open Banking?
Open banking is the process of making financial data available to third parties from banks and non-bank financial institutions via application programming interfaces (APIs). This means that banks are allowing third parties to access this information which then allows them to build new products and services tailored to deliver better customer experience.
The earliest steps towards open banking concept took place in the late 2010s, with the UK’s Open Banking Initiative and the EU’s Payment Services Directive (PSD2) coming in 2018. Some countries started adopting open banking initiatives based on the European and UK models.
According to Allied Market Research, the open banking market is growing at 24.4%, reaching $43.15 billion by 2026. Banking and capital markets have the largest market size in open banking while payments is the fastest growing segment in financial services. The application market has the largest market size in the distribution segment of open banking. The various partnerships between companies in the market will see the distribution segment grow faster than any other segment.
Open Banking Model or Initiatives
Open Banking initiatives cut across several dimensions which includes the type of institutions and third parties involved; timelines for implementation; and the range of products and services. Deloitte stated in their article on the cross-industry data-sharing ecosystem, that all global open banking-driven initiatives fall broadly into two categories — market-driven and regulatory-driven. There is a third one, hybrid model, where both the market and government take active roles in the ecosystem’s development.
Here, key players define the policy and technical standards. Adopters do not have a mandatory open banking system. Countries adopting a market-driven model include Japan, Singapore, South Korea, US.
Singapore has facilitated a huge fintech market built around APIs, for example, in risk-decision making in the absence of formal credit-scoring agencies. The Monetary Authority of Singapore (MAS) introduced API guidance in order to provide structure and oversight to the exchange of data.
Toshio Taki stated in a 2019 interview on Fintech Asia that around 80% of all consumption in Japan is cash-based. One key reason for the high dependence on cash is the lack of a dominant e-payment platform that is generally accepted unlike its developed nations peers. Japan’s Financial Service Agency (FSA) obligated banks to publish their Open APIs policies and contract third party providers. Implementation of open banking remains voluntary and the regulation lacks clarity on data portability. Around 130 banks among the largest 140 planned on doing so.
South Korea’s Financial Services Commission (FSC) launched a pilot program across ten banks in 2019 that enabled customers to access their accounts through one single mobile application. Around 5.5 million open banking accounts were registered post pilot phase. This spurred innovation and competition in the ecosystem. As at last reported, 72 fintechs and commercial banks currently offer open banking related services in South Korea for 20 million customers.
Open banking in the US is driven through competition with fintechs and banks – both incumbents and challengers. Regulatory oversight on open banking in the US is hard because of the highly fragmented and state-based nature of its legal and financial system. This could give the US an advantage, without the pressure of compliance, innovation will accelerate. US banks and financial institutions do allow third-party data scraping services such as Plaid, Yodlee, and MX to give users read-only access to their financial data and allow them to easily move money in between institutions.
The UK led the development of open banking to promote competition in the banking and payments industry. EU’s PSD2 (Payment Services Directive Two) started in 2018 and regulated third-party providers (TPPs) started integrating with banks’ APIs to access consenting customers’ bank data and offer financial services and products. Since 2018, open banking adoption among UK consumers have surged. The rest of Europe has been slower to adopt but they are not far behind. Business insider elaborated on the huge role of the UK and EU in development of open banking.
The Central Bank of Nigeria (CBN) already drafted a regulatory framework for implementing open banking. This framework establishes data sharing with accredited participants across the banking and payment ecosystem. According to Open Banking Nigeria, open banking is the only hope for financial inclusion for millions of Nigerians.
Hong Kong Monetary Authority (HKMA) in 2019 launched its Open API guidance which was divided into four phases starting with data sharing on products and services before going into transactional information and payments. Similar to Hong Kong, Brazil rolled out a four phase open banking initiative. The first phase started in February, 2021. The initiative is led by the Central Bank of Brazil and the participation of large and medium-sized banks in Brazil is mandatory, while for other institutions, participation is optional. The first phase will ensure banks deliver the architecture for the market to create novel financial products and services. The phases are set to be completed by the end of 2021 and it hopes to achieve its open banking goal of sharing data among accredited parties, financial management tools, payments initiation processes.
The Consumer Data Right (CDR) Act became law on July 1, 2020 ushering the beginning of open banking in Australia. The initiative was rolled out in stages. As of now, consumers can share their bank data with any accredited third-party provider they want. CDR was implemented to help consumers monitor their finances, utilities and other services and compare between different offerings seamlessly. This encourages competition and innovation between the service providers thereby helping consumers access products and services that suit their specific needs better. The CDR will also be implemented in other sectors like energy, telecommunications and could also be applied to any sector in the future.
India launched Unified Payment Interface (UPI) in 2016, allowing anyone to access their bank account and make transactions from authorized apps (e.g. PayTM) to any bank. The UPI initiative was brought to the market by the National Payments Council of India (NPCI). The banking and financial services sector is evolving into an API-based collaborative model. The emergence of API aggregators, neobanks, are ushering in a new customer experience and creating new business models. Bigger players like ICICI Banks have also joined the game through the release of their developer portal which consists of over 250 APIs.
Factors driving innovation in open banking
There are various key enablers of innovation in open banking.
Data is one of the most valuable assets a bank may possess. Banks have a lot of personal information about their customers. Name identification, address, tax ID information, utility bills, identification numbers. And also, financial information from transaction history. Transaction history can be used to deduce information such as spending patterns, financial capabilities and lifestyle preferences. This data allows banks to offer customized banking services.
In Nigeria, there are over 73 million active bank customers, with this number growing year on year. Given Nigeria’s strategic initiatives around financial access, mobile penetration, identification number, banking and payments over the next few years, it is going to be almost impossible for anyone to be digitally invisible. This data is going to provide rich consumer insights and create economic profiles of consumers, to create personalized financial experience which had not been possible using the traditional banking legacy systems.
The customer experience
One of the main reasons behind promoting open banking is to improve the experience of the end customer. Open banking will give consumers the ability to access different bank accounts through a single service and also allow any user to decide which banks to keep their money and what service to use to manage their finances. Open banking will ensure easy, cheap and instant money transfer. One of the key priorities of open banking is to enhance user security in digital banking solutions. To access banking APIs, third-party providers will have to obtain licenses from regulatory authorities. Users will be able to determine what financial information that they are ready to share with third parties.
Benefits of Open Banking
Open Banking will provide innovative services to consumers and support a simplified and better payments experience – from e-commerce purchases to subscription payments to loans and far more.
Open banking can facilitate real-time credit monitoring to confirm eligibility and the best rates for loans.
Consumers would easily monitor and switch between banks and fintechs, depending on the most convenient experience, promotional offerings, lower transaction fees or higher interest savings accounts. Personalized platforms like Apple, Google, Spotify and Amazon shape customer experiences. Consumers want instant, personalized services. Open banking addresses that by offering products and services that will aid the consumers in efficiently managing their finances and making better decisions.
A standardized open banking system will provide tools that help consumers understand their financial habits and the full range of available services, identify ways to predict when an individual might struggle financially, and improve access to lower cost services and financial advice. These benefits will ultimately have a positive impact on global financial literacy.
Open banking will create massive opportunities beyond streamlining financial operations. Understanding how, when and why people spend their money is extremely valuable for businesses who seek insights into their customers.
For SMEs, open banking stimulates new opportunities for funding and access to capital. SMEs will have access to more personalised financial product offerings, as data such as SMEs revenue trends and spending patterns can help banks offer tailored product offerings. Open banking also offers merchants the chance to lower their payments costs, improve their cash flows and reduce fraud.
While the relationships between fintechs and banks may be uncomfortable to start, both parties will quickly recognize that open banking creates opportunities for all players to work together and deliver better financial services to a wider range of people.
Fintechs democratize services that were once available to the wealthy. For instance, technology and data make it easier and less expensive to source investment research which in turn helps people to make better investment decisions.
Another example is lending. Traditional lenders have had a restrictive view on how to assess risk even though they possess big data on consumers, which meant that many people, including small business owners, were either turned down or charged a higher interest rate. By taking a broader view of financial data, and leveraging the technology required to assess risk properly, fintechs can include factors that traditional lenders have never considered and provide more people and businesses with access to capital. Open banking breaks down one of the barriers to fintech innovation – access to financial data and customers.
Open banking gives banks the opportunity to secure their future relevance. Banks can start a ‘marketplace’ of fintech partners and charge a fee for curating these services on behalf of customers. This will also help banks to gain a deeper understanding of customers’ financial habits, lifestyles, financial capabilities and predictively recommend new products and services in a personalized way.
If banks are interested in building a challenger bank, they can fast-track development by combining services from several third-party providers. For instance, Australian banks have shown willingness to position themselves as third-party providers and bring their own offerings to the market. To be successful, banks must be willing to engage the developer community and invest in technology.
Regulators must be responsive to changing customer demands and technological progress. Regulators should remove barriers to innovation and investment in the open banking ecosystem. Also, regulators should leverage technology and innovation to improve effectiveness through analytic tools, automation and artificial intelligence. Open banking improves transparency and enables regulators to govern effectively participants and the movement of data to ensure all parties, including customers, remain protected.
Globally, open banking is still at its early stages, however it is quite clear that there are huge potentials inherent in the industry if well tapped. Innovators ought to double down on building products while other key stakeholders would do well to provide the requisite digital assets and conducive regulatory environment that will enable maximize its limitless possibilities.