Open Banking- A primer

Do you know “Open Banking” is the UK variant, whereas the general term for it across the world is “open banking”?

In the UK, the letters ‘O’ and ‘B’ are capitalized, whereas it is not in the rest of the world. This is because the practice of lowercase refers to the action of providing open access to financial data. Whereas in the UK, an initiative spearheaded by the Competition and Markets Authority (CMA) uses the uppercase.

The reason behind it is that CMA mandated that the CMA9 (nine biggest banks in the UK) offer access to financial data in a secure and standardized format with customer’s explicit consent to share the data.

To elaborate further, “Open Banking” or “open banking” is the practice of sharing a customer’s financial data with Third-Party Providers (TPPs). This information sharing happens through Application Programming Interfaces (APIs), giving the TPPs access to the customer’s data.

While the term might sound a bit scary, it is not unsafe as it sounds. The sharing of customer data with TPPs only happens after the customer explicitly agrees to share their data. Nowadays, banks are diligent and are setting up infrastructure that offers TPPs access only to data agreed to be shared.

Furthermore, open banking aims to offer improved and user-oriented financial services as opposed to the misconception of banks gearing up to sell customer data.

Before we go further, let’s go to the roots of open banking.

Origin of Open Banking

The term Payment Service Directive 2 or PSD 2 is now identified with “open banking.” It also has its predecessor, PSD that was released in late 2007.

The primary aim of PSD was to harmonize consumer protection with the rights and obligations of payment service providers and users. PSD and PSD2 were introduced to establish an integrated payments market that offered best-in-class security and infrastructure to the end-users.

PSD also allowed countries to include sections that are explicitly valid for their payment industry. It was released as legislation on November 1st, 2009 and accepted by all EU and EEA member states. However, even though PSD offered a comprehensive framework, it was not inclusive when considering international payments outside the European Union (EU). Furthermore, it was not designed for Third-party service providers in its scope.

These loopholes led the European Union to build a more robust framework for this directive, which resulted in Payment Service Directive 2. It came into force on January 13th, 2018, spearheading banking’s adaptive capabilities. The primary highlight of PSD2 is that it offered many strategic experiences.

Customer authentication is the main element of PSD2, and it encompasses the following points:

• To strengthen customer trust by deploying the highest standards of security
• Offer a better pricing model to the consumers
• Make transactions safe and secure
• Level the playing field for payment service providers for both current upcoming players
• Transparency in payment services

Since this legislation has been out and about, many fintech, merchants, and tech players have been vigorously channeling their resources in becoming TPPs. PSD2 categorizes the TPPs into two categories:

Payment Initiation Service Providers (PISP): Regulated TPPs can initiate payments directly from the customer’s accounts based on their explicit consent.

Account Information Service Provider (AISP): Regulated TPPs who access customer data and provide them a single view of all their accounts for better financial management. Even this action requires the customer’s explicit consent.

Open Banking and PSD2

One of the most popular and key term associated with PSD2 is “open banking.” It is often mistaken to be the one and the same. PSD2 and “open banking” have a very clear line of distinction via their scope.

PSD2 has no set parameters for its functioning, and it applies to all payment providers in the region. Whereas “open banking” is well-defined by a single preset API scope, and it has been implemented by the big “9” banks of the UK. But other challenger banks and TPPs have happily boarded the bandwagon of “Open Banking.” Also, PSD2 is the mechanism that allows “Open Banking” or “open banking” to function.

Banks have come to recognize that partnering with TPPs helps them capture new segments and increase their revenue streams. Also, hauling their current infrastructure can turn out to be a costly affair; instead, they can shift the onus onto a TPPs platform. With customers getting comfortable sharing their personal data and the impact of pandemic spearheading digital payments, banks are gearing up to partner with TPPs.

Open Banking - why the need?

Changes in customer behavior, the incessant search for better business models & revenue, adapting regulatory trends combined with the uprising of digital ecosystems have pushed open the gates of “open banking.”

It is now a paradigm shift that shapes the delivery of financial services, with APIs serving as the backbone to the entire infrastructure. With APIs at the fore, customers will get a consolidated view, and financial providers, for example, lenders, the required data to make the right decisions. With “open banking,” the banking industry will witness a restructuring of their services where the end customer/business has a hold of the data and how it can be used.

How APIs work in “Open banking?” or “open banking?”

APIs facilitate the exchange of information between two financial parties. It can be said that it is an open-source platform that allows legacy financial institutions to collaborate with modern-age fintech platforms. It offers secure interoperability that is compliant with the laws and legislations of a particular region.

Also, the APIs are classified into three categories of:

• Public: They are the most popular connectors of “open banking.” They offer TPPs access to consumer data from the bank without the need of storing or saving the data for later use
• Partner: They are specific APIs designed to allow the exchange of data between two companies/businesses. They facilitate vendor-to-vendor communication channels.
• Internal: They are proprietary APIs used by an organization to secure and manage its own database.

Open Banking Use Cases:

Like every other revolution, “Open Banking” or “open banking” has its share of troubles and hurdles in every region. But they are silently creating a revolution by subtly moving the needle in many business scenarios. And walking through them will give a better insight into how the APIs work in open banking.

Financial Services:

“Open Banking” is all set to reinvent the way financial services are now perceived. The highlight of this reinvention is that they do not intend to eliminate the players but give them a new avatar. In simple terms, there no customer data without banks.

The bank’s responsibility is to provide the necessary platform to its customers to have their pick of the services. As fintech’s are now offering that choice, banks are now pressed to reinvent and partner with these new age fintechs to retain the competitor status. And nowadays, many banks have formed a successful partnership to offer the following services:

• A comprehensive view of core banking accounts
• Payment services and choice of networks
• Commercial and personal loan histories
• Tailored investment portfolios
• Native bank apps and enriched experiences

Small businesses:

Akin to individual customers, small business owners will gain insightful visibility into their financial management. They will be able to understand the realities and ripple effects of their financial decisions, for example taking out loans, mortgaging, and expansion. Small business owners can leverage the understanding to improve their cash flow. Likewise, lenders can devise practical loan offerings with an expedited delivery timeline to meet business needs.

Insurance:

Insurance providers can have a complete, dynamic, and current portfolio of the applicant’s finances. They can use the data to draw a sound insurance decision that matches the client’s best interest and business profitability. The customers also get an unparalleled view into spending behavior resulting in diligent financial decisions.

Customers:

“Open Banking” is all set to provide customers with a supermarket aisle experience where they can pick and choose the products they want. This tailored experience offers many advantages to today’s customers in terms of:

• Augmented account visibility and security
• In-depth visibility into spending habits and behaviors
• Instantaneous access to market investments
• An interoperable online and physical payment options

The two sides of “Open Banking”/ “open banking”

Even though it is an innovative concept, there are two sides to this technology. It presents a daunting shift and challenges that are detailed below:

Opportunities:

• The open data philosophy will improve the transparency and democratization of the banking platform.
• It will provide access to the credit deprived and also facilitate entry into foreign markets
• The most important benefit of all would be the ideation and creation of apps that will be fielded in the market by upcoming fintech players.
• Tools like Artificial Intelligence and Machine Learning will be able to predict solutions based on customer spending habits. Automation will be a game-changer for many services.

Challenges:

• It removes the interpersonal relationships between the customer and the bank. As everything is handled digitally, the human connection takes a dive.
• Customers might not be willing to share their details, and there is a lack of apathy/credibility from the customer. Convincing them about the benefits and converting them into leads might take a while.
• Security concerns play a huge role in this field as it is a relatively new field, and it is filled with many trial and error situations that are yet to happen.

The future holds a lot in store for the banking ecosystem. We will witness greater customization and the amplified need for efficacy in financial offerings. With the use of APIs and other related technology of Artificial Intelligence, Machine Learning, the system will transform into an end-to-end customer-centric retail offering. Customers will experience a future where their financial needs are seamlessly anticipated and supplemented by intuitive product offerings.

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