Why financial institutions should look to open banking

Embracing open banking can deliver new paths to faster and smarter innovation

Published August 15, 2022

By Colin Payne

On the road to open banking financial institutions have been issued a set of  rules to give consumers full control of their financial data.

This was considered a significant win for open banking as it facilitates data portability and enables consumers to easily switch financial institutions (and even non-financials), the original goal for open banking initiatives globally.

With this set of rules as guidance, the US may start to adopt open banking standards and when that happens, traditional banks will need to ensure that they’re in compliance.

In the UK, banks learned the hard way as they struggled to catch up with the regulation and become compliant – with a lack of technical knowledge which led to expensive programs on the back of the European Payment Services Directive 2 (PSD2).

The EU pioneered open banking with the advent of PSD2, which is a regulation for electronic payment services which all member countries must follow. Proposed in 2013 as an amendment to the Payment Services Directive (PSD), the goal of PSD2 was to make payments in Europe more secure through open APIs, while boosting innovation and assisting banking institutions to adapt to new technologies.

PSD2 compliance enables financial institutions to create new ecosystems and build regulated BaaS (Banking as a Service) platforms. With PSD2 in place, the EU positioned itself as the global leader for open banking. Looking forward, the EU is doubling down on these standards with a regulation on instant payments as a key new initiative in 2022.

Instant payments are electronic retail payments that are processed in real time where the funds are made available immediately for use by the recipient.

US financial enterprises that continue doing business globally will face increasing pressure to comply with relevant regulatory requirements. The UK has also made great strides in standardizing API models and frameworks to further enhance and encourage the industry to reform.

From these innovations, countries like Australia have leapfrogged and started to broaden the reach of the legislation, touching other areas of data sharing from identity to commerce… it’s exciting stuff for those of us who believe data is the key. So how can countries outside of Europe learn from this?

Tech at the heart – the first challenge

APIs are the basis for open banking, so before a bank can adopt open banking, it must first have a clear understanding of APIs and the approach they want to take. APIs are used by organisations to enhance their digital offerings by integrating and connecting the capabilities of other applications into their own. These can be exposed to specific providers or open to anyone.

As such, the advent of APIs has been critical to the explosion of the internet, especially in the case of mobile applications as they are developed for different devices and operating systems than legacy mainframes were initially designed to support.

According to McKinsey, open banking is defined as “…a collaborative model in which banking data is shared through APIs between two or more unaffiliated parties to deliver enhanced capabilities to the marketplace”.

Under this model, fintech companies can leverage the existing data from traditional banks to create their own new digital offerings for customers, in turn creating a new business dynamic.

The adoption of open banking has been slow in the US due to perceived technical challenges. There is also a hesitancy to invest in change that results in sharing information with others.

As daunting as it can be, an open banking strategy provides traditional banks with the best opportunity to rapidly accelerate their digital transformation initiatives, as well as create fintech partnerships to offer new forms of value to their consumers.

Privacy – the second challenge

It was recently revealed that the effort to bring open banking to the U.S. is stalled by privacy concerns.

The main reason being the Consumer Financial Protection Bureau (CFPB) appears to be stuck on exactly how to manage the consumer privacy and data protection issues created by open banking, especially how big tech companies will use the data.

The sharing of data has always been a given, so it came as a surprise to many when the privacy of individuals’ data was cited as the reason for opposition to the open banking proposals. For the first time, possibly ever, the rights and freedoms of the data subject were not only being considered but brought to the forefront of pivotal federal plans.

The next reasonable steps

As it plans for the implementation of open banking, it is important that the CFPB strike the same balance, demonstrated in Europe and Australia, of enabling progress, competition and business to thrive with the appropriate and adequate protection of citizens’ data rights in order to succeed. Even if the end game is improvement, coming at the expense of people’s privacy will only be met with resistance and non-support.

Executed with the right measures and framework, open banking stands to be successful both because of what it is doing for, and how it is protecting, the customer.

Embedded culture and history take time to change. The proof will be in the details of the proposals, and a standardized approach to the processing of data will realign sceptics' thoughts and opinions. Tightly defined data processing purposes, appropriate retention of the data fit for that purpose and an absence of unnecessary data proliferation will all help this cause. Big tech companies are being forced into the adoption of these principles by global legislative pressures, and this could be a good place to look for guidance for the CFPB.

The laying of legislation in this central formation means that these ‘bumps in the road’ can only be temporary. An effective, comprehensive and encompassing legal landscape is the solid foundation that’s needed. As this cross-state embracing of data privacy, and the rights of the subjects to whom it relates, gathers momentum, popularity and weight with lawmakers, consumers and businesses, the open banking concepts and technology are likely to take off exponentially.

Related: Orchestrated APIs help FIs speed up their digital transformation

Why US banks should embrace open banking

Even prior to the pandemic, research suggested that only 20% of consumers prefer to visit a bank in person. As customers become more accustomed to remote access banking, traditional banks have a definitive business need to deliver high quality digital experiences that mirror (or exceed) the in-person experience.

As traditional banks try to strike a balance between time spent delivering a new digital offering vs. how long consumers wait, virtual banks are positioned to address the modern needs of consumers quickly and reliably and suddenly start to present a viable alternative.

Traditional banks that embrace open banking can provide new kinds of digital services to customers while still using their existing systems. This eliminates the need to rip and replace systems, and they can continue to leverage decades of institutional knowledge to address business-critical issues, such as compliance and governance.

This seems the ideal hybrid – a true win-win for the traditional players who can use the technology to their advantage. After all, it takes decades to build a trusted financial institution and that’s not easily replicated by the new entrants, especially in a world of higher interest, inflation and where trust is a valuable currency in its own right!

By ensuring they can effectively meet the digital needs of their customers, traditional banks can position themselves to better compete against the uprising of FinTech's.

Preparing for the banking revolution

Every revolution has winners and losers, and the ones who strategize reactively will lose.

By embracing the sharing of banking data, traditional banks give themselves the best chance to compete in a landscape where otherwise FinTech's would take over.

As banks look to take that first step towards digital transformation, they must ask themselves, “How long does it take to actually put out a new offering on the market?”

If it’s long enough to cause frustration for their customers, they’re already losing.

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