Open Banking Brings Opportunity… and Risk

With the rise of fintech, challenger banks, peer to peer lending, buy now pay later providers and so much more, the banking industry has experienced more change in the past 10 to 20 years than it had in the previous 200. It sometimes seems to be in a state of constant revolution, with legacy brands struggling to keep pace with technological advancements and changing customer demands. And there is no let up, with a whole new wave of change now crashing over the industry, in the form of open banking.

With open banking, customers will have more control over their own financial data, and banks will be better able to respond to changing customer and market needs. It presents a great opportunity – one worth upwards of $128B by 2030, according to recent research.?

But with every opportunity comes risk, and financial institutions need to plot a careful course to balance their desire to offer competitive services to tech-forward customers, with the need to manage much higher levels of risk.

What is Open Banking?

Open banking is a concept that allows customers to share their financial data securely with third-party providers such as fintech companies or other banks. This is made possible by the use of APIs (Application Programming Interfaces) that enable these third-party providers to access customer data from different financial institutions.

Open banking is intended to increase competition in the banking sector, drive innovation, and improve operational efficiency.

A key benefit of open banking for customers is that it allows them to manage their finances more easily and efficiently, because they can access all their accounts in one place. They can also authorize third-party providers to make payments on their behalf, which helps streamline the payment process.

It is this removal of friction from the process that appeals so much to the modern banking customer – research suggests that some 56% of U.S. banking customers view open banking as a “must have”.

But there are many other advantages that make this such an attractive revolution, not least for the banks themselves:

Open Banking Enables New Business Models

One of the most exciting aspects of open banking is the potential it has to enable new business models for financial institutions. With access to more customer data, banks can create innovative pay-per-use services that are tailored to each individual customer's needs.

For example, a bank could offer a pay-per-use insurance service that charges customers only for the days they actually use their car. This model would be particularly attractive to those who do not drive frequently, would like more control over their spending, or are part of the emerging class of car sharers.

Open banking also allows banks to provide personalized financial advice based on a customer's total spending habits and credit history. By analyzing this data, banks can offer customized investment plans or suggest ways for customers to save money.

The opportunity is there for legacy banking brands to provide the kinds of personalized services that have made so many fintech challenges so successful, and perhaps regain some of the ground they lost.

The Impact of Open Banking on SMEs

Business banking customers also stand to benefit from open banking.

Small and medium-sized enterprises (SMEs) are the backbone of many economies around the world. However, these businesses often face challenges when it comes to accessing financing from traditional banks.

Open banking has the potential to change this, by providing SMEs with more options for financing. With access to a wider range of financial data, third-party providers can use advanced analytics to assess the creditworthiness of SMEs more accurately. This can help SMEs secure loans or other forms of financing that they may not have been able to access through traditional channels.

Open banking can also help SMEs manage their cash flow more effectively. With real-time access to financial data, SMEs will be empowered to make better decisions about when and how to invest in their businesses. This can help them grow and expand, creating more jobs and contributing to economic growth.

Open Banking and Financial Inclusion

Beyond these clear customer benefits, open banking also has the potential to increase financial inclusion and provide access to underserved communities.

Historically, people living in low-income areas or those with poor credit scores have been denied access to traditional banking services. This has forced them to rely on alternative financial services that may be more expensive and less secure.

Open banking can change this, by providing a platform for innovative fintech companies to develop new products and services that cater specifically to these underserved communities. By leveraging open APIs, these fintechs can access customer data from multiple sources, analyze it, and create tailored financial solutions that meet the unique needs of each individual.

Moreover, open banking can help reduce the cost of financial services by increasing competition in the market. With more players vying for customers' attention, banks will arguably be forced to lower their fees and offer better rates in order to remain competitive.

Sounds great, doesn’t it?

But such a seismic shift in the highly regulated banking industry does not come without challenges.

Challenges with Implementing Open Banking

One of the biggest hurdles financial institutions face is dealing with legacy systems and data silos.

Many banks still use outdated systems that are not designed to be integrated with third-party providers. This can make it difficult to share customer data securely and efficiently. Additionally, some banks may have data silos where information is stored in separate databases or applications, making it difficult to access and share information across different departments.

A key challenge in the U.S. specifically is the lack of a unified regulatory framework, an issue not faced by banking counterparts in theU.K., Australia and other parts of the world to which we may look.

Regulators, financial institutions and fintech companies will therefore need to work together to develop clear, common guidelines and standards for data sharing.

But the common thread that runs through all of this is that of increased risk.

With customers' financial data being shared among different institutions and third-party providers, there is inevitably an increased risk of cyber attacks and data breaches. The security of APIs that enable data sharing differs from that of traditional web applications, creating new vulnerabilities.?

Quite apart from the increased vulnerability to breaches, banks must also take steps to ensure they remain compliant with relevant data protection regulations. The General Data Protection Regulation (GDPR) in Europe, the California Consumer Privacy Act (CCPA) in the United States, and similar regulations in other parts of the world have placed greater emphasis on protecting customer data privacy, and open banking brings more complexity to this – and greater risk.

To mitigate this risk, banks and other financial institutions must implement strong risk management and compliance policies when adopting open banking. This includes conducting regular security audits to identify vulnerabilities in their systems, as well as implementing multi-factor authentication methods to prevent unauthorized access.

Moreover, financial institutions must be willing to invest not just in open banking, but in new technologies and systems designed to monitor, manage and mitigate the risks that come with it, and ensure continued compliance.

By implementing strong risk management and compliance policies, banks can not only mitigate the risks associated with open banking, but also build trust with their customers by demonstrating their commitment to protecting their sensitive information, and so take full advantage of the opportunity.