Open Banking and Implementation in the Regulation Standards
For the coming three posts, including this one, we will talk more about open banking, embedded finance, and digital banking, following the chart below. The three topics are in the trough of the cycle.
The data also shows increasing interest in this field. According to Dealroom (Open Banking list | Dealroom.co, no date), in Europe, open banking has raised funding of $1.6B (data updated in September 2022). Moreover, in the global open banking market, the size was valued at $16.1B in 2021 and is expected to grow at a CAGR of 26.8% to reach $128.12B in 2030 (Open Banking Market Size Report, 2022–2030, no date). As per the data from Dealroom (Dealroom.co | Open Banking list, no date), there are 140 open banking companies to date, including the incumbent players.
Open banking, also known as open finance, refers to the use of open APIs that allow third-party financial service providers to access a customer’s financial data with their consent. This enables customers to easily share their financial information with multiple providers and allows for the development of new, innovative financial products and services (Open Banking: Definition, How It Works, and Risks, no date).
We might wonder why open banking is needed in this digital era while banks have kept their customer data in-house. The benefits encompass multidimensional scopes, giving advantages to the financial services company, the merchants, and the customers. The fintech companies have expanded data to build new products and services, the merchants can utilise the products from the financial service providers to improve their tools and payment flow, and the customers can now enjoy more financial services that are previously out of the platform’s scope (Kiskyte, no date).
One key aspect of open banking is open payments, which refers to the use of open standards and APIs to enable the seamless transfer of money between different financial institutions and payment systems. This can help to reduce costs, increase competition, and improve the overall efficiency of the financial system.
One example of open banking in action is the development of digital wallets, which allow customers to store and manage multiple payment methods in a single place. These wallets can be linked to a customer’s bank account, credit card, or other payment methods, and can be used to make payments in-store, online, or through mobile apps.
Another example is the development of peer-to-peer (P2P) payment systems, such as Venmo and Zelle, which allow individuals to easily send and receive money from one another using their mobile devices. These systems have become increasingly popular in recent years, as they offer a convenient and low-cost alternative to traditional bank transfers.
Open banking also has the potential to benefit small businesses, by making it easier for them to access financial services and manage their cash flow.
Moreover, in countries with low adoption of the population to banking services, open banking provides a solution where financial services could boost financial inclusion to the population. For example, India Stack addresses this problem in India by focusing on the three main components to pave the way for open banking(IMF Working Papers Volume 2021 Issue 052: India’s Approach to Open Banking: Some Implications for Financial Inclusion (2021), no date):
- Digital ID. Digital ID has facilitated a large expansion in the user base. This is because ID and KYC pose a great barrier when a user wants to start utilising financial services. One unique problem that the digital ID tries to solve is the technology exclusion across demographics, e.g from the income bracket and age characteristics. With the simplicity of the requirements to establish an identity and the fact that the payment can be used without smartphones, the digital ID helps the inclusion of the population who do not prefer using smartphones (e.g. older people).
- Payments system, called the Unified Payment Interface (UPI). This is a critical feature since all the financial services firms to operate the UPI must hold a certain licence with the limitation compared to banks. Moreover, interoperability is supported by the RBI (Reserve Bank of India). This is created through a standardised open API for the developers, including the markup language that standardised the instructions for sending and receiving money within the system. Also, the banks agree to a common authentication system, making the user journey more uniform across the payment providers.
- Data sharing. In general, RBI has issued guidelines for the implementation of open banking in India, which include the following: Banks must provide APIs to third-party providers (TPPs) for access to customer data, such as account information and transaction history. Moreover, the banks must implement strong security measures to protect customer data, including encryption and authentication, and conduct periodic risk assessments and penetration testing to ensure the security of customer data. On the other hand, the customers must provide explicit consent for their data to be shared with TPPs.
In the UK, the open banking framework was established by the Competition and Markets Authority (CMA) in 2016 and implemented by the Open Banking Implementation Entity (OBIE) in 2018. It is based on the EU’s Payment Services Directive 2 (PSD2) and is designed to increase competition and innovation in the banking sector by allowing third-party providers to develop new financial products and services using customers’ data. The framework is overseen by the Financial Conduct Authority (FCA) and requires participating banks to comply with strict security and data protection standards (v3.1.10, no date).
The UK regulations for open banking are also consolidated, from the standard to the ecosystem. The scope of the standards is the API specification, the security profiles, the user experience guidelines, and the operational guidelines including the issues and dispute management. The open banking standard in the UK also provides developers with a sandbox to test their concept and code without using real transaction data.
Closing Thought
It’s important to note that open banking also raises concerns about data privacy and security. To address these concerns, regulatory bodies are implementing strict guidelines and standards that financial institutions must adhere to in order to protect the personal and financial information of customers.
Overall, open banking and open payments have the potential to improve the efficiency, accessibility, and innovation of the financial system. It’s important to address the concerns and challenges that arise as the ecosystem evolves.
References
IMF Working Papers Volume 2021 Issue 052: India’s Approach to Open Banking: Some Implications for Financial Inclusion (2021) (no date) imfsg. Available at: https://www.elibrary.imf.org/view/journals/001/2021/052/001.2021.issue-052-en.xml (Accessed: 17 January 2023).
Kiskyte, A. (no date) Open Banking explained: Everything you need to know | kevin. Available at: https://www.kevin.eu/blog/open-banking-explained/ (Accessed: 18 January 2023).
Open Banking: Definition, How It Works, and Risks (no date) Investopedia. Available at: https://www.investopedia.com/terms/o/open-banking.asp (Accessed: 17 January 2023).
Open Banking list | Dealroom.co (no date). Available at: https://app.dealroom.co/lists/20832 (Accessed: 19 January 2023).
Open Banking Market Size Report, 2022–2030 (no date). Available at: https://www.polarismarketresearch.com/industry-analysis/open-banking-market (Accessed: 19 January 2023).
Top Open Banking Startups (no date). Available at: https://tracxn.com/d/trending-themes/Startups-in-Open-Banking (Accessed: 19 January 2023).
v3.1.10 (no date) Open Banking Standards. Available at: https://standards.openbanking.org.uk/good-practice/latest/ (Accessed: 17 January 2023).
