There's a revolution taking place in the banking industry. Known as "open-banking" or API-facilitated information sharing, this movement is changing how banks do business and empowering consumers by giving them greater control over their financial data. Although this banking strategy was first employed in 2004 with the first PayPal API, its adaptation in the traditional banking sector was slow, mostly due to the industry's preference for legacy-based solutions. Today, there are hundreds of banking APIs and open banking is meeting consumer and fintech demand for smarter financial technology.
What is Open Banking?
Open banking is rooted in the idea that sharing information will create new ecosystems that provide greater value for both banks and the clients they serve. Using APIs, key digital assets like algorithms, financial data, identity information, and related banking processes are utilized by ecosystems of consumers, fintechs, third-party developers, vendors, and others to maximize value creation.
What's Behind the Open Banking Trend
Business Optimized — For most banks and financial institutions, client experience, efficiency, and revenue growth are top priorities. With open banking, each of these, as well as the overall functionality of the organization, are better optimized by open APIs.
The Evolution of Banking — The industry may have been slow to realize the value of open banking with APIs but most leaders in the industry recognize that open banking is the next logical step in the evolution of banking and that they must adapt accordingly.
Competition — Fintech API growth has been significant in recent years. With this push toward digital transformation, financial institutions stand to lose a lot by failing to get on board. As a result, many banks are beginning to see the value in using APIs to offer the digital banking experiences that clients now demand.
Industry Regulations — The US doesn't currently have regulations concerning open banking. However, the European Parliament has already enacted legislation to this effect, referred to as the Payment Services Directive 2 (PSD2), which becomes law this month (Jan. 2018). The UK is similarly following suit, with the HM Treasury calling for a mandate to make it easier for consumers to decide how their financial data is shared and used. Likewise, the UK implementation of PSD2 is also scheduled to take place in January.
Open Banking and PSD2
The PSD2 European Economic Zone mandate for more consumer-focused banking forces the industry towards greater technological innovation via open web API use, creating high-value digital products and an entirely new banking ecosystem. However, it's not without drawbacks.
For starters, banks will remain liable for the protection of consumer data, per the General Data Protection Regulation (GDPR), even if that data is on a third-party platform. How PSD2 and GDPR will work together remains to be seen as the latter forces banks to assume the responsibility of protecting consumer data while PSD2 requires them to share said data with third parties who may not be taking the appropriate precautions to protect it.
Likewise, beyond de facto REST and OAuth requirements, PSD2 it does not specify a standard for open APIs. As Andrew Whaley, VP of Engineering at Arxan Technologies states, "The APIs for different banks could all be completely different in how they work…the practical problems for an organization trying to consume these APIs (such as a social media organization, or whatever) means that the third-party potentially has to build a different adapter for every different bank."
While most American banks don't have to worry about PSD2 requirements, those with European offices are required to comply, and given the global nature of the bank industry, it may be just a matter of time before a similar push appears in the US. However, given the complexity, diversity and size of the American banking system it is unlikely to be mandated at the federal level for the very reasons mentioned.
Nonetheless, given the strong consumer demand for smarter technology in the banking and financial sectors, open banking is likely to continue to grow in the US. Albeit, it will be large banks, which have both the resources and financial incentive to effectively integrate their operations with open banking, who become its primary adopters.
APIs and Open Banking in Action
Web APIs are the driving force behind open banking. They make the exchange of consumer data seamless and secure. Financial products can quickly and easily be compared and new products and services are realized through connectivity to consumer accounts, expanding the value chain in a variety of ways.
Mobile Payments — Mobile money transfers happen in a matter of minutes or seconds, dramatically reducing settlement times and reducing operating costs for banks, which pass those savings on to clients.
Service Provider — Banks use an open API to accelerate and simplify the process of buying a home. It connects consumers with mortgage lenders and real estate agents who are then able to track applications in their own portals.
The Fintech Hub — Global financiers work in cooperation with fintech companies to drive innovation across sectors using open APIs, public sandboxes, and partnership opportunities. As an early adopter, these banks gain significant market share, giving them a strong competitive advantage.
The Data Platforms — A startup uses aggregated consumer financial data, obtained via open APIs from a variety of financial institutions, to create a comprehensive personal financial management platform. Customers receive financial advice, products and services tailored to their specific goals.
A few years ago, open banking was little more than a broad concept that analysts predicted would revolutionize the way that banks, consumers and third-parties interact with one another. With these implications finally realized, the industry will never be the same because, with open banking, the door to financial innovation is wide open.