Open Banking Meaning Example Risks How It Works

Open Banking Meaning

These third-party applications help customers manage their accounts and make transactions, among other services. Because of its regulatory, collaborative, and competitive nature, open banking enables secure interoperability in the banking industry. However, the banking information exchanged could have positive and negative implications.

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Key Takeaways

Open banking enables other companies to see consumer information with permission. It is an initiative that started in Europe and spread around the world.This innovation helps clients access new apps that may help them with services like loans, accounting, investing, etc.Several banks such as Barclays, BBVA, and others provide these solutions. It is also possible to find several third-party companies that created apps.Despite being useful, APIs may pose risks such as breaches or users giving out their information to malicious actors.

How Does Open Banking Work?

Banks and financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more must innovate to help their customers manage finances, make payments, etc. Also, they need to focus on improving their services to increase business revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more while giving clients access to automated accounting and streamlined lending. With its collaborative model where banking data and services are shared between different parties through APIs, it is the answer to all this.

While the technology that enabled open banking is not necessarily new, the legislation that supports it is recent. In 2007, the European Parliament devised the Payment Services Directive (PSD or PSD1). It was an important step to legalize the practice on the continent.

In 2018, the new PSD2 went into effect. It ushered in a new wave of APIs that aimed to help clients use their data for new purposes. Open banking PSD2 made this type of banking mandatory for all banking institutions operating in Europe.

Open banking essentially works by creating a channel between a bank’s information about its customers and the third parties that provide services through APIs. While the technical process will vary from bank to bank, the result is the same: the customers are empowered with their financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more.

Now, they no longer need the permission of the bank to access these details. It makes the process much smoother if they need to share data to get services.

Third parties can use this information to provide several services, such as data analysis and transaction processing on behalf of the user. APIs can only do so with the user’s permission, which reduces the risks of sharing sensitive data.

Examples

Opportunities

Like any other innovative technology, open banking online comes with a few promises. For instance:

It follows the open-data philosophy of allowing information to be restricted and shared freely via open-source software.Not only the transparency of banking information will be improved and democratized, but access to foreign markets and credit access may also be easier as people will have an easier time sharing their data.However, the main changes are in innovation. Creating apps that use that data and are not owned by banks can be a game-changer. Before open banking, only the bank could offer services for the client, as they controlled the financial information. Now, with a few clicks, any startup offering a creative service can do it as well.Companies like DueDil and Ormsby Street are good examples. But new startup prospects are only constrained by their creativity.Some possible new solutions include options that will make lending easier, tools that will use artificial intelligence to predict events based on consumer spending, an automated accounting app, for example, and much more.

Risks & Challenges

While open banking is an innovative concept that makes banking simple, it has its share of risks. However, most of it stems from the user, not from the banking entities. For example:

There is a risk of breaches using the open banking API, but the risk is not significantly higher than a data breach if the software is good. Human error is, after all, the largest reason for security breaches.Another reason why consumers may run into problems is that they might give away details about their accounts to scammers or fraudsters in general. Banks will not be victims of scams as they have trained personnel, but it is easier to fool the user.Optimally, banks should educate their clients about the best practices to protect their information. However, since most people do not have direct conversations with their banks, this form of banking is unlikely to happen.Banks tend to have a high-security standard, as their business depends on it. But a small startup companyStartup CompanyA startup can be expressed as a business in its initial phases, searching for a practical and scalable model. Often, these companies launch and market a unique idea, product, or service that in some way offers fresh benefits to the society. Reliable models aid in the rapid growth of the business.read more may not be able to pay for the state-of-the-art security protocols, being an easy victim of hackers. Also, these third-party companies may be hacked, too, and unwillingly give customer information to criminals.

Consumers can avoid most of these problems by carefully researching any company before divulging their information with them. Avoiding unlicensed companies and checking their security protocols is a good idea as well.