Back in 2015, the European Parliament adopted a new version of its Payment Services Directive, which included regulations to promote the adoption of open banking. Since then, several countries in the EU have developed their own legal frameworks to push for open banking. What’s more, similar initiatives around the world are already turning this approach into a force to be reckoned with in the financial services industry.
It makes sense. Open banking aims for a highly interconnected financial system to make financial services more agile and sophisticated, which perfectly aligns with the needs and demands of markets everywhere. That’s not all. Open banking promises a massive overhaul of customer experiences across the board through increased transparency and easier wealth management.
Here’s how that looks and what it can mean for the future of financial services.
What Is Open Banking?
Open banking (also called “open financial data”) is a financial services approach that fosters the adoption of technology that connects third-party APIs with financial institutions. In other words, it’s all about using tech to enable software engineers to build apps and services that complement, supplement, and integrate with existing financial services.
Thus, open banking pushes for an expansion of the current financial universe but puts the emphasis on transparency and collaboration rather than a mere addition of more financial actors. By opening traditional banking systems to both financial and non-financial organizations, open banking offers fertile ground for the development of new products and services.
One of the keys to open banking is customer consent. Why? Because open banking aims to provide easy access to sensitive customer data from banks. Without the explicit consent of bank customers, there’s no possible way that open banking would work.
Obtaining that customer consent, though, might be the hardest challenge standing in the way of open banking, especially in a time when many companies have yet to prove they are worthy custodians of their customers’ data. However, the benefits of open banking can help financial institutions convince customers to opt in. Among the top advantages, there’s greater flexibility in wealth management, more visibility of all accounts, and more convenient access to diverse services.
Open banking has the potential to reshape the entire financial system, including a new way to use bank accounts, credit cards, investments, loans, mortgages, and insurance policies. Feel like I’m exaggerating? You just need to take a look at the new digital habits and the massive adoption of online banking during the pandemic to check how the landscape is changing in favor of open banking and paving the way for the revolution it entails.
Open Banking Today
Following a very thorough report by McKinsey, we can say that open banking today has 3 distinct propositions:
- Infrastructure providers—non-financial actors that only take care of providing banks and fintechs with the foundations to build open banking solutions. While their services don’t directly target customers, these providers are essential for the rapid development of new customer-facing open banking solutions, as they supply critical services to mount open banking apps, like backend infrastructure.
- Product augmenters—companies (which can be financial or not) that leverage direct access to banking data to augment their products or services. They can do so to streamline their supply chains, speed up their transactions, better manage their cash flow, and automate lending processes.
- Customer experience providers—services that wouldn’t exist without open banking, including account-aggregation platforms to monitor financial information from multiple accounts across different financial institutions.
Put like that, it might seem like open banking isn’t really a big deal. But that’s just because it’s an emerging trend. Since open banking is so relatively new in the financial landscape, many institutions haven’t had the chance to leverage it yet. What’s more, governments are still contemplating how to better accommodate their financial laws and regulations to allow these alternatives to thrive.
The Future of Finance
It’s not an easy path forward. There are higher-margin products such as mortgages and investments that are more complex to regulate, so they are still out of the scope of the current open banking regulations. The ability of the APIs is also a point of friction, as many countries only allow for data to be read, not written. That’s because controls over transactions across different institutions are a challenge from the regulatory and technical standpoints.
Does that mean that the adoption of open banking will be limited? Not precisely. While it’s limited today, it seems likely that regulators will adapt legal frameworks to give space for open banking to grow. Where will open banking grow the most remains to be seen. It’s probable that digital-only banking will largely benefit from a more flexible approach to financial regulation and data.
Faced with that challenge, traditional banks are already starting to partner with other companies to diversify their offerings and reach new customers who might fall out of their orbits. That feels like the road businesses will take in the mid-term: embedding finance solutions in their platforms, applications, and services to streamline their experiences. In a way, having these APIs to easily connect with the banking system will merge different industries at different touchpoints to provide a more seamless journey for all consumers.
The future for open banking looks promising in that light, as it has enough potential to foster a host of innovative financial services and products that potentiate what we already have or that meet needs we don’t even know we have. We aren’t there yet, but the hurdles ahead are more related to regulations than technical abilities, so they may be overcome more easily should there be enough determination to make open banking happen.
Naturally, such a massive shift will force traditional banks to assess their place in the financial system, as open banking clearly favors the innovation that fintechs are known for. It’s hard to know how that traditional banking system will adapt to those new circumstances, but one thing is for sure—they’ll have to do it, no matter what.