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In this guide, we will explore open banking which holds the promise of making the whole banking process better and discuss the benefits it can offer to individual customers and businesses.
The banking sector has undergone a number of changes over the years. Due to the digitization of records and the use of mobile platforms to serve the masses, banking looks very different today than it did years ago. One major change that is sweeping the banking sector is open banking. While relatively new, open banking holds the promise of making the banking process better for both the customers and the banks they patronize. But what is open banking? Are there risks associated with it? And is it right for you as a user? In this guide, we delve into the topic.
While the banking industry is perhaps more evolved than ever, there are still certain challenges that users face. These challenges are about dealing with data and how this data is used. The biggest collection of information about the state of a customer’s finances can be seen in their bank transactions. This data includes how much money goes in and out of their bank accounts, where they spend their money the most, and so on.
The issue is that banks are not the only ones who could make use of that information. Third-party companies that offer financial services to consumers often need this information to tailor services to them. If a customer doesn’t have a credit history, access to banking information will make it easier for them to access whatever services they need.
However, sharing this information with third parties has always been very tricky. For years, the infrastructure simply wasn’t available to do so. When it was, issues regarding data privacy, customer consent, and others made it difficult for users to consent to sharing their data and for their banks to do so. This is where open banking comes in as it offers solutions to this long-running problem and very much appears to be the future of banking.
Open banking is the practice of banks sharing customer information such as transaction history with other banks and non-banking third parties. This is done using application programming interfaces (APIs) and essentially creates a network through which different institutions can share the same data.
Say a customer wants to sign up for a budgeting app that determines how they spend their money and the ways that they can cut back and save more. To do this, the app would need to view and analyze their transaction history with their current bank. Open banking allows the bank to share this data with the app.
One notable thing about open banking is that all of these transactions take place with the customers’ consent. If you’ve ever signed up for a third-party financial service, you might recall being asked to grant permission for them to access your data. This would be an example of open banking.
Open banking is predicated on the fact that consumers will need to access many products and services outside of their primary bank. These services will need their data to do this properly and by leveraging open banking, everyone is better served.
As we’ve explained, the foundation of open banking is the APIs. But not all APIs are the same and there needs to be agreement between everyone in the open banking initiative. Because API is essentially a way to bridge different software, anyone can technically create one. But for safety reasons, the banking industry tries to restrict itself to only the tried and tested software.
Typically, the government, the banks, and the regulators will agree on certain criteria that guide the development of API. Once the API is built and deployed, businesses can begin leveraging and building programs on top of the API which solves various problems.
Take the issue we discussed about credit history. It can be hard to approve or deny someone a line of credit if there is no history to go off. But a look at their typical bank transactions in a month will give an idea of their financial situation. This way, people are not shut out of accessing credit facilities.
Open banking also gives customers a say in if and how their data is shared. By opting in to open banking, customers can decide if their banking data will be shared with third parties.
Third parties that want to enter the finance sector and share their products and services with the public will need past data. Through open banking, they can get just this.
Within the banking world, it is common to hear the term open finance as well as open banking. On the surface, it can be easy to confuse one for the other. But while they are connected, they aren’t the same. In the simplest terms, open finance is a more complex version of open banking. In open banking, third parties can access account information and can enable transactions by a third party like PayPal Holdings Inc. (NASDAQ: PYPL).
Open finance, however, goes much deeper than this. Open finance allows third parties to access information not just regarding transaction history and customer identity but also investment history, pensions, and even mortgages. Using this, a wider range of products and services can be tailored to the customers’ needs.
While open banking sets the stage for what could be done with free and authorized sharing of customer data, open finance is building on this.
Open banking offers a lot of benefits, some of which are as follows:
For consumers:
For Businesses:
While these benefits are to be acknowledged, there are also some risks to consider:
Open banking has many potential uses, some of which are as follows:
Thanks to the many benefits it offers both institutions and individuals, open banking has found extensive uses around the world. Notably, different ways of regulating it around the world have also impacted those uses.
In the United Kingdom, for example, open banking is used to facilitate transactions using the payment processor Wise. With this third-party platform, customers can send and deposit money into their bank accounts. Banks like Monzo can also show the balances for all of a customer’s accounts, even those with other banks, in a single interface. Open banking is regulated in the UK by the Financial Conduct Authority (FCA). FCA allows customers to authorize third-party applications to access their data and facilitate transactions.
In the United States, an example of open banking is Capital One’s DevExchange. It allows users to open savings accounts on third-party applications and view their current balances inside applications like budgeting platforms. The Consumer Financial Protection Act (CFPA) guides regulating open banking in the US. Specifically, under the act, any business that offers financial products and services to consumers has to make such information available via open banking.
Open banking is not just a way to facilitate information sharing. It is also an innovative practice that is on track to revolutionize banking as we know it. It can help not only develop better products and services and push them into the market but also allow customers to have a better view of their own financial situations.
Open banking as a concept comes with its challenges and is still far from its final form. Nevertheless, it is one of the most promising developments in the financial sector.
Open banking is a system built on APIs that allows banks to share information regarding customer transactions and general data with third parties, with the customer’s consent.
Open banking works by leveraging APIs which allows software belonging to different businesses to communicate with one another and share information.
Open banking helps businesses that need customer data to access it easily and lets customers transact on various platforms seamlessly.
Open baking makes banking more convenient for the customer and other businesses.
Open banking is mostly safe, with data breaches being notably rare.
Businesses that deal in financial information such as banks, loan providers, app developers, and so on can use open banking.
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