Open Banking: Opportunities and Challenges

Open banking is breaking down the walls of silos within the financial sector.

Historically, banking was designed to be conservative and highly compartmentalised to safeguard funds and maintain customer trust. Over time, technological advancement has radically transformed banking into an open field characterised by multiple innovations.

 Today, banks are competing based on the ability to innovate while making banking services more relevant. Open banking is a notable disruptive force in this evolution, which grants FinTech companies a significant role in shaping modern financial services.

Open banking started in the 1980s when Deutsche Bundespost (German Federal Post Office Bank) experimented by inviting 2,000 private users to test a new online banking service framed as “My bank in the living room.”

The success of this experiment laid the foundation for self-service banking. This innovation was enhanced by the development of the Home Banking Computer Interface (HBCI), a publicly available open protocol specification, by three German banks, namely the Sparkassen-Finanzgruppe, German Cooperative Financial Group, and Association of German Banks in 1998.

This was replaced by Financial Transaction Services (FinTS) in 2002. The evolution of open banking continued with the creation of SOFORT in 2004, which combines HBCI and screen scraping to enable a client to log into their bank account to pay for a service online.

For example, by granting a service provider permission to access their banking information and login details, the service provider can complete payment transactions on behalf of the client. 

In essence, open banking is a system that allows third-party financial service providers to access financial information from banks and other financial institutions through APIs (Application Programming Interfaces), with the express consent of the account holders. It promotes competition and innovation in the financial services industry by enabling easier financial data sharing. 

How does Open Banking work?

The main idea of open banking is putting the client in the driving seat by allowing them to select how much of, and to whom, their personal financial information can be shared. The client does this by giving their consent to a third-party service provider to access their data, held with one financial institution or across the board to multiple financial institutions.

Open banking leverages application programming interfaces (APIs), which serve as a secure conduit to enable communication between different computer systems.

The advantages of open banking include saving money through the avoidance of overdraft fees, enabling balance transfers, real-time comparison of financial services, increased access to financial services advice, education on prudent financial habits and robust financial management.

The growth of open banking is driven by progressive regulation and the proliferation of API technology. API is critical to the success of open banking since it enables cost-effective and efficient data integrations in real-time by consolidating multiple data and connectivity requirements in one place.

Open banking comes with numerous advantages, such as enhanced customer experience, improved financial management, access to new services, increased financial inclusion, reduced cost of doing business and improved security and control.

Open banking connected to artificial intelligence (AI) could enhance a financial institution's ability to predict a good candidate for loans and offer it before the client even starts looking for loans.

In terms of use cases, open banking provides several services, such as account aggregation, that consolidates financial data from multiple institutions into one space, enabling users to have oversight of all their financial accounts without logging into multiple platforms.

 Also, open banking facilitates Payment Initiation Services. Typically, payment initiation service providers (PISPs) rely on open banking APIs to initiate payments directly from a user's bank account to a third-party account, which means users can make payments from a bank account to a merchant's account without the use of credit or debit cards.

 Other services enabled by open banking include Loan Comparison Platforms, Personal Finance Management (PFM) Tools and Credit Scoring Services.

Challenges

Although open banking comes with many opportunities, its evolution is not without implementation challenges, including security and privacy concerns, cybersecurity threats, regulatory compliance, technical integration and interoperability, as well as low adoption due to poor consumer education and awareness.

One of the concerns in deploying open banking is trust and safety issues. This can be resolved through several measures, including strong authentication, continuous monitoring, adherence to security standards, data encryption, robust consent mechanisms and Regulatory Compliance.

GDPR in the European Union is touted as one of the strictest regulatory standards and is supported by data protection laws, which ensure that all consumer data is safeguarded by all stakeholders participating in the open banking ecosystem.

Beyond regulatory provisions, open banking is only successful if consumers are open to sharing information with third parties since open banking will only be successful with their positive attitude towards sharing data.

As open banking evolves worldwide, some countries and regions, such as the UK, EU, Switzerland, Mauritius, Nigeria, Singapore and Australia, already have regulations in place, whereas others, such as New Zealand, the US, Japan, Brazil and Canada, are still evolving their open banking regulatory framework.

In conclusion, open banking provides much value for consumers. Therefore, all actors in the banking ecosystem, especially regulators, must create a conducive environment for it to thrive.

Kwami Ahiabenu II (PhD) is a Technology Innovations Consultant
E-mail: kwami@mangokope.co