What exactly is open banking about? More data equals better services and that’s at the core of open banking technology. It requires the sharing of financial information between traditional financial institutions, like banks, and third party providers, or TPPs. But an open banking system is as much about the customer as it is about innovating financial services.
Currently, financial services are offered by providers who don’t interact with each other. The data on one user is spread across different silos of information. A digital transformation of financial services would be possible but only if these data sources can be shared and if authorized by the user.
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Apart from regulations regarding the sharing of data, the great challenge is in developing the technology: the ecosystem, and most importantly, the open banking APIs (application programming interfaces) needed for secure data exchange.
Open banking fits in well in today’s sharing economy. If cars (think Uber) and houses (think Airbnb) can be shared to create better systems, so can financial data. Customers can gain from this sharing, especially if the laws help them make an informed choice.
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Of course, Uber and Airbnb consider themselves tech companies, but that’s how the shared economy went digital on a large scale. It’s the same for open banking business. According to the World FinTech Report, 60% of banks and 70% of fintechs believe that a revenue-sharing model, meaning banks and TPPs share generated revenue, is the best model.
86% of global banks surveyed by Finastra consider using open APIs to enable Open Banking capabilities.
An API is what allows an application or software to securely and efficiently interact with another. APIs can be open or proprietary.
The likes of Apple or Google can have APIs with terms and conditions that partners will accept because it makes business sense. However, smaller companies will find it more difficult to get partners to accept proprietary terms like that. It’s the same in financial services as well as large banks will be setting the rules on data sharing.
This is one reason to have open banking and an open API model. Open APIs allow for easier and more secure ways to share data, reducing the difficulty in bringing new solutions to the market. Regulations are already beginning to back this, especially in Europe.
New financial services have always needed banking data. The first generation of applications, particularly personal finance management tools, had to use “screen scraping” to get data, but this required customers to provide login details to the app. The app would then choose the information needed from all the available data. This is more cumbersome and less secure than APIs, which is a more precise data pipeline.
The challenges with technology don’t stop there though. Deciding to share data doesn’t immediately translate into well-built APIs that allow this to happen.
Core banking systems may not play well with the tech required to build open APIs. Banks generally have already developed a complex set of applications over time. Like all systems, over time these legacy systems have become inefficient and are not always compatible with newer technologies, including modern APIs.
This means the banking systems need to invest in open banking API development and technology; so do the TPPs.
There are technology vendors with the tools for designing, testing and monitoring APIs. And, there is also a developer community that continually works on improving API design and features. Banks and TPPs need to use and develop these resources in order to make APIs that will be widely adopted and attract more developers.
Of course, some banks already see this investment as an alternative stream of revenue. While the EU Revised Payment Services Directive (PSD2) mandated APIs to be free, it does not apply to APIs that go beyond the basic requirements. Banks such as Nordea and BBVA are hoping to generate revenue from building APIs that do go beyond the basic requirements, providing better services.
Open APIs also mean that banks are dependent on TPPs to maintain good security. The concerns about the poor implementation of APIs is holding back open banking. Data breaches at a TPP can expose customers, especially if they store financial data.
While open banking tech develops, banks need to have systems that detect fraudulent transactions. PSD2 standards require all payment service providers, including banks, to perform a risk analysis of all financial transactions; this needs to be done in real time as well.
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But more important, is the detection of vulnerabilities in an API implementation. Poor implementation of open banking APIs can result in fraud so it would take specialized fraud monitoring to detect such weaknesses.
In a developing market, it’s important to assure customers of data privacy and security. Innovative financial services won’t be able to find customers if reports of data breaches hurt confidence in the product.
Regulations like PSD2 have provisions that require banks and TPPs to ensure this, but developing the technology would be the best way to implement it. This could mean everything from stronger ways to authenticate users to developing systems that provide only the necessary access to data.
True digital transformation happens only when existing businesses adopt the latest technology so that the benefits are passed on to the customers. A KPMG report on open banking suggests that small and medium-sized enterprises will be slow to adapt to open banking even when banks set up the APIs required.
But, there is a solution for this. The report says that there needs to be better communication on open banking and that it should be technology vendors who should drive this engagement. For example, PSD2 now requires additional security authentication for online transactions exceeding €30. A technology vendor that can help with international payment solutions via an open banking platform is both providing an essential service and increasing engagement with open banking systems.
The same report also showed that high-growth and ambitious businesses looking to expand fast would be the most willing to use open banking platforms. For instance, 24% said they would invest in open banking solutions if payments between suppliers and customers can be made faster and easier. Also, 22% said they would pay for a dashboard of financial accounts, loans, savings and assets. Most importantly, up to 50% said that open banking solutions would be acceptable from trusted financial service providers.
The impact of open banking is seen in more than just the banking system. It has spread into the whole financial services market.
While it’s unlikely that regulators will force insurers to share data like the banks do, there are several related factors that are driving insurers to do it anyway. Open banking is bringing new insurtech companies to the market with a new mindset of openness which is essential for securing their future relevance. They focus on tech and use data to provide personalized and integrated services. These new insurtech firms also promote an ecosystem of products, rather than individual services from separate companies which ultimately leads to more refined service portfolios, which means customer retention and better ROI.
‘Open insurance’, that is sharing and using data and services across industries by means of open APIs, is a rising trend no less important than open banking. It empowers insurance service providers to build what is anticipated by the customers, digital offerings and business models, and then connect with customers via new ways that drive operational excellence.
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The insurance industry can learn from early adopters of open banking. The banks that embraced open banking technology and platforms benefited the most with diversified revenue streams due to versification of their traditional offerings and enhanced customer value. It’s best not to wait for regulation or share the bare minimum data. Customers will get used to integrated services and so technology companies are already willing to provide these services.
Open banking is meant to create an ecosystem of services that rely on access to data, but this ecosystem develops based on the regulations each market has for data sharing.
Let’s start with the European Union, who have taken a long-term approach to it. The EU has always had regulations when it comes to data privacy and sharing.
The PSD2, or the Revised Payment Services Directive, governs payment services and providers. The regulation wants more non-banks to provide services and to improve competition in the European Economic Area (EEA). It also wants a more coordinated approach to consumer rights.
All of this supports open banking. In fact, a key provision of the PSD2 allows for account access to non-banks. Nordea was an early adopter, opening its APIs to developers and customer data. Then there are initiatives like the Berlin Group working on PSD2 access.
The UK’s separation from the EU doesn’t alter regulations either. Many of PSD2’s provisions are part of UK law and their Open Banking Standard, which is just as strong.
The US, however, is missing this centralized approach to open banking and data sharing. There is no central regulatory system, with as many as eight federal agencies having some jurisdiction over access to financial data. The US Treasury Department is trying to organize agencies to allow users to authorize access to financial data.
This has not stopped fintech innovation of course, but the market is not scalable without long-term regulations. Currently, agreements are between individual banks. An example is Chase and Wells Fargo with Xero and Finicity.
South of the border, Mexico has laws that support open banking APIs in the financial system. They’re also trying to develop standards, especially relating to API standardization. The Central Bank of Brazil is also working on an open banking model.
The Asia-Pacific region is more aggressive in implementing open banking APIs. Singapore has a fintech market built around APIs for risk analysis as credit scores are not available. The Monetary Authority of Singapore has established a fintech division to regulate the process.
The Hong Kong Monetary Authority has required Tier 1 banks to open their APIs. South Korea was the first country to launch a common API infrastructure across financial institutions. In India, the implementation of digital identities for citizens is creating a digital ecosystem that includes open banking APIs. Australia is considering regulations similar to the PSD2.
Africa has provided surprise innovators in open banking systems. Consider Rwanda. The National Bank of Rwanda has published a regulation on collecting and analyzing customer data with the financial technology market growing.
Nigeria is developing API standards for a number of banking services. In South Africa, both innovative banks and fintechs are pushing open banking trends. In East Africa, new risk assessment models are emerging from alternative sources of data like mobile phone usage, and the most popular example is M-Shwari.
In summary, open banking is the digital transformation of an established financial market. More data and regulations on authorized use of data can provide a lot of benefits for the financial sector.
Of course, any change in technology and an established system also comes with challenges. Change is inevitable. But these challenges cannot be ignored.
While there are still multiple challenges, the benefits of open banking are driving its wider adoption. Fintech software vendors are building cloud solutions, deploying machine learning algorithms and creating advanced data analytics platforms to tackle open banking issues.
As a trusted tech provider, Avenga continues to develop a whole variety of digital solutions for the BFSI sector, reviving the vision of financial institutions so they can stay relevant to their customers. Our proven track record of software development services and solutions shows that we support our clients as they embrace openness and become active participants of this new digital world.