The banking industry is undergoing rapid transformation, with Open Banking being a particularly important development in recent years. Companies like Monzo and Starling offering fresh approaches to financial management are proliferating in response to millennials' increasing reliance on digital tools.
The theory is as follows: if we allow these businesses access to our data, they become better equipped to cater to our spending patterns, hence fostering a more competitive and innovative financial environment. This will eventually lead to better and more cutting-edge tools for handling our finances.
But what is Open Banking, and why are companies and consumers increasingly interested in using it as a payment method? In this article, we analyse the benefits and drawbacks of Open Banking.
What is Open Banking? And How does it work?
Be it the competitive formation of the railway network in Britain (which has led to us having perhaps the planet’s best-organised underground systems, despite its resource-related imperfections) — or the revolution in air travel brought about by competition for air dominance — monopolies tend to lead to stagnation, whereas competition results in innovation. Open Banking may show similar patterns.
Open Banking: What's it all about?
First, let's become acquainted with the concept of “Open Banking”. Open Banking is the free flow of information between financial institutions and authorised outside parties. Both individuals and businesses may profit from the newfound ease with which they can share their financial information with other parties.
Let’s explain how Open Banking works
With Open Banking, you and your bank will have access to the same view of your account details, including your balance and a record of your recent transactions.
Since 2018, however, Open Banking regulations have required the UK's major banks to enable customers to share their financial data with approved third-party suppliers. It's easy to perform and doesn't need a lot of paperwork.
Open Banking may be utilised in customers' daily lives in a variety of practical ways, such as via third-party applications that automatically save money for you or evaluate your expenditure to assist give tailored budgeting suggestions.
Online payment systems would likewise benefit greatly from open banking. Permission to link directly to your bank may now be provided to merchants and businesses. Customers may avoid entering their card information by authorising the purchase from their computer or mobile device.
The Pros of Open Banking: Top 8 things to know — Consumers
Why is Open Banking beneficial to customers? Here are eight advantages:
1. You get safer transactions.
Consumer concerns that their data is not secure since it is now accessible to third parties and businesses are legitimate given the importance of data security. Contrary to popular belief, security is integral to Open Banking. The authentication of customers has improved dramatically in recent years, and all information is now secured and kept safely.
By 2024, 1.75 billion individuals throughout the world will be using mobile banking, according to Statista. Slow to adopt mobile banking services run the danger of losing customers to rivals who have already jumped on the bandwagon.
2. You have more control over your bank.
We used to wait in line outside the bank and then had to beg the management if they had any time to help us with our financial duties.
Those times have passed. Open banking means keeping the bank in our pockets now that digital banking has got it there. Open banking provides a greater breadth of services to customers than was before possible with digital banking. There's a lot more to it now than just looking at our bank balance.
By providing proactive advice on financial well-being based on sophisticated analytics, open banking makes the banking experience more engaging and participatory.
3. You can direct your own spending habits.
There used to be clear boundaries in the power dynamic between banks and customers, with banks holding the upper hand and customers dependent on them. The advent of open banking is tipping the scales in favour of consumers.
Open banking has levelled the playing field in the financial services industry by allowing both conventional banks and FinTech startups access to the same financial data and releasing the full potential of analytics.
Consumers not only have more options when it comes to selecting a financial services provider, but they are also the only arbiters of what information about themselves may be shared.
The role of banks as default data custodians has changed. The advent of open banking has restored this power to the buyer.
4. You are more satisfied.
One method in which Open Banking accomplishes its primary objective of enhancing the quality of financial services for customers is by enhancing the quality of the customer experience.
Making payments and keeping track of one's accounts through things like integrated accounting software is now quicker and requires less form-filling than ever before.
This enhanced customer service has the added benefit of increasing sales. More clients may decide to convert and successfully finish payments if the procedure is simplified with Open Banking.
Consumers now have more say over what information is shared with banks because of the proliferation of Internet banking. In addition, banks may cater to the specific requirements of their consumers by providing individualised financial services. Apps like Mint, for instance, may compile information about your financial situation from a variety of sources.
5. You get tailored and relevant products.
Most banks provide services that are identical and narrow in scope. What's more, the majority of banks aren't exactly reliable sources of financial advice. Customers have more banking alternatives, or service providers, to select from thanks to Open Banking. As a result, you are not restricted in your choice of software by the fact that it is included in your subscription.
The features offered by banking applications tend to be the same across the board. Customers would greatly benefit from the introduction of customisation and personalisation options as a result of new service providers entering the market.
6. You get more of everything in one place.
Consumers need access to comprehensive data so they may make educated choices about their money. Thanks to open banking, you can access all of your accounts in one convenient place and make the best-informed choice possible on your personal finances.
Customers have a friend and protector in open banking. Unfortunately, not everyone has the business savvy or foresight required for optimal planning, budgeting, and investment. With the use of open banking technologies, we can analyse our spending patterns to locate banking solutions that are specifically suited to us, which makes conserving money much less of a hassle.
On top of that, using a reputable payment service makes shopping online less of a hassle, takes less time, and reduces the risk of fraud.
As a result of the 2018 updates to Open Banking, customers may access additional services in one convenient location, since data formerly accessible solely to their banks is now stored in a centralised area and can be accessed by third parties as needed.
Both banks and their clients stand to gain from adopting open banking practices. Since consumers' banking information can be aggregated in one place, banks may provide individualised financial services.
Using an online banking application, customers and companies that manage their accounts at several banks may set up numerous payments with a single login. Instead of logging into several banking apps to make separate payments, you can do it all in one place.
7. You get streamlined payment processes (and instant transactions).
The expansion of available payment methods made possible by improvements in open banking technology benefits both consumers and companies. Those who participate in the “gig economy” would benefit greatly from these novel payment methods since they reduce the likelihood of not being paid.
A further benefit of a simplified cash flow environment is the possibility of real-time account unification through effective and secure invoice harmonisation. Open Banking expedites the transfer of funds, so you get your hands on your money without any delay. This helps a company's cash flow and lowers the possibility of expensive transaction failures.
8. You get more adaptability.
Open banking allows new companies to join the financial sector without being restricted by the status quo. This increases competition in the banking industry by lowering the barriers to entry. Customers may soon be able to choose from a wider range of financial institutions and services thanks to the increased competition.
Open Banking Advantages — Consumers with Businesses (or working Freelance)
To what extent do consumers with their own companies, or working freelance, benefit from Open Banking?
1. Your work has reduced transactional expenses.
Depending on which processor a business uses, the cost of processing credit card transactions can add up quickly. Account-to-account (A2A) transfers, however, cut down on these expenses significantly.
2. Your work has access to expansive, competitive services.
I explained, in the introduction to this guide, the impact of genuine competition in any industry: improvement, often radically and quickly. Financial institutions will need to expand their services.
More banking competition, therefore, is potentially good for everyone. Open banking is not intended to eliminate the need for conventional financial institutions. It's a chance for them to prove themselves worthy of success and go on into a digital, customer-focused era.
It's no accident that several well-known banks have launched mobile and web-based banking services to provide their consumers with more convenience and better rates. Banks are seeing the rise of FinTech unfold before their eyes and responding positively by integrating the new tools into their operations.
3. You can enter the banking space, and integrate banking-related solutions, more easily.
More rivalry; lowered entrance barriers. The banking industry has not always been so flexible, and it has had to deal with a lot of historical baggage. Customers would create an account at a single financial institution where all their information would be housed, leading to inefficient reliance on such establishments.
Since banks and building societies were destined to dominate the industry, there was little opportunity for new digital-only entrants.
Thanks to open banking, upstarts have the same access to information as established financial institutions, paving the way for the development of novel, lower-cost alternatives to the status quo. By lowering entrance barriers, open banking has made the industry more accessible to more people.
The Cons of Open Banking: Top 8 things to know — Consumer biggest challenges
Is Open Banking without any drawbacks? Open Banking, like any other topic, has both pros and cons. While embracing open banking has many obvious advantages, it may also have significant drawbacks:
1. Distrust
Open Banking is a new idea, although APIs have been around for a while. There will be a lot of opportunities for learning from mistakes in the future.
Some of us struggle with adapting to new technological environments. Some customers and organisations may be slow to warm up to Open Banking because of its novelty. There will be a learning curve before Open Banking becomes the standard.
The fact that 6.5 million Open Banking payments were processed successfully in August 2022 demonstrates how widespread the use of this system is becoming.
When introducing a new technology that alters established practices over lengthy periods of time, disinformation and a lack of confidence are inevitable obstacles, with new problems arising from new solutions such as BNPL.
It's natural for people to be sceptical at first, but open banking is holding its own despite this first pushback. Since its implementation in January 2018, open banking has been adopted by 24.7 million people throughout the globe in 2020, with an expected increase to 132.2 million users by 2024.
Consumers gain greatly from not having to interact with a banker or wait in queue for hours, but this presents a significant issue for financial institutions. Banks lose a significant competitive edge in their branding and customer retention efforts when they remove the human aspect.
Customers' loyalty to a bank used to be directly proportional to how well they got to know their personal banker or the teller at their local branch. Thanks to open banking, any financial institution may make the transition to a digital-only service and be evaluated only on the quality of its financial offerings.
Formerly associated with its employees, a company's name is today synonymous with the quality of its wares and the effectiveness of its service. That requires a significant shift for financial institutions.
2. The regulatory framework is catching up.
Unbundling retail banking services is a central proposal of open banking, which would provide new divisions and tiers to the industry. Regulators now have an even bigger difficulty than before, given that regulating the smaller, more conventional financial sector was a monumental task in and of itself.
They'll need creative solutions and additional manpower to manage the ever-expanding complexity of the financial system.
This ecosystem will also include non-financial services corporations engaging in regulated activities or serving as third-party suppliers of outsourced vital operations, both of which provide additional challenges for regulators.
3. Worries about cyber risks.
With the development of cybercrime, it is prudent to verify the legitimacy of any free programme or service before trusting it with access to your financial data.
While Open Banking is safe, some scepticism is to be expected given the sensitive nature of the data involved with these Open Banking applications. The goal is to emphasise the system's security and the safety of their data. However, it is crucial that users understand the need to verify the legitimacy of any Open Banking software they use before to getting started.
Overall, customer worries about data security have slowed the move towards open banking. Banks and other financial services providers must be transparent about their data storage and use practices. Many controversies involving the improper collection, usage, and sharing of consumers' financial data have discouraged the widespread transition to online banking.
4. Accessibility
While technology advancements have made banking easier to use, barriers to entry still exist. Perhaps millennials and Gen Zers are more open to a fully digital banking experience, but what about the rest of us?
If you like visiting your bank in person, you may find that your visits decrease after switching to Internet banking.
5. Your traditional lenders may have lost ground.
There are still certain financial institutions that aren't ready for Fintech's cutting-edge innovations. As a result, their customers could be limited in what they can do with Open Banking at the moment.
Open Banking is a radical departure from the conventional method of banking. The fact that Open Banking will make payments increasingly simpler and safer is excellent news for both commercial enterprises and their customers. Despite Open Banking's downsides, there's no denying the benefits it may bring to consumers and companies.
In order for banks to participate in a massive, unregulated initiative to digitally transform the nation's infrastructure, they will have to assume tremendous risks.
Banks will need to revise their risk policies as their contacts evolve from dealing directly with customers to collaborating with TPPs. This is done so that financial institutions may confidently send their money to third-party processors (TPPs)…
Pros & Cons of Open Banking: Research — What the academic research shows
It all arguably took off with cryptocurrencies giving the consumer more power than a steel titan of the 19th century. Today, people are more ready than ever for the next step of consumer banking, Open Banking. This section is for those who want an academic take on the matter.
The following are the results from the study of Zhiguo He of Chicago Booth University, Jing Huang of Booth Postdoctoral Principal Research, and Jidong Zhou of Yale University. The authors consider the theoretical consequences of loans and give caveats.
Although open banking seems to benefit consumers at first glance by requiring established financial institutions to open their doors to new entrants, it eventually becomes prohibitively expensive.
Issue #1
The first issue that He, Huang, and Zhou point out is an information externality, which occurs when one consumer's decision to share data has unintended consequences for other customers. Let's pretend a consumer reveals her financial information to both a traditional bank and a fintech lender in the hopes of getting a better interest rate.
Her spending habits are revealed to the fintech lender, which may then extrapolate data on clients who are less forthcoming with details. What's fantastic for one open-banking consumer today may not be so great tomorrow.
Issue #2
Second, there's the so-called “winner's curse” to consider. Take the example of the open-handed bank client. She probably isn't happy with the interest rate her bank is giving, as she's seeking a loan from the fintech company instead. The fintech will do its own evaluation, just as the bank did before.
Let's pretend the alternative online lender succeeds where the bank fails. Possible explanations include the bank's incorporation of previously undetected risks into its analysis. The fintech has succumbed to the winner's curse, in that it has secured the client but now must bear the risk that it had overlooked.
The origin of the winner's curse may be traced back to an imbalance of information that is expected to change as the number of fintech lenders expands. Many fintechs nowadays are primarily software businesses, and some of them have quite potent capabilities to analyse data of many types, including social media posts.
Because of open banking, they have access to far more information. Sooner or later, the price they quote a customer might be spot on.
A conventional bank would be at a disadvantage, avoiding undercutting a fintech firm for fear of seeming to have missed something obvious to the latter's sophisticated models. “It's a much bigger winner's curse situation,” he explains.
All parties may be worse off in equilibrium if the information externality and the winner's curse exist, even though data owners can opt-out willingly and refuse to share their data. With access to this wealth of data, a fintech might provide a really competitive rate, driving away any potential rivals.
If a banking client is aware of this and chooses not to give his data, the fintech will still be able to infer information about him as long as other customers are sharing.
Issue #3
Yet a third threat, pinpoint advertising, has been identified by the researchers. Businesses are becoming better at marketing to customers in real-time, such as sending a deal by text message to a customer they know is now in the store. Fintech lenders might take a similar tack if they learned, for instance, that a banking client was going out of town and really needed cash.
According to He, Huang, and Zhou, “open banking” is expected to be “perhaps the most transformative trend in the banking industry in the coming decade” as the conversation across the world continues to develop. But this tendency may be more promising in its early stages before large financial institutions begin competing with digital giants.
Open Banking Rollout Timeline for the UK…
Other than the digital crypto wallet changing everything, how did we get here?
| Jul 2013 | A new PSD2 proposal has been released by the European Commission. The premise of open banking is that account providers (like banks) give other parties permission to view account data and start payments. |
| Sep 2014 | In a new paper, the Open Data Institute and Fingleton Associates advise financial institutions to build standardised application programming interfaces (APIs) to facilitate access by third parties. |
| Jan 2016 | In the EU's Official Journal, you can now find the final version of PSD2. Most requirements must be implemented by EU member states within that time frame. |
| Feb 2016 | HM Treasury has released the first set of open banking guidelines, outlining best practices for the collection, dissemination, and use of open banking data. |
| Aug 2016 | The CMA has released its findings from its examination of the UK's retail banking industry. |
| Sep 2016 | The Open Banking Implementation Entity has been established. |
| Mar 2017 | With the release of Open Data, information about products, store hours, and ATM placements will be freely accessible. |
| Jul 2017 | Account details, as well as the processes for initiating transactions and payments, are outlined in detail. |
| Oct 2017 | Enrollment in the Open Banking Directory is now live for supervised institutions. |
| Jan 2018 | The EU's member states must comply with the PSD2 deadline. Third-party access to client account information and payment services is a must for every payment service provider. All payments with at least one provider located in the EEA are affected by this. |
| Jan 2018 | The CMA 9 deadline approaches in the UK. There should be a standardised, open API for checking accounts from the nine main UK banks. There is now an open banking standard. |
| Mar 2018 | The Open Banking Standards have updated to version 2. |
| Sep 2018 | There is a new version of the Open Banking Standards available, and it includes the Customer Experience Guidelines. |
| Sep 2019 | The deadline for implementing PSD2 RTS has arrived, restricting access to data to only those who have been granted access by the client. Strong customer verification is needed for electronic payments, and methods for skimming information off of a user's screen will be outlawed. |
Pros & Cons of Open Banking: Examples — Use Cases
- Businesses/consumers can benefit from payment products — That boost cash flow, decrease expenses, enhance transparency and control, and lessen the likelihood of fraud thanks to the open banking feature known as payment initiation.
- Favourable loan conditions — Options may be limited or perhaps unavailable to you if you do not have an extensive credit history. However, thanks to open banking, creditors will have easier access to your past financial information.
- Better money management — Open banking solutions, with access to your account data, may assess your incoming and outgoing funds to help you spot problems and possibilities (such as reduced fees or higher interest rates).
- Centralised apps — Simply said, account aggregation is the ability to see all of your accounts in one location. Instead of using several websites or applications for different purposes, you may just use one.
What kind of info does open banking “open up”?
The world is already accustomed to the idea of crypto exchanges, wherein every transaction is both private and public. There are three main areas that are “opening up” as a result of open banking: account data, product data, and payment initiation.
Bank records
What you'd expect from account information. Items like:
- Name of Account Holder
- Type of Account
- Currency
- Opening Date of Account
- Details about a transaction (cost, sellers, and so on)
Specifics on the Item
The goods and services that a financial institution provides are the subjects of product data. To learn about the services a bank offers its customers, for instance, you formerly had to physically visit the institution. You can contact them now via phone or, preferably, through their website.
With open banking, however, this data is standardised and made more accessible, allowing third parties to better recommend products and services that fit your needs. (Imagine if your bookkeeping program suggested better banking options and alerted you when the time was right to switch.)
Commencement of payments
Transferring money from one bank account to another is the essence of payment initiation. Open banking allows this process to be initiated by other software, applications, or websites, rather than requiring the user to log in to their online banking service and go through each stage of the payment procedure by hand.
It's also possible to expedite the process, but only with the account holder's permission.
The beneficiary of the money also stands to gain significantly. You can only imagine the number of incorrectly referenced “electricity” payments received by a huge utility provider. The solution to this problem is open banking.
Pros and Cons of Open Banking: The Verdict
TTLDR: i) Convenience, ii) Save money, iii) Personalisation, and iv) Better ability to make choices.
What you might expect in the future:
- Financial accounts of any kind — (Checking, savings, retirement, etc.) may be seen in one consolidated summary.
- Improved accessibility — Not everyone has access to benefits like low interest rates on loans. Some claims could even be flat-out refuted. But now, thanks to improvements in banking data access, those who have been previously excluded will be able to use a wider range of financial services.
- Expect more “robo-advice” — And other forms of automation as financial data becomes open and available in a standardised fashion, as well as the automation of presently manual operations.
Open Banking is a trend that is gaining popularity in the banking industry worldwide (related: best EM funds). Online banking has become more popular, providing several advantages to customers, organisations, and financial institutions.
However, these advantages are not without their costs. Let's go through the upsides and downsides of open banking so you know what to expect from your online banking and what to watch out for.
Open banking is revolutionising banking in the European Union. Consumers may now choose whether third parties, such as fintech startups, have access to their financial data according to new regulations. The hope is that increased rivalry and freedom for new ideas would speed our progress towards cashless societies and cheaper banking fees.
However, there are many who disagree with the concept, such as Mick McAteer of the Financial Inclusion Centre in the United Kingdom. He told BBC News in 2017 that it was a “daft idea” that may lead to customers being taken advantage of.
Consumers could actually come out worse off with open banking, according to studies by Zhiguo He of Chicago Booth, Jing Huang, a postdoctoral primary researcher at Booth, and Jidong Zhou of Yale.
Conventional financial institutions act as data gatekeepers for their clients. A freer flow of information would increase competition between banks and fintech firms, which have pioneered automation and innovation in financial services including lending, trading, advice, and digital currencies.
Customers may benefit from increased bargaining power if they have the option to share their data more broadly. Bank records could be transferred easily, costs could be reduced, and new forms of creativity might be unlocked. Banks are being pushed in this way by new EU regulations that require them to modify their back-end systems to facilitate data exchange.
