Evolution of Banking

Life systems are created by the unique bonds formed by the matter. Certain configurations paved the way for exchange of energy between them in an orderly fashion.

For that matter, any sustainable system has this feature of exchanging value among its participants and an ability to handle entropy and a circular property to keep the system in a perpetual motion. Banking system is not an exception to this nature!

According to Wikipedia, a bank is?a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans.

The purpose of banking system is to ensure cash flow in the market, and it manages the flow of money between people and businesses.

The evolution of banking can be divided into following main phases:

The Early Years - The first banks were established in ancient times, when people began to store their money in safe places. These early banks were often run by religious institutions, such as temples.The first prototype banks were merchants who gave grain loans to farmers and traders who carried goods between cities around 2000 BCE in Assyria, India and Sumeria. Temples and palaces served as secure repositories for wealth and valuable goods, providing rudimentary banking services such as safekeeping, lending, and currency exchange.

Middle Ages : During the Middle Ages, banking activities expanded with the rise of trade and commerce. Merchants, moneylenders, and early banking families such as the Medici in Italy established banking institutions and conducted financial transactions, including money lending, investments, and letter of credit services.

Emergence of Modern Banking (15th - 18th Century) : The Renaissance period witnessed the emergence of modern banking practices. Banking institutions like the Bank of Amsterdam (1609) and the Bank of England (1694) were established, introducing concepts such as central banking, fractional reserve banking, and the issuance of banknotes.

Industrial Revolution and Banking Expansion (18th - 19th Century): The Industrial Revolution brought significant advancements in technology, transportation, and manufacturing. Banking expanded alongside these developments, facilitating the financing of industrial projects, supporting the growth of global trade, and enabling the establishment of joint-stock companies.

Branch Banking and Spread of Networks (19th - 20th Century): In the 19th century, banks began establishing branch networks, allowing them to serve customers across different geographical locations. The spread of railways and telegraph communication further facilitated the growth and coordination of banking operations.

Electronic Banking and Computerization (Late 20th Century): The late 20th century saw the advent of electronic banking and computerization. ATMs (Automated Teller Machines) were introduced, enabling customers to conduct basic transactions independently. The development of online banking platforms and the internet allowed customers to access banking services remotely.

Fintech, Neo Banking : The rise of financial technology (fintech) has disrupted traditional banking models. Fintech startups leverage technology to offer innovative financial services, ranging from payment solutions to lending platforms.

Neo banking, also known as digital banking or challenger banking, refers to a new wave of financial institutions that operate primarily online and deliver banking services through digital channels. Unlike traditional brick-and-mortar banks, Neo banks are built with a strong focus on technology, user experience, and innovative features.

Key characteristics of Neo banks include:

1. Digital-First Approach: Neo banks prioritize digital channels, offering mobile applications and web platforms as the primary means for customers to access and manage their accounts. They often provide a seamless and user-friendly interface, enabling customers to perform various banking activities conveniently.

2. Minimal Physical Presence: Neo banks typically do not have physical branch locations. Instead, they leverage technology to provide banking services remotely, reducing overhead costs associated with maintaining a physical network.

3. Customer-Centric Experience: Neo banks aim to deliver a customer-centric banking experience, focusing on personalization, simplicity, and transparency. They often provide real-time transaction notifications, spending insights, budgeting tools, and other features that empower users to have better control over their finances.

4. Agile and Innovative: Neo banks prioritize agility and innovation, leveraging emerging technologies to offer unique services and features. They may integrate with third-party fintech platforms, provide open APIs (Application Programming Interfaces) for developers, and explore partnerships with other companies to expand their service offerings.

5. Specialized Services: Neo banks may focus on specific customer segments or niche markets. Some Neo banks specialize in serving freelancers, small businesses, or underserved communities, offering tailored products and services to meet their unique needs.

6. Collaboration with Traditional Banks: While some neo banks operate independently, others collaborate with traditional banks. They may partner with established financial institutions to offer banking services using the partner bank's infrastructure or banking license.

7. Regulatory Compliance: Neo banks, like any other financial institution, are subject to regulatory requirements and must adhere to applicable banking regulations and consumer protection laws. They may obtain necessary licenses or partner with regulated entities to ensure compliance.

Neo banks have gained popularity due to their user-friendly interfaces, competitive offerings, and innovative features. They often aim to address pain points associated with traditional banking, such as cumbersome processes, high fees, and limited accessibility. However, it's important to note that the specific features and services offered by Neo banks may vary, and customers should research and evaluate each Neo bank's offerings before choosing one that aligns with their financial needs and preferences.?

Open banking is a term that refers to the practice of providing third-party financial service providers with open access to consumer banking, transaction, and other financial data from banks and non-bank financial institutions through the use of application programming interfaces (APIs). Open banking aims to increase competition, innovation, and transparency in the financial sector, as well as to offer more choices and better services to consumers.

History of Open Banking - The concept of open banking has been evolving for decades, but it gained momentum in the 21st century with the emergence of new technologies, regulations, and consumer demands. Here are some key milestones in the history of open banking:

1980 - The first online banking experiment was conducted by Deutsche Bundespost (German Federal Post Office) with five external computers and 2,000 participants.

1998 - The Home Banking Computer Interface (HBCI), an open standard for electronic banking, was launched in Germany.

2007 - The first Payment Services Directive (PSD1) was adopted by the European Parliament to harmonize payment services regulation across the EU and to foster competition and innovation.

2013 - Sofort, a German online payment service that used screen scraping technology and HBCI, was acquired by Klarna for around $150 million.

2015 - The revised Payment Services Directive (PSD2) was adopted by the European Parliament to further enhance consumer protection, security, and access to accounts by third-party providers.

2016 - The UK Competition and Markets Authority (CMA) ordered the nine largest banks in the UK to implement open banking by January 2018.

2018 - The UK Open Banking Implementation Entity (OBIE) launched the Open Banking Standard, a set of specifications and guidelines for enabling secure and interoperable data sharing and payments between banks and third-party providers.

The Financial Data Exchange (FDX) is driving open banking adoption in the U.S. and Canada by providing standard tools for secure and reliable consumer data access. According to their website, FDX is a non-profit, international technical standards body working to align the industry around one common, interoperable, and royalty-free API data standard called FDX API.?

2020 - The European Banking Authority (EBA) issued guidelines on the conditions for granting exemptions from contingency mechanisms under PSD2, which require banks to provide fallback access to third-party providers in case of technical failures or unavailability of APIs.

2021 - The OBIE reported that over three million UK consumers and businesses were using open banking-enabled products as of January 2021, a growth of 77% since August 2020.

2023 - There are already 53 million consumers using FDX API for data sharing, according to?FDX reporting?in April 2023. Also, UK achieved 7 million Open Banking users milestone.

Open banking APIs are the key enablers of data sharing and payments between banks and third-party providers. They are software interfaces that allow different applications to communicate with each other securely and efficiently. There are different types of open banking APIs, such as:

Account access APIs : These are APIs that allow third-party providers to access information about financial accounts held by consumers or businesses with banks or non-bank financial institutions. They can include balance inquiries, transaction history, account details, etc.

Payment initiation APIs : These are APIs that allow third-party providers to initiate payments from financial accounts held by consumers or businesses with banks or non-bank financial institutions. They can include single or recurring payments, domestic or cross-border transfers, etc.

Consent management APIs : These are APIs that allow consumers or businesses to grant or revoke their consent for third-party providers to access their financial accounts or data or to initiate payments on their behalf. They can include authentication methods, consent scopes, expiration dates, etc.

Other APIs : These are APIs that provide additional functionalities or services related to open banking, such as identity verification, fraud prevention, customer support, etc.

Next Wave : The new world order is inching towards “Digital values”, “Openness” and “Algorithmic Trust”, a whole new level parallel to the existing domains. AI and Chips going to be the undercurrents for the applications of the banking system. We saw banks from Brick-and-Mortar to the Digital in the 20th and the early 21st century. In the mid part of 21st century banks will transform to “invisible” but ubiquitous, with the embedded finance, voice banking, internet of things and banking as a service.

References -
https://www.openbanking.org.uk
https://en.wikipedia.org/wiki/History_of_banking
https://www.investopedia.com/articles/07/banking.asp
https://www.forbes.com/advisor/in/banking/what-is-a-neobank/#:~:text=Neobanks%20are%20digital%2Donly%20banking,lot%20of%20time%20and%20effort./