What is open banking?

Open banking is a financial services model that provides a secure way for consumers and businesses to give regulated third-party providers access to their payment account data and to initiate payments.

This is done via application programming interfaces (APIs), which can look at consumers' banking data and identify the best financial products and services for their needs.This information includes consumer banking transactions, and other financial data.

Open banking gives customers more control over their financial information and provides new services and applications. For non-financial companies, this allows them to offer customised financial services to their customers, make more data-driven decisions and innovate in payments and account management.

How does open banking work?

Customers are generally required to grant consent to allow the bank to share their data with third-party providers (TPPs). Customers control access to their financial data, the aspects of data they want to share and who they want to share it with. If they change their mind, they can revoke consent at any time.

Open banking enables financial services through APIs, which facilitate the secure exchange of financial information. In traditional banking, data is siloed within individual institutions, making it challenging for outside applications to interact directly with financial accounts.

Open banking disrupts this by mandating standardised data formats and secure communication protocols, creating a more level playing field. Third-party services can integrate with multiple banks under common rules, regulations and technical standards. It is safe and secure due to robust APIs, regulated bank-level security, tokenisation and strong customer authentication (SCA).

Benefits of open banking

Open banking provides consumers, businesses and financial institutions with several opportunities to offer more choice, more competition and ultimately better solutions.

Here are some of the benefits of open banking:

Help lenders get a more accurate picture of a consumer's financial situation and risk level to offer more profitable loan terms
Help small businesses save time through online accounting and help fraud detection companies better monitor customer accounts and identify problems sooner
Level the playing field between established banks and new, smaller banks
Strengthen customer relationships and retention
Offer new services that enable customers to manage their finances instead of simply facilitating transactions
Obtain detailed financial data that can inform strategic choices from risk assessment to financial planning
Accelerate data flow, expediting transactions and enabling quicker reconciliation
Enable more direct payment methods, resulting in lower transaction costs

Open banking challenges

While open banking offers many benefits and opportunities for innovation, it also has risks and challenges. From integration issues to security vulnerabilities, here are some potential risks of open banking:

Inconsistencies in quality could lead to service interruptions or unreliable data, causing operational difficulties and necessitating costly adjustments
Unanticipated integration issues and challenges that require specialised expertise and troubleshooting
Absence of universal standards reduces interoperability
Regulation hurdles that make it difficult to keep up to date with changes
Hidden costs of compliance or technical adjustments
Security vulnerabilities, leaving potential gaps in data protection and security protocols that, if exploited, can damage customer trust
And one of the biggest challenges, reluctance of customers to share their data due to confidence issues.

Open banking use cases

Open banking isn't one product or service but a framework enabling several different financial services. The use cases are actively evolving, but here are some current use cases:

Payment initiation services. Retailers can initiate payments directly from a customer's bank account, bypassing traditional payment gateways for faster settlements and reduced transaction fees.
Account aggregation. Financial advisors and wealth management firms can pull in data from multiple accounts, giving them a more comprehensive view of a client's financial status.
Automated budgeting. Smart expense management systems can automatically categorise and track spending from multiple bank accounts, simplifying financial reporting and oversight.
Instant loans and credit scoring. Financial institutions can access real-time data to assess credit more accurately, speeding up the loan approval process.
Automated invoice reconciliation. Businesses can automate matching invoices to transactions, reducing administrative work.
Multi-banking platforms. Corporations can consolidate their accounts from different banks into a single dashboard, making it easier to manage global operations.
Personalised marketing. Retailers can analyse transaction data to offer targeted customer promotions based on spending habits.
Real-time fraud detection. Businesses can detect unusual activity quicker to reduce the risk of financial loss.

Open banking is set to alter the competitive landscape in the financial services industry. From increasing competition to reducing costs and sparking new innovations in banking, open banking positively benefits both consumers and financial institutions.