Open Banking — Future, Challenges & Opportunities
Open banking enables financial service providers from a third party to access and use financial data from banks and other financial organizations with the users’ consent. It involves the electronic, secure, and standardized communication of financial information that customers have given permission for. By allowing users to offer trusted third-party providers access to their financial data, open banking intends to encourage competition, innovation, and consumer choice in the financial sector.
With the development of technology and the rising need for individualized financial services, the idea of open banking gained traction. Open banking aims to end banks’ historical monopoly on customer data by requiring them to provide safe APIs for sharing customer data in an open and secure manner.
Third-party providers can create creative applications and services that make use of client financial data. These services can include investing platforms, loan and payment services, budgeting tools, account aggregation (where users can view numerous bank accounts in a single app), personal finance management apps, and more. Customers that use open banking can better manage their financial data and make use of more specialized and affordable financial goods and services.
The two main categories of third-party providers are:
Account Information Service Providers (AISP) are authorized to retrieve account information from banks and financial institutions and to aggregate financial data from banking institutions.
Payment Initiation Service Provider (PISP) are authorized to begin payments into or out of a user’s account without requiring a card or log-in information.
In the upcoming years, it is expected that the global open banking market will expand dramatically. The size of the worldwide open banking market was around $25.14 billion in 2022–2023 and to increase at a CAGR of 27.2% from 2023 to 2030 to reach $135.17 billion by 2030 (Source: Grand View Research). Open banking services were used by 24.7 million people as of 2020; by 2024, that figure is expected to rise to 132.2 million.
Around 71% of global financial institutions have already implemented or plan to implement open banking initiatives, according to research by the Open Banking Initiative. According to a Deloitte study, 64% of customers think open banking will improve their ability to manage their finances.
APIs have been multiplying at a rapid rate. Over 11,000 APIs were listed in the Open Bank Project’s global open banking API directory as of 2021. Partnerships and collaborations between banks and the fintech sector are growing. 504 fintech-bank agreements were established globally in 2020, an increase of 33% over the previous year. (Source: The World FinTech Report by Capgemini, 2021).
But open banking continues to raise questions about data security. Millions of clients have been impacted by several open banking-related data breaches. For instance, the UK-based finance business Monzo disclosed a data breach in 2020 that affected some 500,000 consumers.
An overview of how open banking functions is provided below:
§ Client Consent: The procedure starts with the client explicitly giving permission for the sharing of their financial information with third-party suppliers. Most of the time, their bank will provide a safe web platform or mobile application for them to give their approval.
§ API Integration: Banks and other financial institutions offer APIs that permit reputable third parties to safely access consumer data. Information including account information, transaction history, balances, and other pertinent financial data can be exchanged via these APIs.
§ Secure Data Transfer: When a customer requests a service from a third-party provider, like a personal finance management software or a loan comparison platform, the third-party provider securely retrieves the necessary financial data from the customer’s bank using the authorized API.
§ Data Aggregation and Analysis: To provide specialized services, insights, or suggestions, third-party suppliers gather and analyze the customer’s financial data. For instance, based on the client’s financial profile, they might give tailored loan offers, investment advice, or budgeting tools.
§ Service Delivery: Using the financial data that has been analyzed, the third-party provider provides the service or product that the consumer has requested. This can entail showing account data, making payments possible, or producing reports.
§ Ongoing Data Access: By allowing ongoing access to customer data, open banking APIs make it possible for third-party providers to offer consistent and up-to-date services. The consumer, however, still has control over their data and is always free to remove access.
As far as the major players of banking and their segmentation is concerned, there are a wide range of participants, including financial institutions, tech firms, regulators, and fintech startups.
§ Financial and Banking Institutions: Open banking involves a considerable contribution from conventional banks and financial institutions. They implement open banking APIs, give customers access to their financial data, and create cutting-edge services. Examples comprise:
The open banking movement has been actively promoted by BBVA (Spain), which has also embraced working with fintechs. To promote innovation and enhance customer experiences, it has developed developer portals and APIs. Another conventional bank that has forayed into open banking is Barclays. To promote the creation of fresh applications and services, it has introduced an API sandbox and developer portal. DBS Bank, Banco Santander, JPMorgan Chase, HSBC, and other institutions are testing out open banking.
§ Technology Companies: A range of tech companies provide services to support open banking and enable safe data sharing. They create identity verification systems, data aggregation tools, and API platforms. In this field, important participants include:
Plaid (bought by Visa) focuses on making it possible for financial institutions and outside applications to communicate seamlessly. They provide services and APIs that make it easier to share data, start payments, and verify accounts. Solutions for data gathering and analytics are offered by Yodlee (Envestnet). Google has collaborated with banks and payment processors to demonstrate its interest in open banking. Their digital wallet, Google Pay, has grown to include banking features, enabling users to link their bank accounts, process payments, and handle their finances. With services like Amazon Pay and Amazon Lending, Amazon has looked into prospects in the banking industry. Their sizable client base and digital infrastructure make them a viable player in this market even though they are not specifically focused on open banking. Other participants include Tink, TrueLayer, Token.io, etc.
§ Fintech startups: These companies have been critical in promoting innovation and utilising open banking features. They develop innovative financial services, improve consumer interactions, and use data to develop individualized solutions. Among the top competitors are Revolut, Monzo, Wise, N26, etc.
§ Payment Service Providers (PSPs): In the open banking environment, PSPs make payments and transactions possible. They offer solutions for interoperability, security, and infrastructure. PayPal, Stripe, Adyen, Square, Worldline, and other significant PSPs are active in open banking.
Some significant opportunities in the area of open banking are:
§ Enhanced Customer Experience: Open banking permits the sharing of financial information with outside sources, facilitating the creation of cutting-edge programs and services. This may result in more tailored financial products, greater consumer involvement, and simplified business procedures.
§ Fostering Innovation: Open banking enables the production of new financial goods and services, which promotes competition, fosters innovation, and results in customer-centric solutions.
§ Collaboration and Partnerships: Open banking makes it easier for established banks and fledgling fintech companies to work together. Banks may use the flexibility and creative ideas of fintech firms, and fintech firms can profit from the infrastructure and existing customer base of traditional banks.
§ Financial Inclusion: By giving previously underserved people access to financial services, open banking has the potential to support financial inclusion. Open APIs enable fintech businesses to create products that address client requirements, such as low-cost financial services, microloans, and budgeting tools.
§ Data-Driven Insights: Open banking makes it possible to combine financial information from various sources. Banks and other service providers can benefit greatly from this data by learning more about client behavior, spending habits, and financial health. Utilizing this data will enable more accurate risk assessment, targeted marketing, and personalized advice.
§ Ecosystem Development: Open banking fosters an environment where different players, such as banks, fintech firms, technology suppliers, and regulators, may work together and advance the financial sector. This ecosystem has the potential to spur innovation, enhance regulatory compliance, and generate fresh business prospects.
If we talk about the challenges involved in open banking, primarily two types of challenges are there — technical and regulatory.
Technical Challenges
§ API Standardization: Open banking needs standardized APIs to facilitate easy integration and interoperability between various platforms and systems. However, due to different legacy systems, data formats, and security protocols, attaining API standardization across numerous banks, financial institutions, and third-party suppliers can be difficult.
§ Data Privacy and Security: Open banking involves the exchange of private financial information; thus these issues should be taken very seriously. Critical problems include ensuring secure data transfer and storage, strong authentication systems, access controls, and encryption. To safeguard against unauthorized access, data breaches, and fraudulent activities, effective cybersecurity measures must be in place.
§ Legacy System Integration: A large number of conventional banks and financial institutions use outdated technology that wasn’t made for open integration. It can be difficult to integrate these technologies with current API infrastructure and guarantee compatibility. To enable seamless data sharing and communication, large investments, system changes, and migration initiatives may be necessary.
§ Scalability and Performance: Processing a huge volume of data in real-time for open banking can be challenging for scalability and performance. For deployment to be effective, systems must be able to manage large amounts of data requests, maintain low latency, and deliver a dependable user experience.
Regulatory Challenges
Due to the need to strike a balance between innovation and competition with the preservation of consumer rights and financial stability, open banking projects confront a number of regulatory obstacles.
§ Data Protection and Privacy: The sharing of financial and personal information that occurs in open banking raises questions regarding data protection and privacy. Customer data collection, storage, and sharing are subject to stringent regulations, such the EU’s General Data Protection Regulation (GDPR). It can be difficult to ensure adherence to these rules and permit data sharing.
§ Consent Management: In order to access a customer’s financial information and start transactions on their behalf, open banking depends on that customer’s agreement. It is crucial to establish reliable consent management frameworks that provide customers with control over their data and the option to cancel consent at any time. Defining explicit consent procedures, guaranteeing openness, and resolving concerns with informed consent and data access rights are some of the regulatory hurdles.
§ Security and Fraud protection: Regulatory frameworks frequently demand robust data encryption, strong authentication protocols, and fraud protection tools. The problems that need to be overcome include ensuring compliance with security requirements, keeping an eye out for fraudulent activity, and putting in place reliable customer authentication procedures.
§ Competition and Market Dynamics: Open banking gives new players and outside suppliers access to banking infrastructure and customer data in an effort to promote competition and innovation. Creating a level playing field, stopping anti-competitive behavior, and assuring fair access to financial infrastructure and client data are examples of regulatory problems. Regulators need to combine fostering competition with preserving market stability.
§ Regulatory Oversight and Supervision: Banks, fintech firms, payment service providers, and data aggregators are just a few of the many stakeholders in open banking. Regulatory issues include developing oversight mechanisms, maintaining compliance with regulatory obligations, and defining the duties and responsibilities of each stakeholder. To ensure compliance with data privacy, consumer rights, anti-money laundering (AML), and know your customer (KYC) rules, financial institutions and third-party providers must negotiate complicated regulatory environments. It is a big difficulty to adhere to numerous rules while retaining operational effectiveness.
§ Cross-Border Operations: Open banking efforts frequently cross international borders, necessitating collaboration and coordination between authorities in many jurisdictions. The harmonization of regulatory frameworks, handling cross-border data exchanges, and guaranteeing adherence to pertinent legislation in many nations are some regulatory problems.
§ Customer Protection and Dispute Settlement: Regulatory frameworks must include methods for protecting customers, such as transparent dispute settlement processes, liability frameworks, and complaint handling procedures.
Collaboration between financial institutions, regulators, and technology suppliers is necessary to build safe and standardized open banking frameworks that protect customer interests and ensure the stability of the financial ecosystem.
In India, open banking is a relatively new idea, and its adoption is still in its infancy. In August 2020, the Reserve Bank of India (RBI) published a drafting framework for open banking that included a staged implementation process. The framework mandates that banks create APIs that give outside suppliers access to their consumer data and payment infrastructure. The APIs must guarantee the confidentiality and privacy of client data and follow any technological guidelines established by the RBI.
The National Payments Corporation of India (NPCI) received permission from the RBI in November 2020 to act as an “Account Aggregator,” allowing clients to securely and effectively share their financial data with outside suppliers.
A few Indian banks, like HDFC Bank and ICICI Bank, have already deployed open banking APIs for their clients. But since many banks are still working on building out their infrastructure and APIs, there is still a long way to go before open banking is widely used in India, but the legal foundation and technological foundation are being built progressively to facilitate its expansion.
