The world has been churning the Open Banking mill for years, and India recently joined the bandwagon. The Indian government set the scene for the Open Banking system with the advent of UPI in 2016. However, in the last two years (post-pandemic period), the nation witnessed an extensive acceptance and adoption of Open Banking in the BFSI sector, fast-tracking fintech innovations. This feat is directly proportional to the government’s nationwide campaigns that include the roll-out of IndiaStack, the launch of scalable Open Banking initiatives by banks, and improved funding to Banking-as-a-Service platforms. Today, India is at the forefront of Open Banking with a market size of around 3 to 4 million customers and is expected to grow by 46% by 2026.
What is Open Banking?
Open banking is a new-age banking practice that provides Third-party Service Providers (TSPs) open access to consumer and financial data from banks and Non-Banking Financial Companies (NBFCs). It uses Application Programming Interfaces (APIs) to converge data from the banking world with the rest of the financial universe.
It is imperative to note that financial data is made accessible to TSPs only after explicit customer consent. Thus, customer data is transparent yet secure and accessible anytime.
Expected to hit $48 billion in 2026, open banking has accelerated technology innovation and adoption. It has facilitated a level-playing ecosystem via data portability and interoperability across the country. As trailblazers in enabling open banking ecosystems, fintech firms are aggregating data from various financial institutions and giving people and businesses more freedom in leveraging financial information.
Open banking helps personal finance businesses analyze spending habits and offer personalized product
recommendations. Lenders can comprehensively view customer’s financial situation, assess risk levels and offer optimal account terms. Customers can also leverage open banking to understand their financial situation before making financial decisions. By providing a window into customer behavior and expectations, open banking helps reshape customer experience and frictionless commerce.
Before we go further, let’s explore the roots of open banking.
Origin of Open Banking
The concept of Open Banking dates back to the 80s in Europe. Fast-forward to 2007, the arrival of a Payment Service Directive 1 (PSD1), harmonized payment services regulation and increased competition among financial service providers in the EU.
The primary aim of PSD was to harmonize consumer protection with the rights and obligations of payment service providers and users. It established an integrated payments market that offered best-in-class security and infrastructure to the end users. PSD also allowed countries to include sections that are explicitly valid for their payment industry. It was released as legislation on November 1st, 2009, and accepted by all EU and EEA member states.
However, even though PSD offered a comprehensive framework, it was not inclusive when considering international payments outside the European Union (EU). Furthermore, it was not designed for TSPs in its scope.
These bottlenecks led the EU to build a more robust framework for this directive, which resulted in Payment Service Directive 2 (PSD2). It came into force on January 13th, 2018 with new rights for certain third-party providers (TPPs) to directly access online payment accounts with explicit customer consent through the bank’s dedicated interface (built on APIs).
Customer authentication is the main element of PSD2, and it encompasses the following points:
- Strengthen customer trust by deploying the highest standards of security
- Offer a better pricing model to the consumers
- Make transactions safe and secure
- Level the playing field for payment service providers for both current upcoming players
- Transparency in payment services
Since this legislation has been out and about, many fintech, merchants, and tech players have been vigorously channeling their resources in becoming TPPs. PSD2 categorizes the TPPs into two categories.
1. Payment Initiation Service Providers (PISPs): Regulated TPPs can initiate payments directly from the customer’s accounts based on their explicit consent.
2. Account Information Service Provider (AISP): Regulated TPPs who access customer data and provide them a single view of all their accounts for better financial management. Even this action requires the customer’s explicit consent.
PSD2 laid the groundwork for open banking, a practice that is very relevant, safe, quick, and easy to use.
Need for Open Banking
The world of financial services is a dynamic environment. It can be primarily ascribed to the rise of new technologies in the digital banking ecosystem, heightened regulation scrutiny, and constant change in customer behavior and expectations. Besides these, the relentless search for a sustainable service model for underserved markets and additional revenue streams also define the landscape of financial services. In addition, FIs are obliged to stay compliant, manage costs, and maintain security and trust, and governments look for ways to boost innovation and competition across the banking sector.
To manage complex customer needs and drive innovation and opportunity far beyond banking, the financial services industry needed to break through the conservative wall around the customer’s financial data. Thanks to PSD2, banks and fintechs can now make the data useful and relevant.
It now serves as the key to enhancing collaboration between financial services providers, rendering superior products and services for customers, reducing risk, pursuing strategic growth opportunities, and adapting to the new-age banking ecosystem.
Closed Banking Vs. Open Banking
How do APIs work in Open Banking?
APIs are the backbone of Open Banking infrastructure for two reasons.
- It facilitates the exchange of information between two financial parties
- It offers secure interoperability that is compliant with region-specific laws and regulations
The world of finance sees it as an open source platform that allows legacy financial institutions to collaborate with modern age fintech platforms.
With APIs at the forefront, customers will get a consolidated view, and financial providers such as lenders will get the required data to make the right decisions. This empowered banks and FIs to revamp their products and services to meet ever-changing customer needs.
The APIs can be classified into three categories:
- Public APIs are the most popular connectors for open banking. They give TPPs access to customer information from the bank, but they don’t store or save that information for later use.
- Partner APIs are specific APIs designed to allow the exchange of data between two companies or businesses. They facilitate vendor-to-vendor communication channels.
- Internal APIs are proprietary APIs used by an organization to secure and manage its own database.
Use Cases in Open Banking
Financial Services
Open banking is all set to reinvent the way financial services are now perceived. The highlight of this reinvention is that they do not intend to eliminate the players but give them a new avatar. In simple terms, there is no customer data without banks.
A bank’s responsibility is to provide the necessary platform for its customers to have their pick of the services. As fintechs are now offering that choice, banks are pressed to reinvent and partner with these new age fintechs to retain the competitor status. Today, several leading banks have formed successful partnerships with fintechs to offer the following services.
- A comprehensive view of core banking accounts
- Payment services and choice of networks
- Commercial and personal loan histories
- Tailored investment portfolios
- Native bank apps and enriched experiences
Small businesses
Akin to individual customers, small business owners can use open banking to gain insightful visibility into their financial management. They will be able to understand the realities and ripple effects of their financial decisions such as loans, mortgages, and expansions. Small business owners can leverage the understanding to improve their cash flow. Likewise, lenders can devise practical loan offerings with an expedited delivery timeline to meet business needs.
Insurance
Insurance providers can access a complete, dynamic, and current portfolio of the applicant’s finances. They can use the data to draw sound insurance decisions that matches the client’s best interest and business profitability. The customers also get an unparalleled view into spending behavior resulting in diligent financial decisions.
Customers
Open banking is all set to provide customers with a supermarket aisle experience where they can pick and choose the financial products they want. This tailored experience offers several advantages to new-age customers as listed below.
- Augmented account visibility and security
- In-depth visibility into spending habits and behaviors
- Instantaneous access to market investments
- Interoperable online and physical payment options
Challenges in Open Banking
Open banking removes interpersonal relationships between the customer and the bank. As everything is handled digitally, the human connection takes a dive.
Customers might not be willing to share their details, and there could be a lack of apathy/credibility from the customer. Convincing them about the benefits and converting them into leads might take a while.
Security concerns play a huge role in this field as it is a relatively new field, and it is filled with many trial and error situations that are yet to happen.
Opportunities in Open Banking
The open data philosophy will improve the transparency and democratization of the banking platform. It will provide access to the credit deprived and also facilitate entry into foreign markets. The most important benefit of all would be the ideation and creation of apps that will be fielded in the market by upcoming fintech players. Tools like Artificial Intelligence and Machine Learning will be able to predict solutions based on customer spending habits. Automation will be a game changer for many services.
Intrigued about the forthcomings of open banking and financing?
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