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Open Banking: The Next Banking Revolution

What is Open Banking?

Open banking is one of the most significant FinTech innovations that empowers the customer. It allows the consumer to leverage their own data to access better financial services and achieve greater financial outcomes. Open banking relies on open Application Programming Interfaces (APIs) to enable third parties and service providers to access a financial institution’s customer data. The mechanism allows consumers to choose whom to share their data with while also granting the right to revoke such access. The financial institution and the third party ensure that the highest standards of customer privacy and data security are maintained throughout the data exchange process.

“The role of Open Banking is to improve the utility of the account, in terms of building more compelling use cases or improving the customer experience.”

~ Harsh Natrajan, Lead Financial Sector Specialist, Finance, Competitiveness & Innovation, World Bank

Through open banking, customers can share their data with budgeting apps, insurance companies, and lenders to get better and more personalized services. The most significant benefit of open banking is elevated customer experiences. Moreover, it creates novel revenue generation opportunities for the banks and credit unions that share their customer data.

APIs Power Open-Banking

Application programming interfaces serve as bridges between distinct software. They facilitate heterogeneous systems to seamlessly communicate with each other. They can be considered translators that know all languages. They accept information in a certain language (format) and disseminate it to all concerned participants in the languages and formats each one understands.

Open APIs are the backbone of modern banking and FinTech. They allow third-party developers to build their applications and services around the data of a financial institution. They foster a unified ecosystem of diverse service providers under one roof. Customers have access to all those services in an interconnected financial services ecosystem.

Traditional Banking vs. Open Banking

Open Banking in Numbers

 

Why is Open Banking the Future of Finance?

Banking has long remained a closed industry, with banks enjoying a monopoly over financial services. This left little to choose from for the customer. The digitization movement and evolution of the FinTech industry, with an explosion of non-banking financial companies (NBFCs), has introduced the customer to the concept of choice, earlier missing from the financial services domain. Open banking envisions a financial ecosystem that will evolve into a unified platform powered by APIs to allow customers to pick their preferred services and products. It will enable fair and equitable access to financial products and services.

Source: iExceed

Open banking will facilitate the release of data from the monopoly of banks and make it the customer’s property. Customers will then have the right to grant or revoke access to their data on an application basis. This will bring financial freedom to customers. It will empower the end-user to use the diverse vehicles of financial well-being without having to navigate multiple complex and disjointed platforms. Through shared data and AI-powered recommendation mechanisms, the most suitable options will be brought to the customer. With greater autonomy over data and the power to choose, the customer will be able to experience financial services just like services from any other industry.

“Today, we are proposing a rule to give consumers the power to walk away from bad service and choose the financial institutions that offer the best products and prices,” said Rohit Chopra, Director of the Consumer Financial Protection Bureau (CFPB), USA, while introducing the long-awaited open banking rule in October 2023. “With the right consumer protections in place, a shift toward open and decentralized banking can supercharge competition, improve financial products and services, and discourage junk fees,” Chopra added.

Open banking focuses on enhancing competition in the industry, empowering consumers to manage their money better. It elevates customer experience by allowing the consumer to make informed financial decisions. They can compare and choose the most suitable financial products and services from available options. This will help improve the quality and accessibility of services. Open banking fosters a culture of innovation, customer-centrism, and competition in the industry.

The sole hurdle to the growth of open banking is growing concerns around data security and individual privacy that arise with open access to data. These also give rise to a lack of trust among customers. To protect consumer interests, regulators worldwide are rolling out guidelines to secure data and prevent breaches. Along with this, educating the customer and ensuring compliance with standards are paramount.

Is Open Banking Same as Open Finance?

Open banking is a practice where financial institutions share permissioned data with third parties with the consent of the customer. On the other hand, open finance relates to the broader footprint of an individual that can be leveraged to create a framework for the evolution of financial services. In effect, open banking is the first step of sharing data that extends to achieving the ultimate goal of open finance.

Open finance builds on the foundation laid down by open banking, deepening data integration and broadening the accessibility and availability of products and services. While open banking involves access to banking and transaction data, open finance stretches it out to insurance, tax, pensions, and much more.

Open finance facilitates the integration of the diverse aspects of individual money behaviors in one place to enable efficient financial management. It provides deeper insights into an individual’s overall financial health. For instance, it helps gauge how investments are performing and supports smarter investment decisions using advisory services. Open finance is aimed at creating a unified environment to improve financial well-being.

A significant difference between the two is that open banking has been around for a few years, whereas open finance is quite new. Open banking started with the rollout of the Payment Services Directive (PSD) by the EU. PSD2 further intensified the efforts to use data collaboratively among financial product and service providers through regulated and compliant practices. However, open finance is largely unregulated and still under research to assess the need and purview of oversight.

Open Banking around the World

Be it APAC, EMEA, or LATAM, many regions are proposing frameworks and guidelines to facilitate interoperability, bolster financial inclusion, and accelerate digitization to fuel open banking. Nations worldwide, including Nigeria, China, South Korea, Saudi Arabia, Brazil, Bahrain, Mexico, Japan, Columbia, Argentina, and India, are increasingly witnessing a breed of new players in FinTech, instant payments, and InsureTech. Open data is expected to fuel not just open finance but also facilitate economic growth for these nations.

“Open Finance will be successful in Brazil, due to three factors: a very broad scope for data sharing, a local willingness to share data and high-quality of the regulation provided by the Central Bank. Standardisation was also key for success in both user experience and APIs.”

~ Carlos Carneiro, Head of Open Finance Strategy, Itaú Unibanco

The only difference is in the approaches adopted to enable open banking. The EU, UK, Australia, and Mexico have taken a regulation-based approach to provide a controlled growth environment for open banking and have come up with regulations early. The US, Japan, Singapore, and India have taken a more market-driven approach. After observing transactions, these nations are working to provide frameworks and guidelines to aid open banking. Bahrain, Brazil, and Nigeria have launched a few guidelines to drive open banking initiatives while New Zealand, Canada, and South Africa are still observing how the open banking ecosystem is shaping up and what benefits it may provide to the domestic market.

EU: Payment Services Directive Version 2 (PSD2)

PSD2 is the EU’s open banking regulatory framework. PSD has been in existence since 2007 and dictates how banks and credit unions share user data in standardized formats through protected mechanisms only. It also mandates that data be shared with only licensed TPPs. Being the first to come up with regulations around data sharing, the EU serves as a baseline for governments across the world to initiate regulations.

Australia: Consumer Data Rights (CDR)

CDR was released in 2018, after recommendations of the Review of Open Banking in Australia. It was based on the transformative impact data is expected to have on the financial sector. The review highlighted that an accredited data recipient in any sector must also be a data provider in a standardized and equivalent format on customer approval. This is aimed at fostering a “more dynamic and vibrant” financial landscape.

“The Consumer Data Right – set down in the law notion that the user owns all of their data, not just their financial data.”

~ Jacob Parker, CEO of Fiskil

US: Personal Financial Data Rights (PFDR) Proposal

The proposal covers data providers and third parties who gain access to consumer data. It explains which institutions are data providers and which are TPPs, related to financial products and services. It obligates the provider to provision access and both providers and users of data to maintain security and privacy across access and transmission channels. The regulation is complex and detailed with the aim of performing the dual function of enabling access without introducing vulnerabilities to customer privacy. The rule will enforce standards to establish and maintain standards for financial institutions to share customer-authorized data with third-party providers. PFDR is designed to accelerate open banking, citing the multitude of benefits it has for the banking industry and the ways it has benefited the European region, where open banking is much more evolved and organized. The organization sought comments till December 29, 2023, and plans to share the final rule in Fall 2024.

Advantages of Open Banking

Open banking offers a plethora of benefits for all participants – customers, financial institutions, banks, and credit unions.

Customer: The Ultimate King

Every bank, credit union, and third party that succeeds keeps the customer at the fore of all decisions. Here’s how open banking supports the customer:
  • Customers can exercise greater control over their financial data. They can choose who accesses their data, and to what extent, and can revoke permissions whenever they want to.
  • Through a streamlined view of available services, such as credit facilities, loan eligibility, and credit card options, customers get to practice smarter financial management.
  • With open access to consumer data, digital payments in the open banking system require stronger customer authentication protocols, improving overall security and reducing fraud.
  • Instant gratification and tailored products are some of the most significant benefits for the customer. This brings the banking experience closer to that of other customer-facing industries.
  • With open banking, employees can get salaries for financial emergencies in advance for the number of days they have worked. This also enables faster access to credit and financing.

Businesses: The Beneficiary

A common saying in the services industry is that a satisfied customer is the best business strategy. And open banking is one way to bolster customer experiences, loyalty, and satisfaction in multiple ways:
  • With insights driven by customer data, businesses can offer better and more personalized services, aligned with the customer’s spending patterns.
  • Open access facilitates the automation of financial processes by entrusting third parties with customer data. This enables business stakeholders to focus on delivering greater value through their core offerings and improve operational efficiencies.
  • Businesses can use customer data and their own financial data to tap into novel financing sources and simplify access to credit.
  • Lightning-fast and cost-effective payments, powered by open banking-based services, provide greater control over the capital flow. It enhances the financial management capabilities of the business.
  • The ability to offer innovative products and services at reduced prices elevates brand positioning and lifts conversion rates.

Financial Institutions: The Data Repository

Despite the availability of massive data volumes, financial institutions, especially legacy banks, have lagged in leveraging the untapped potential of such data. Plus, FinTechs and NBFCs, the torchbearers of tech adoption in the industry, have increased the competition manifold. Open banking is an opportunity for FIs to redefine their growth trajectory in the age of digitization:
  • FIs can leverage data to create new financial products and services. As the primary controllers of data repositories, these institutions have an edge over other businesses.
  • Open banking empowers banks and credit unions to compete against modern financial service providers, such as FinTechs, and neobanks. They can address the dramatically evolving customer demands while managing the escalating costs of launching new products and services.
  • It drives stronger data protection, compliance, and security efforts to maintain the integrity of data and customer privacy. This fortifies transparency and accuracy in data and reporting.
  • It opens new streams of revenue for FIs, giving them an opportunity to enhance customer loyalty through differentiated offerings. FIs can strategically monetize customer data and further enhance earnings.

Challenges Financial Institutions Face in Adopting Open Banking

Openness adds to the complexity of operations and workflows for banks and credit unions. They must strategically plan their transition and redefine business models to lay the foundation of a collaborative financial ecosystem.

Refurbish Legacy Systems

Banks need to upgrade their technology stack in order to accommodate modern APIs. They need a responsive, fast, and agile intermediary layer that enables data access to third parties without making the internal systems vulnerable. Upgrading technology, data management practices, and process flows of legacy systems to modernize the banking experiences is crucial to using the edge data provides over new players in the market. Source: softwareag.com

Fortify Security and Financial Privacy

Since data sharing entails more than just opening up access to data warehouses through APIs, adopting open banking begins by enforcing strong compliance and security measures. Ensuring compliance with data use and sharing regulations internally and of third parties is paramount to protecting customers’ privacy. Further, upholding the rights of the customer to enable or disable access to their data at will is a critical aspect of open banking.

Redefining Business Models

Becoming the center of the developing open banking ecosystem requires banks to redefine operating models, workflows, and business processes to effectively monetize data. They must enable swift and secure data sharing through API-based integrations while simultaneously discovering alternative routes of revenue generation and competing in the financial services market.

Avoid Becoming Data Pipes

One of the most significant risks banks and credit unions face is that of turning into a data supply pipeline for FinTechs and other budding players in the financial space. Forming strategic collaborations, developing innovative products and services, and breaking out beyond the  existing boundaries of retail are essential for banks to maximize the gains from the open banking environment. Open banking naturally fosters economies of scale through big data and networking capabilities. It is set to alter the competitive landscape of financial products and services across the spectrum.

Principles of Open Banking

The working premise of open banking is to facilitate the secure sharing of banking data with third-party providers. It works on the following principles:

User Consent

The data accumulator must explicitly seek permission from the account holder to securely share their data with TPPs. The process involves transparently revealing purposes the data will be used for, the duration for which it will be stored, and the level of privacy that will be maintained. The permission granting and revocation takes place only via secure authentication practices.

API Integration

The bank or the FI that collects consumer data augments its technology stack with an intermediary layer that uses APIs to connect with third parties that need user data. These APIs share encrypted information securely. The FI must collaborate only with regulated and compliant third parties.

Data Retrieval

The third party retrieves the desired data only for customers who have given their consent. Third parties may necessitate the sharing of some kind of data for certain services to ascertain user eligibility or provide personalized offerings. For instance, knowing the credit score might be required to approve loans.

Service Delivery

APIs use secure mechanisms to deliver the requested data to third parties. Depending upon the services of the third party, the data may be rendered non-identifiable to maintain privacy or shared as is to facilitate personalization.

Opening Secure Channels of Data Access

Open banking requires more than just a technology upgrade. It involves legal, contractual, and regulatory contexts to smoothly enable data sharing among the participants. Banks must take the following initiatives:

Features of Open Banking

Open banking is a concept that revolves around harnessing the untapped potential of data. Its key features include:

Tokenization

A primary feature of data sharing in open banking is replacing the original data with tokens that have no intrinsic value. The data is replaced after encryption, making it extremely difficult for unauthorized entities and those without the decryption key to extract value from the data. The tokens are stored and shared, while actual details like card numbers, etc., remain protected.

Transparency

This means information regarding who accesses consumer data, what data is shared, and the purposes it is being shared for is fully disclosed to the customer. Additionally, the customer has complete control to disable data exchanges or limit access.

Interoperability

The notion of openness rests on the availability and accessibility of data to all financial institutions equally. This means data will be shared in standardized formats using standard APIs to provide equal opportunities to all participants to gather insights from it. This is expected to boost competition and streamline interactions to elevate customer experience.

Governance

Data governance is the most crucial aspect of open banking. It includes defining standards and mechanisms to collect, store, share, update, and delete data. It is key to building the trust of stakeholders and customers. It is crucial to maintain the integrity of the emerging data-first banking and financial ecosystem.

Financial Inclusion

Complete financial inclusion is one of the major Sustainable Development Goals (SDGs) to for 2030, and also the goal of the World Bank’s Financial Access 2020 initiative. The goal is to make money accessible to everyone even.

Privacy

A major aspect of open banking is that open data should not become synonymous with zero privacy. To protect consumer interests, it involves controlled, tokenized, randomized, and non-traceable bulk data.

The Open Banking Ecosystem

The open banking ecosystem is the collaborative community of banks and FIs, third parties, technology providers, and regulators. They all share the common ambition of elevating the banking experience.

Revolves Around the Customer

It drives innovation to enhance customer experiences, bolster data privacy, and offer differentiated products and services to make lives easier. Open Banking is a Paradigm that Benefits all Participants Source: MX.com Banks, FinTechs, credit unions, and other financial institutions improve their operational models to rapidly innovate valuable services using non-personally identifiable data. Increased availability of data enhances opportunities for data services and boosts customer engagement and satisfaction. Adequate regulatory oversight ensures that customer privacy is maintained and that the highest standards of security are ensured throughout the ecosystem. All participants in the ecosystem have well-defined roles:
  • Banks: Provide the infrastructure to facilitate the accumulation, management, and sharing of data.
  • FIs: Leverage technology to offer innovative products and services to the customer.
  • Third Parties: Use customer data to deliver excellence by introducing new and impactful products and services using the banking infrastructure.
  • Technology Providers: Provide the technology to ensure compliance, enable data sharing, and create new and innovative solutions to address customer needs.
  • Regulators: Provide rules to ensure that data shared among banks and third parties is secure and all involved participants practice superior security to prevent cyber threats.
Source: https://blog.brankas.com/the-ultimate-guide-to-open-banking-what-it-is-and-why-it-matters

Is Open Banking Safe?

Open banking rests on secure data-sharing practices. Diverse regulations are in place to ensure the safety of open banking. Protecting the privacy of the end-user, ensuring non-traceable data consumption, and preventing cyber threats from breaching the open banking ecosystem are paramount. Some of the popular measures implemented by participants in this ecosystem are:

  • Strong Authentication: Processes such as 2FA, and biometric authentication are used to verify the identity of the initiator for each request.
  • Encryption: All data exchanged between participants is encrypted to ensure that no unsolicited user can intercept, decipher, or alter the data.
  • Access Controls: Users have complete authority to enable, disable, or limit access to their data by third parties. Only permitted data can be shared for the purposes a user has consented to.
  • Stringent Oversight: Governments and regulatory bodies impose security and privacy measures extensively. They ensure compliance by conducting regular audits and levying heavy penalties for compliance failure.

Use Cases of Open Banking

Here’s a look at the top 12 categories of use cases that open banking is expected to achieve in the near future according to a survey by Open Banking Excellence.

Factors Driving the Growth of Open Banking

In the rapidly evolving global financial landscape, the key drivers of open banking adoption are:

Rapid Technological Transformation

Ubiquitous mobility, smart devices, and pervasive connectivity have made a variety of products and services accessible to the customer. The emergence of AI, blockchain, and big data, along with the growth of the e-commerce industry, has introduced customers to new and elevated experiences. The use of analytics and real-time technologies has further brought services closer to the customer, providing greater affordability and choice.

Weight of Customer Expectations

Hyper personalization and anytime, anyplace access offer convenience, speed, and frictionless access to customers across industries. Digital and non-baking challengers with a laser-sharp focus are increasingly redefining financial experiences with customer-centric propositions. Customers have grown to expect the same quality, personalization, and value from financial service providers as well.

Evolving Regulatory Atmosphere

With an increased focus on protecting customer interests and fostering competition, regulators envision an open and accessible financial ecosystem. Policymakers worldwide have proposed frameworks to enable data sharing with third parties with customer consent. Incorporating the ability to swiftly adapt to regulatory shifts has become an industry imperative.

Emergence of Competing Players

From FinTechs to global digital giants, condensing and overlapping services pose a threat to the banking industry. The emergence of lean and agile providers seamlessly accommodates customer demands, offering personalized and digitized experiences. Keeping a safe distance from banking regulation and not being weighed down by legacy systems gives them an edge over traditional banks and credit unions.

The Future of Open Banking

We are at an inflection point for the banking industry. With the emergence of decentralized finance, cryptocurrencies, BNPL, and instant payments, the consumer and financial landscape are undergoing significant transformation. The field is open to experimenting and pivoting the industry to its next era.

Enhanced consumer awareness, increased competition, and availability of the latest tools and technologies make for a great opportunity. Consumers want to experience a financial ecosystem where loyalty is not the only reason to stick to a provider, but value, affordability, and quality of service determine who stays and who exists in the competition. Additionally, open finance, in its early stages as of now, is the perfect augmentation to open banking to drive the financial industry to the data-first age.

Open banking has given a technology-fuelled approach to traditional banking to redefine the financial landscape in association with FinTechs. It drives customer experience to new levels of satisfaction and loyalty. It will facilitate improvement in financial services and lower fees. The future of open banking envisions:

Emergence of Account Information Service Providers (AISPs)

In the open banking architecture, AISPs will become the aggregators of customer data. They will accumulate data from various banks and financial institutions. This will form the framework of a unified UX. It eliminates the current unsafe and unethical practices of screen-scraping. This will lead to an increase in both competition and the safety of the financial ecosystem. It will create opportunities for cross-selling and help customers make informed decisions.

Increased Financial Safety

Greater regulatory oversight will enforce the licensing of data accumulation, sharing, and use. Further, users will determine the volume and content of financial information they are willing to share. This entails informing users of their rights and responsibilities and the rules of the open banking ecosystem. The PSD2 directive, for instance, is designed for customer security and privacy in the digital banking ecosystem. Regulated and secure data governance will help build user trust in open banking and ensure its success in the long term.

Simplified Onboarding

With seamless and instant access to user data, financial service providers will have new capabilities to simplify and expedite user onboarding. KYC and other verifications can be shared through trusted mediums. This will allow users to access a product or service immediately. A user’s financial history or transaction records will not be a hindrance but an aid to access better products and services. For businesses, it will ease entry into new markets.

“Open Banking is an interregnum between today’s payments system and a future dominated by central bank digital currencies (CBDCs) and the Metaverse.”

~ Robert Courtniedge, independent payments expert

Enhanced Forecasting

Combining big data and machine learning capabilities with massive data volumes, accessible from a single source (AISPs) will significantly improve insights for FinTechs. Increased predictive capabilities will facilitate the offering of greater value through targeted services and products via maximized personalization. It will increase accessibility and optimize the financial well-being of customers.

Explosive growth in innovation and increased sophistication of the open banking model will make users’ profiles and their experiences an organic part of the financial ecosystem. Therefore, embracing open banking is the only way to prepare for the future of banking and financial services.

How Can Banks and Credit Unions, and TPPs Get Prepared for Open Banking?

While banks and other financial institutions are struggling to meet the expectations of digital-savvy Millennials, the demands of digital-native Gen Z customers are already influencing the banking landscape. Gen Z now comprises 26% of the global population and younger customers consider Open Banking more valuable.

The Open Data economy is expanding rapidly, against the backdrop of the accelerated pace of regulations and the proliferation of platforms. Bankers, credit unions and TPPs need to be prepared before this wave of change turns into a Tsunami that engulfs legacy financial entities.

Open Data is the starting point for Open Banking. However, data today is dispersed across varied platforms, making it disparate. The prerequisite for Open Banking is data aggregation and consolidation, making data ready to be accessed by APIs.

The first step for banks, credit unions and TPPs is to orchestrate data to achieve data integration and interoperability, and abide by data exchange protocols like JSON, XML, or ISO 20022.

Once this is achieved, here’s a blueprint of processes for banks, credit unions and TPPs to be ready for Open Banking:

  • API Gateway: It is a centralized entry point for managing and securing API interactions such as authentication, authorization, rate limiting, and other security measures.
  • API Management Platform: The platform enables easy discovery and consumption of APIs by external developers, partners, and internal stakeholders through features like API documentation, versioning, analytics, and a developer portal.
  • Microservices Architecture: Decompose the monolithic system into smaller, modular services that are responsible for specific business capabilities. Each microservice can expose its functionality through well-defined APIs, enabling flexibility, scalability, and independent deployment.
  • Service Orchestration: Orchestration ensures the seamless flow of data and operations across different microservices, allowing APIs to interact and work together to execute end-to-end transactions.
  • Event-Driven Architecture: Events can trigger actions within the core banking platform and notify interested parties about relevant changes or updates. This architecture ensures loose coupling, scalability, and responsiveness in handling API interactions.
  • API Security and Authentication: Apply role-based access controls to ensure that only authorized users or applications can access specific APIs and perform authorized actions.
  • Scalability and Performance: Employ techniques like horizontal scaling, caching, load balancing, and auto-scaling to handle increased API traffic and ensure optimal performance even during peak usage periods. Implement monitoring and performance testing processes to proactively identify and address bottlenecks or performance issues.
  • Compliance and Governance: Ensure compliance with regulatory requirements and industry standards related to API usage in the banking sector. Implement proper data governance practices, security controls, and monitoring mechanisms to maintain data privacy, security, and compliance with relevant regulations.

Value Creation by Tech Partners in the Journey to Open Banking

While there’s a lot to be done, the good news is that financial institutions can rely on a specialized technology partner to work closely with them to streamline data, provide connectivity between public APIs, and offer proprietary platforms that support embedded experiences.

Here’s how an experienced technology partner can support banks, credit unions and TPPs to unlock the full potential of open banking:

Data consolidation: Select a technology partner that can help consolidate disparate data across all accounts, such as transactions, deposits, mortgages, and investments to provide a holistic view of customers.

Microservices-based platforms: A microservices architecture is required for banks and credit unions to scale based on developments in the open banking ecosystem. Such an architecture supports service orchestration, which enables financial institutions to build and sustain an ecosystem of external partners.

Community building: This involves connecting with developer portals for accessing APIs in a sandbox environment.

API Policy and Management: A trusted technology partner can help banks, credit unions, and TPPs to integrate APIs and related technologies that are compliant with regulations. They can also help financial institutions with API management and security.

With the growing adoption of Open Banking, legacy banks and traditional credit unions will come under pressure to adapt to remain competitive and relevant. Contact us to smoothen your journey to open banking and harness its true potential.

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