Open banking is a banking policy that allows third-party financial service providers to access consumer banking, transactional, and other financial data from banking and non-banking financial institutions through Application Programme Interfaces (APIs).
This practice has the potential to shape the consumer’s experience of banking services. Under open banking, banks enable access and control of consumers’ personal and financial information to third-party service providers such as fintech startups and online financial service vendors.
Let’s first understand the promise of open banking.
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The Promise of Open Banking
Open banking is a force driving innovation in the banking industry. By using networks instead of centralization, open banking can help financial services customers to securely share their data with other institutions.
An open banking API will be able to look at a consumer’s transaction data to identify and suggest the best financial products and services to them, based on their spending habits, interests, and needs. With networked accounts, open banking will help lenders get a clearer picture of a consumer’s financial standing and risk-taking capacity to offer more profitable loan terms to them.
An open banking app would provide a more reliable picture of a customer’s financial situation than any guidelines currently available. As a major plus for customer experience, open banking will push established bigger banks to be more competitive with smaller banks, ideally implying low costs, better customer service and improved technology.
The Risks of Open Banking
Areas of risk with open banking include:
- Testing and verification of APIs – Exposing several APIs without rigorous and stringent quality checks can expose data to huge risks. The validation of API endpoints, formatting, and integration testing happens during the development ad integration phase. The challenge is that the testing of Open APIs requires higher effort than is needed for their development.
- Endpoints security – Endpoints can remain insecure and vulnerable, posing serious security threats. Valid API formats are necessary to protect the security of third-party APIs, besides endpoint security activities such as monitoring and software.
- Strategic risk – The decision of whether or not to become an open bank can have several strategic implications. If a bank decides to turn its products and services into a platform for other partners to develop on, they will need to find the right partners and networks.
- Reputational risk – All banks manage the reputational risk posed by data breaches and similar incidents on the side of strategic partners. However, open banks will need to mitigate and monitor additional dimensions of this reputational risk, according to Jacob Kasoff, Head of Model Risk Management, Regions Bank.
With financial regulatory bodies and government agencies proposing independent authorities to oversee open banking standards, compliance requirements and governance, banks will need to immediately comply with PSD2 and GDPR.
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Any lag in accommodating these regulations as part of the open banking framework can explode banks to the risk of financial and reputational loss, says Sasidharan Chandran, a banking and financial services risk management consultant at Tata Consultancy Services.
Will Open Banking Reduce or Increase Information Asymmetry
The open banking movement will go beyond payments with the goal to disrupt the entire range of banking services to benefit the customers. However, several challenges exist for open banking:
- The ability of third-party providers to offer an enhanced customer journey courtesy all the available data
- The technological innovations required to manage and ensure data privacy and security
- Clarity over the ownership rights in this process of commodifying and making personal financial data accessible
- The willingness of customers to trust several companies with their personal financial data
However, there’s one area not getting enough attention – whether or not open banking will create a more transparent banking system. And, whether open banking will reduce or increase information asymmetry between customers and financial services companies.
At the bank level, relationship banking has been core to mitigating the bank’s exposure from this imbalance in information and avoiding as much as possible costly decisions to extend banking services and products to problematic customers.
This relationship-based traditional banking model might break down to some degree under the open banking model as an entire range of services allow customers to easily interact with multiple financial services providers, given that each will have a partial view of the customer’s financial behavior.
According to Mark Cummins, Professor of Finance at the Dublin City University Business School, there is a link between information asymmetry and the banking industry’s structure, and this dynamic needs further consideration in an open banking environment.
On the other hand, open banking might reduce information symmetry through better analysis and processing of raw personal financial information, and customer’s willingness to permitted access to this rich data to benefit from tailored and cost-effective financial solutions.
Surely, there is a lot of hype around open banking. But, over the coming years, we might get to see traction around use cases in the lead markets that will drive greater competition and more fast-paced adoption in other markets.
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