*By Iatezaz Alblowi
Open banking involves opening banking systems to third parties to allow them to provide services directly to customers. In other words, open banking facilitates customer data and functionality to be accessed by financial institutions and other third-party providers – transforming the relationship between traditional entities and customers. This access to data and functionality allows challenger banks, neo-banks, fintech, and big techs to develop new innovative financial products and services and provides traditional banks an ideal opportunity to improve their customer experience.
Open APIs, in particular, will enable banks to collect actionable data from a variety of internal and external sources, such as purchasing patterns, financial objectives, risk tolerance, and even social connections. This data’s insights will allow for more proactive (and correct) multi-channel marketing, shifting from reactive sales pitches to proactive solutions and consulting services.
Beyond Traditional Banking the Open Banking Applications:
With open banking, clients can integrate and access information from different bank accounts and financial institutions in a single application or dashboard. This provides them with a comprehensive view of their finances, including account balances, transaction history, and expenditure analysis.
- Personal Financial Management (PFM): Open banking enables the development of PFM technologies that provide personal financial information and analytics. These applications can assist individuals in managing their money more effectively by categorizing expenses, creating budgets, setting savings goals, and offering tailored advice.
- Payment Services: Customers can utilize open banking to initiate payments directly from their bank accounts, bypassing traditional payment methods such as credit or debit cards. This allows for seamless and secure payments through authorized third-party applications or websites.
- Identity Verification and KYC (Know Your Customer): Open banking APIs can streamline and enhance identity verification and KYC processes. Financial institutions and other service providers can securely access a customer’s verified financial data to verify their identity and comply with regulatory requirements.
- Improved Access to Financing and Affordability: Open banking provides lenders with access to more comprehensive and up-to-date financial data, enabling them to make more informed lending decisions. This can lead to increased availability of loans for individuals and businesses, especially for underrepresented groups. Additionally, open banking can foster more competitive lending options and lower interest rates.
Open Banking’s Transformation of the in-Banking Ecosystem for MSME:
Increased access to financial services through data sharing has the potential to significantly impact individuals and MSMEs by providing them with opportunities they wouldn’t have had otherwise. Traditionally, limited data from conventional sources could lead to individuals being disqualified from accessing loans and other financial services. However, with open financial data, creditworthiness assessment can be enhanced by incorporating additional sources such as rent, phone, and utility bills. By leveraging alternative data through open financial data initiatives, individuals and MSMEs with thin credit histories or no formal records can now gain access to formal credit, often for the first time. For example, an Experian study demonstrated that including utility data in credit assessments allowed 20 percent of customers with minimal documentation to become “thick file” customers. This means that these individuals, who previously lacked sufficient credit history, now have the opportunity to establish a comprehensive credit profile, enabling them to access a broader range of financial services. Scaling up these positive outcomes on a larger scale has the potential to generate significant economic impact. When considering the broader economy, increased access to credit through alternative data can contribute to raising the credit-to-GDP ratio. In the United States and the European Union, incorporating alternative data could potentially increase the credit-to-GDP ratio by 20 basis points. In India, the impact could be even more substantial, with a potential increase of 130 basis points. This translates to a boost in GDP of approximately $80 billion to $90 billion by 2030.
Increased user comfort. Customers save time when interacting with their financial services provider because of data sharing. MSMEs, for example, may produce paperwork more quickly during customer onboarding. Consumers may apply for loans without using mortgage brokers thanks to open access to data on available mortgage products and applications that are automatically prefilled. This not only simplifies the procedure but also allows clients to take advantage of the best pricing. Startups in the United Kingdom, which launched its Open Banking system in 2018, leverage open-banking data to enable quick and easy mortgage applications to all participating providers for free, in contrast to traditional mortgage brokers, who charge arrangement costs.
Product selections have been improved. Customers can save money if open financial data expands and improves the number of product possibilities accessible to them. An open-data environment, for example, makes it easy to move accounts from one institution to another, assisting retail and SME consumers in their search for the best conditions. Also, access to financial data can connect with alternative lenders, crowdfunding platforms, or peer-to-peer lending networks that may offer more flexible financing solutions suited to their requirements.
Improved Credit Access: Open banking allows for a more thorough and accurate evaluation of MSMEs’ creditworthiness. MSMEs may give potential lenders or credit providers a more comprehensive view of their firm by giving access to their financial data, including transaction history and cash flow trends. This can aid in securing better terms and conditions for loans, credit lines, or financial goods.
Strategic Approaches for Banks to Leverage Open Banking for Growth and Differentiation:
- Banks should embrace collaboration and actively pursue collaborations with fintech startups, third-party suppliers, and other players in the open banking ecosystem. Banks can develop new goods and services by cooperating and using external knowledge, technology, and client bases.
- Stay Agile and Adaptable: The world of open banking is changing. Banks must remain flexible and adaptive by closely monitoring market developments, regulatory changes, and client preferences. They must be willing to pivot their tactics and adjust their offers in response to changing client needs and market realities. Banks should see the notion of open banking as an opportunity rather than a threat. They must see the benefits of sharing data and partnering with other parties to provide better services and experiences to their consumers.
- Invest in Technology Infrastructure: Banks must invest in a strong technological infrastructure that enables open banking. This involves creating secure APIs, data integration capabilities, and scalable systems capable of handling the increasing data volumes and transactions that come with open banking.
- Create an Open Banking Plan: Banks should create a comprehensive plan outlining their open banking goals, priorities, and roadmap. Customer demands, regulatory requirements, technical infrastructure, and collaborations should all be considered in this plan.
- Customer-Centricity: Open banking allows banks to provide personalized and tailored experiences to their customers. Banks can gain deeper insights into customer demands and preferences by integrating customer data from various sources. Banks should utilize this data to create and deliver customized products, services, and experiences that meet their customers’ individual needs.
- Drive Innovation: Open banking enables banks to innovate and establish new revenue streams. Banks should foster an innovative culture within their organizations, encouraging employees to think creatively and experiment with new ideas. To remain competitive, they should invest in research and development, allocate resources to developing technology, and actively seek innovative solutions.
Regulatory Landscape of Open Banking:
Only a few nations have passed legislation requiring open banking. The majority of economies have been concerned about an unfavorable regulatory environment, for example, but not limited to:
- In 2022, as one of the key outputs of the Open Banking Program, the Saudi Central Bank (SAMA) announced the release of the Open Banking Framework. It includes a comprehensive set of legislation, regulatory guidelines, and technical standards based on international best practices to enable banks and FinTechs to provide open banking services in the Kingdom. The first edition of the open banking services focused on the Account Information Service (AIS), and the second version will focus on the Payment Initiation Service (PIS). SAMA is also monitoring the progress of banks and FinTechs to ensure they are ready to deliver open banking services in the first quarter of 2023.
- The European Banking Authority is responsible for providing guidelines and recommendations to governments and financial organizations. Payment Services Directive 2 (PSD2) requires banks and other account-holding payment service providers to give registered/authorized Payment Initiation Service Providers (PISPs) and Account Information Service Providers (AISPs) secure read and write access (including payment initiation) to the customer’s account data via open APIs upon customer request. PSD2 entered into force on 12 January 2016.
- PSD2 prompted the UK’s Competition and Markets Authority (CMA) to order the country’s nine largest banks to adopt an “open-banking standard” for sharing customer and transaction data with third parties. As of December 2020, the UK had awarded around 200 third-party provider (TPP) licenses for open-banking APIs, or application programming interfaces.
Unmasking Vulnerabilities: Understanding the Risks of Open Banking:
- Data Privacy and Security is one of the risks that open banking entails, as it involves banks and third-party suppliers exchanging sensitive financial data. This creates privacy and security issues concerning data. To safeguard consumer data from unwanted access, breaches, and abuse, it is critical to have strong security measures in place. To alleviate these dangers, encryption, secure authentication, and monitoring techniques should be used.
- Regulatory Frameworks and Compliance Standards: Open banking is subject to regulatory frameworks and compliance standards. Banks and third-party suppliers must follow these requirements to ensure data protection, privacy, and fair competition. Noncompliance can result in legal and reputational consequences, such as cash penalties and a loss of consumer confidence.
- Consent Management: In open banking, obtaining and managing consumer consent for data sharing is critical. Insufficient consent measures can lead to the risk of unlawful access. Regulators play a crucial role in ensuring that consumer permission is collected transparently and that customers have control over their data-sharing options. Robust consent management systems and processes are required to reduce the risk of illegal data access and disclosure.
- Third-Party Protection: Collaboration with third-party suppliers is required for open banking. Banks must thoroughly screen and monitor these service providers to ensure they have adequate security measures in place. Due diligence, contractual agreements, and constant monitoring of third-party providers are essential to reduce the risk of data breaches or abuse.
* MSF – CME-1 with a background in SME funding.
References:
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- The future of open banking payments: J.P. Morgan. The Future of Open Banking Payments | J.P. Morgan. (2022, July 8). https://www.jpmorgan.com/insights/payments/payments-optimization/open-banking-payments
- European Central Bank. (2018, October 5). The Revised Payment Services Directive (PSD2). https://www.ecb.europa.eu/paym/intro/mip-online/2018/html/1803_revisedpsd.en.html
- REMOLINA, N. (2019). Open banking: Regulatory challenges for a new form of financial intermediation in a data-driven world . Ink.library.smu.edu.sg. https://ink.library.smu.edu.sg/cgi/viewcontent.cgi?article=1006&context=caidg
- Executing the open banking strategy in the United States. Deloitte Insights. (n.d.). https://www2.deloitte.com/us/en/insights/industry/financial-services/open-banking-model-strategy-united-states.html
- Sama Issues Open Banking Framework. (n.d.-b). https://www.spa.gov.sa/2397576
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